Leaders Stay On Top Amidst Mid-Table Shuffle

BMI View: Asia's Oil & Gas Risk/Reward Ratings ( RRR s) are characterised by the following: good reward scores are concentrated in states with high below-ground potential and good demographic profiles but good risk scores are mainly found in countries that have poor resource profiles. In the upstream, with the exception of Australia, several resource-rich countries underperform in this category as a result of poorer risk scores. Papua New Guinea has moved dramatically up the upstream table, thanks to pending LNG developments in the country. In the downstream, traditional giants such as Singapore, South Korea and Japan still dominate the top, thanks to strong risk performance s from stable operating environment s . However, we warn that emerging countries are challenging their top positions and could see their overall scores improve if the domestic regulatory environment eases up.

The main themes arising from BMI's Oil & Gas Risk/Reward Ratings (RRRs) for Asia are:

  • High level of state involvement in the sector keeps industry scores low relative to other regions, as it takes a toll on Country Rewards scores and Industry Risk scores, both of which assess different facets of the level of state involvement and control over the sector.

  • Unsurprisingly, countries with large below-ground potential top the Upstream RRR tables. However, there are several countries with huge exploration potential that have underperformed. Indonesia is a case in point, as increasing signs of state intervention have led to the deterioration of its operating environment. This has in turn pushed down its Country Rewards and Risk scores.

  • Interestingly, with the exception of Australia, it is the markets with poor Upstream Rewards such as Hong Kong, South Korea, Taiwan and Singapore that show some of the highest scores in Industry Risks, which in has in turn lifted their final Upstream Risk/Rewards scores. Nonetheless, poor below-ground prospects leave them at the bottom of the regional table.

  • In the long term, we see room for Upstream Rewards to grow on the back of reserves and production growth as unconventional exploration looks set to pick up.

  • For Singapore, Japan and South Korea, large downstream capacities combined with strong operating environments have helped them maintain their high positions in our regional Downstream RRR rankings. Nonetheless, we warn that they risk losing their advantage as they come under challenge from emerging competitors, such as India and China, with larger markets and newer plants.

  • Although some of the world's fastest-growing downstream market demand is in Asia, fuel price regulation and high energy dependency in many developing markets have pushed down scores for Country Rewards and Risks. As a result, many countries such as Vietnam and Indonesia have underperformed in our downstream rankings. The continuance of high crude oil prices and fuel subsidies poses significant downside risks to the profitability of the downstream segment in developing countries.

  • Countries that top our overall RRRs perform relatively well in both upstream and downstream, though we do highlight that Australia is at risk of falling off the top as its lead with runner-up China continues to narrow.

Asia's Oil & Gas Risk/Rewards Ratings
Upstream R/R Ratings Downstream R/R Ratings Oil & Gas R/R Ratings Rank Previous
*Higher rating = Lower risk. Source: BMI
Australia 70.5 62.2 66.4 1 1
China 61.1 62.8 62.0 2 2
Vietnam 66.1 47.9 57.0 3 4
India 53.8 56.7 55.3 4 3
Japan 48.2 61.5 54.9 5 6
Thailand 52.1 55.7 53.9 6 8
Papua New Guinea 61.8 44.7 53.2 7 12
Malaysia 54.5 51.3 52.9 8 7
Pakistan 55.7 49.6 52.7 9 9
Philippines 56.7 47.5 52.1 10 5
Singapore 39.3 64.7 52.0 11 11
South Korea 33.2 60.2 46.7 12 10
Indonesia 40.0 51.3 45.7 13 13
Hong Kong 35.8 52.1 43.9 14 14
Taiwan 16.9 36.5 26.7 15 15

The Upstream Leaders

Australia has the highest overall scores in the upstream ratings. Its profile is bolstered by its good performance in Country Rewards and overall Risks, for which it leads the region by a wide region. It is an open market with a competitive environment and has relatively well-developed links to the export market in Western Australia. This has more than compensated for its less impressive showing in Upstream Industry Rewards, in which it is surpassed by Vietnam and China. Unconventional resources and underexplored regions of Australia provide further growth opportunities. However, we do warn that high costs and growing infrastructure constraints as exploration and production (E&P) moves beyond Western Australia could see its lead in the upstream narrow.

Imbalance Of Risks And Rewards
Asia Upstream Rewards And Risks Ratings

Vietnam remains second, thanks to its very strong upstream rewards thanks to good below-ground potential in its under-explored waters and above-ground certainty. Policy continuity alongside a relatively open operating environment also lends support to its overall Upstream RRRs. However, E&P in the contested South China Sea, where many of these prospects lie, poses a significant downside risk to the long-term returns of venturing deeper into Vietnamese and Philippine waters. Unconventional exploration and investment has helped China to retain fourth place in the regional table. Industry Rewards scores could be raised the next quarter as recently-announced gas price reforms are factored-in as monetary incentives to raise capital investment.

On the back of revisions in our production forecasts for Papua New Guinea (PNG), the country has seen a steep increase in its Upstream Industry Rewards. This has fed into its overall ratings, sending it four places higher to sit third in our regional upstream table. In contrast, a fall in the Philippines' Upstream Industry Rewards and higher risk of a clash with China has seen it lose its third place to PNG.

Resource-Rich Countries Hit By Country Structure

State involvement in the upstream sector continues to weigh on the RRRs of some of the most resource-rich countries. Although most oil and gas projects are licensed under the production sharing contract (PSC) model, most of them involve high local content requirements and entitles national oil companies (NOCs) to large shares in new projects. This regulatory framework has pulled down scores in Malaysia and Indonesia, despite these countries' sizeable resource base. Indonesia's score in Upstream Country Rewards could be further downgraded, if an amended law mandates a share in all contracts for temporary regulator SKKMigas - which had replaced disbanded regulator BPMigas.

Resource-Rich Countries Underperforming In Risk Category
Upstream Risk/Rewards For Selected Countries

Pakistan may have moved up the table to sixth place, but its shift is only a result of the fall in overall upstream scores by countries that had been ahead of it the last quarter. Problems plaguing the sector - particularly continued delays in key gas infrastructure developments - persist. Both India and Malaysia have seen their Upstream Industry Risk scores fall, dragging down their overall upstream performance. This is mainly a result of our downward adjustment of scores for their licensing terms and privatisation trend to reflect the slow progress we see on this front. Malaysian NOC Petronas ' warning that the state is becoming far too dependent on it for the national budget, at the expense of its ability to invest, has also hit the country's ratings for Country Risk s .

Although regulatory troubles are hindering India's short-term potential, we highlight that if they are overcome, the country could see its Upstream RRRs scores improve. In fact, the upward adjustment of domestic gas prices to nearly double that of the previous level in late June 2013 is a positive sign that could shift its Industry Rewards up the next quarter. Although prices of about US$8 per million British Thermal Unit (mnBTU) are still below international levels, this will raise the incentive for investment into the country's deepwater and unconventional resources. The country also appears to be moving ahead with a shale gas regulation. A shale gas licensing round is slated to be held by December 2013, according to the Indian Oil Ministry, the success of which will hinge on regulatory terms and favourable reform of its production sharing contracts (PSCs), which are still under review.

Asia Upstream Sector Risk/Reward Ratings
Upstream Industry Rewards Upstream Country Rewards Upstream Rewards Upstream Industry Risks Upstream Country Risks Upstream Risks Upstream R/R Ratings Rank
*Higher rating = lower risk; Scores out of 100. Source: BMI
Australia 51.3 100.0 63.4 87.5 86.2 87.0 70.5 1
Vietnam 70.0 70.0 70.0 65.0 42.6 57.1 66.1 2
Papua New Guinea 58.8 65.0 60.3 80.0 37.6 65.2 61.8 3
China 68.8 50.0 64.1 55.0 53.0 54.3 61.1 4
Philippines 47.5 80.0 55.6 65.0 48.0 59.1 56.7 5
Pakistan 46.3 77.5 54.1 75.0 30.6 59.5 55.7 6
Malaysia 55.0 60.0 56.3 45.0 60.6 50.5 54.5 7
India 56.3 47.5 54.1 50.0 59.5 53.3 53.8 8
Thailand 35.0 72.5 44.4 80.0 51.7 70.1 52.1 9
Japan 15.0 70.0 28.8 100.0 82.1 93.7 48.2 10
Indonesia 37.5 50.0 40.6 35.0 45.5 38.7 40.0 11
Singapore 6.3 50.0 17.2 100.0 73.6 90.8 39.3 12
Hong Kong 0.0 50.0 12.5 100.0 71.9 90.2 35.8 13
South Korea 5.0 32.5 11.9 90.0 69.6 82.9 33.2 14
Taiwan 15.0 0.0 11.3 10.0 67.7 30.2 16.9 15
Average 37.8 58.3 43.0 69.2 58.7 65.5 49.7

Downstream Support

Singapore has returned to the top of our downstream charts, thanks to an improved performance in overall Downstream Rewards and its top-of-the-table performance in Downstream Risks. As the oil products trading hub of the region, supported by large and sophisticated refineries, the country is well-placed to compete in the global fuels market thanks to its good physical trade and financial infrastructure networks. Other top performers include the region's traditional refining giants South Korea and Japan. Like Singapore, a mature industry coupled with a stable operating environment has boosted their Downstream Risks scores to seal their top places in the region's downstream segment.

Traditional Giants Face Emerging Challenges
Downstream Risk*/Rewards For Selected Countries

However, we highlight that these traditional leaders are under threat. With mega-refineries emerging in India, China and in the Middle East, they are coming under intense pressure from new players cutting into its traditional market share. This has been exacerbated by a weak global macroeconomic environment that is tempering global demand for oil.

In terms of Downstream Rewards, these traditional refining giants are also being eclipsed by emerging markets. Thanks to their large and still-growing domestic market for oil and gas consumption, countries such as India and China are leading the region in this respect. Domestic fuel price regulations, which have artificially depressed prices and are affecting the refining margins, are holding back risk scores for these markets.

State involvement in downstream pricing has also hit risks and rewards in other emerging markets such as Indonesia, Vietnam and Malaysia despite an expected increase in domestic consumption. Nonetheless, the Indian and Chinese markets have made up for this weakness with an active effort to develop a large refining sector that can not only meet the needs of the domestic market, but also target the export market. Chinese government policies to upgrade fuel standards and a recent reform of its pricing mechanism - to more closely align with price changes in the global market - have also created opportunities for rewards.

Room For Downstream Progress
Downstream Risk*/Rewards For China And Regional Average

Rising demand and limited domestic fuel supplies create opportunities in South East Asian countries. However, their scores are only average because there appears to be a growing risk of overcapacity in the region. While early investment is likely to pay off, later entrants into these markets may find themselves struggling not only because of oversupply in the domestic market, but also from tough competition in the wider regional market.

This could improve especially with growing inclinations towards relaxing price controls. Indonesia has made the politically difficult decision to raise fuel prices by cutting its subsidies. Malaysia's Petronas also seems to take a stronger stance against subsidies, with its chief executive calling them a 'poisoned chalice'. Even partial reform is likely to cause a significant reshuffle at the top of our Downstream RRRs table.

We can see the difficulties of the downstream sector reflected in the downstream scores of the markets. The chart below of our ratings shows that the risks associated with operating in the downstream segment in Indonesia and China are greater than the opportunities (shown by the lower score for risks than for rewards), suggesting a particularly high relative opportunity cost for these two markets.

Pricing Levels Hurt Downstream Rewards
Asia Downstream Rewards And Risk Ratings
Asia O&G Downstream Risk/Reward Ratings
Downstream Industry Rewards Downstream Country Rewards Downstream Rewards Downstream Industry Risks Downstream Country Risks Downstream Risks Downstream R/R Ratings Rank
*Higher score, lower risk. Source: BMI
Singapore 51.1 56.0 52.3 100.0 84.1 93.6 64.7 1
China 67.8 63.0 66.6 45.0 67.7 54.1 62.8 2
Australia 44.4 66.0 49.8 100.0 77.7 91.1 62.2 3
Japan 42.2 72.0 49.7 100.0 72.5 89.0 61.5 4
South Korea 37.8 72.0 46.3 100.0 81.4 92.5 60.2 5
India 50.0 70.0 55.0 65.0 53.9 60.6 56.7 6
Thailand 46.7 60.0 50.0 75.0 60.1 69.0 55.7 7
Hong Kong 32.2 52.0 37.2 100.0 67.0 86.8 52.1 8
Indonesia 51.1 56.0 52.3 45.0 55.0 49.0 51.3 9
Malaysia 51.1 46.0 49.8 45.0 69.0 54.6 51.3 10
Pakistan 44.4 56.0 47.3 65.0 40.1 55.0 49.6 11
Vietnam 45.6 50.0 46.7 45.0 59.8 50.9 47.9 12
Philippines 32.2 63.0 39.9 70.0 58.1 65.2 47.5 13
Papua New Guinea 32.2 56.0 38.2 75.0 37.3 59.9 44.7 14
Taiwan 34.4 34.0 34.3 20.0 73.9 41.6 36.5 15
Average 44.2 58.1 47.7 70.0 63.8 67.5 53.7

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