Irrational correlation. The Singapore market continues to pin O&M plays such as Keppel Corp (KepCorp) and Sembcorp Marine (SMM) to the movement of oil prices despite the relatively distant correlation. While companies such as SPC will see immediate and direct benefits from increases in oil prices, rig builders can only hope for a stabilisation of oil prices at a sufficiently high level for Oil Majors and NOCs to initiate multi-billion dollar capital expenditures. Futures prices are currently trading in backwardation, signalling mixed views on the potential of the upward trek of oil price. Although capex may have been set aside, we caution that Oil Majors and NOCs are likely not in a hurry to jump back on the rig building bandwagon until they see a sustained and elevated price for oil that is held up by fundamental demand.

Pinning hopes on Petrobras. There has been excitement over what Petrobras can bring to Singapore's rig builders with its massive capex plans for the next five years. In fact, we believe that it is currently the only foreseeable positive catalyst that can significantly change the fortunes of Singapore's rig builders. Other NOCs and oil majors have gone eerily quiet on their capital expenditure plans. Petrobras is rumoured to be shopping for yard prices to build up to 7 drilling units in the latter half of 2009 and will also be planning to build 8 eight Floating Production Storage and Offloading (FPSO) hulls for the pre-salt Tupi development. We are estimating that Petrobras budgeted about US$500m for each FPSO hull.

Maintain NEUTRAL. KepCorp and SMM are solid blue-chips with sovereign backing, good management and comfortable cash positions. These will allow both companies to ride out the current climate. However, investors must understand that without contract wins, oil price changes will be the key daily driver for their share prices. Recent geopolitical situations, the uncertainty of increased worldwide consumer demand in the summer season and speculation have introduced accentuated volatility in oil prices. We advocate dexterity and nimbleness in trading these two company's shares should investors choose to participate. We are retaining our HOLD rating with a fair value of S$2.65 for SMM (today's US$237m contract win from Sea Dragon forms part of our forecasts of potential contract wins). Look to accumulate at about S$2.40. For KepCorp, we upgrade the stock to a HOLD rating as we raised our fair value to S$6.40 (prev. S$4.90) due to higher SOTP valuation matrices. Look to accumulate at $6.10 or lower.