KS Energy: Fixed charter rates lend visibility in an uncertain environment

Volatility persists in oil prices. The price of crude oil has risen more than 50% this year, hitting a high of about US$73/barrel on 12 Jun 09. The correlation between oil and equity prices has also increased significantly since the financial meltdown last September. With an unwinding of the Armageddon scenario and improving investor sentiment, global risk appetite increased. This and various concerns about the strength of the USD with the huge amount of quantitative easing underway led to a weaker dollar, fueling higher oil prices. However, crude oil price seems to be facing some resistance currently with fatigue in the equity market, falling to about US$68/ barrel two days ago.

Looking for a real demand for oil. Demand for oil ultimately depends on economic recovery, and economic indicators are showing more positive signs in general. OECD composite leading indicators point to a slower pace of deterioration in most of the OECD countries with possible troughs in countries like China and the UK. The US Conference Board leading index of consumer expectations also improved significantly from a low of 50.5 in February this year to 69.4 last month. However, a proportionate increase in the demand for crude oil and oil products seems elusive. Demand from OECD countries for oil products remains low (Exhibit 1), though some form of stabilization is expected, if leading indicators sustain their upward trend.

Fixed charter rates. Jack-up day rates have been affected by lower oil prices, but KS Energy's contracts are based on fixed charter rates, so lower spot rates are unlikely to impact the group adversely for now, unless oil prices trend significantly lower and customers negotiate for lower rates. Things should be looking better for the group's customers with the recent recovery in oil prices.

Maintain HOLD. KS Energy's fixed charter rates and existing contracts will serve it well during this downturn, but its distribution business may continue to feel the impact of reduced capital expenditure by oil companies. As the current level of oil price is still unable to induce a full recovery in overall E&P activity and markets remain relatively volatile, we maintain our HOLD rating and S$1.36 fair value estimate on the stock. However, the inventory restocking of commodities by China and possible oil speculation by institutions may contribute to higher oil prices despite soft fundamentals, which would lend support to the stock price.

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