CEE Oil & Gas Sector Companies Update

We expect the oil price to continue its recovery, being mainly supported by the willingness of OPEC and its allies to lower their production, but also by a gradual lifting of Covid-19 related restrictions. Lack of production in Libya (due to the security situation) and a sharp decline of oil output in the USA (as a result of depressed oil prices) also help to balance the global oil market. We forecast the price of Brent to stay above USD 40/bbl in 2H 20e and reach an average price of USD 50/bbl in 2021e. According to our estimates, the global oil market could be rebalanced (i.e. demand to equal global supply) already towards the end of this year.
Since the outbreak of the Covid-19 virus, the European refining margins have been extremely volatile facing on one hand a strong support from weak crude oil prices and a widening of the Brent-Ural spread and on the other hand being pressured by a sharp weakening of motor fuel consumption (as of mid-March) and virtually the complete absence of demand for jet fuel. Thus, ARA gasoline crack spreads fell from ca. USD 7/bbl at the beginning of March to USD -2.2/bbl in the second half of April. We expect a less volatile refining environment in 2H 20e as the gradual improvement of motor fuels demand combined with preferences for holiday destinations reachable by car (rather than by plane), as well as a further reopening of regional economies should improve the overall consumption of motor fuels.
Based on the market feedback, motor fuel demand is recovering in all markets, although the speed of recovery differs from country to country. Thus, in AT, HU and SK demand for transportation fuels has almost fully recovered, while in Poland the demand is still ca. 15-20% lower yoy. Retail margins remain stronger yoy, thus offsetting the negative impact of lower sales volume, while non-food sales have also strongly recovered, which should make the segment an important contributor to earnings for players with a higher exposure to retail (e.g. PKN and MOL in our CEE coverage).
Production cuts implemented by Russian companies coupled with less availability of Middle Eastern crude and the recovery of oil demand in China made Ural crude more expensive than Brent, which is strongly impacting the refining margins of Ural-based CEE refiners. Extension of the the 9.7 mn boe/d cut by another month could keep the price of Ural at par with or even above Brent.
Inexistent demand for jet fuel is not an issue for most CEE refiners, which are technically capable of either converting jet fuel into other middle distillates or using it as a feedstock for petchem production. An exception is OMV, which has higher exposure to jet fuel (ca. 9%).
In our CEE coverage universe we favour companies with an efficient portfolio of upstream assets able to generate positive FCFs even in a low-price environment. Both OMV (BUY, TP EUR 37.0) and MOL (BUY, TP HUF 2,500) have portfolios which should return positive cash earnings due to low opex/boe, flexibility in spending on E&A and existing gas price regulation in a number of markets.
In downstream we like players which are able to quickly adapt their refining output to fast-changing market conditions. Higher diesel yields and lack of heavy fuels continue to be regarded as important competitive advantages, while exposure to petchem could provide additional flexibility in allocating refining capacity between motor fuels and petchem production. Among downstream players, we favour Lotos (BUY, TP PLN 67.0) , which has a strong exposure to diesel (56% yield) and a small exposure to jet fuel. The ongoing acquisition of Lotos by PKN could provide additional support to Lotoss share price.