Friday, March 28, 2008

Correction: Sinopec and PetroChina Likely to Participate in China's Overseas Quest for Oil

The previous article concluded that it was not very likely that Sinopec and PetroChina would participate in "China's Overseas Quest for Oil." However, this conclusion should be corrected as, from further analysis, it appears that that both PetroChina (PTR) and Sinopec (SNP) will participate in China's overseas oil quest, based on senior management's comments, as discussed below.

Sinopec's Comments Concerning Overseas Oil and Natural Gas Acquisitions:

Sinopec management has made several comments that indicate that overseas properities acquired by Sinopec Group would be transfered to the publicly listed subsidiary, Sinopec Corp (SNP). As a first example, in the First Quarter 2006 earnings conference call, the Sinopec Analyst for Citigroup Tom Hilbolt asked if Sinopec Corp would receive rights to Sinopec Group's international properties. The response by Zhang Jiaren , Senior Vice President of Sinopec Group indicated that Sinopec Corp would receive rights to overseas properties:

"As for the Sinopec Corp we haven't made our steps in the international acquisition of E&P assets, however as soon as the assets acquired by the parent company is generating stable return and risk is minimized the listed company or Sinopec Corp has the priority to buy the assets from the parent company."

More recently, a similar comment was made during the Third Quarter 2007 Sinopec Conference Call, by Dai Houliang, CFO of Sinopec Group, in a response to a question by Credit Suisse analyst Prashant Gokhale concerning Sinopec Group's ability to transfer international assets to Sinopec Corp.

"With regard to the purchase of overseas assets of the parent company, Sinopec Corp has the first right of refusal to purchase the overseas assets of the parent. But currently we have no concrete plan or proposal on that. "

In the last few months, Sinopec appears to be aiming to increase its activity in acquiring international assets. According to the article "CIC Intends to Increase Investment for Sinopec"
from the January 18, 2008 issue of the China Chemical Reporter, China Investment Corporation plans to assist Sinopec Corp in acquiring overseas assets, and specifically:

"A senior manager of Sinopec Corp. had ever expressed that the company intends to increase an investment in oil upstream business, including acquiring oil assets in overseas markets from its parent Sinopec Group. Sinopec Corp. has set its strategy to boost its oil upstream business and focus on integrated businesses with global leadership positions."

PetroChina's Comments Concerning Overseas Oil and Natural Gas Acquisitions:

On March 20, 2008, as reported by the Financial Times, PetroChina announced plans to acquire 50% of parent company CNPC's CNPC Exploration and Development, which holds most of the CNPC's oil fields abroad -- but does not include CNPC's Sudan assets, which are the subject of a campaign (Harvard, EU) to divest holdings of PetroChina by Western investors. Further, Jiang Jiemin, CNPC's and PetroChina's chairman, announced on March 20, 2008, that

"Our company now has the mission to be an international integrated energy company. We need to speed up development of overseas businesses. For our international business, the strategy is that for the existing oil fields we will stabilize production and enhance exploration for new discoveries. As for acquisitions, we will take every opportunity."

CNPC has already set a president for transferring international assets to the publicly listed subsidiary, PetroChina, as CNPC transfered 67% of its acquired PetroKazahkstan assets to PetroChina in 2006 for $US2.76Bn. The purchase price can be considered a transfer of assets in that in 2004, CNPC paid $US4.18Bn for 100% of the assets of PetroKazhkstan, so the purchase price paid by PetroChina to CNPC is actually slightly lower proportionally verses the originally purchase price by CNPC in 2004 (and it is likely that the oil assets would be worth more in 2006 verses 2004 due to the higher price of oil, which probably more than offset any depletion during the period).


The net effect of the right of Sinopec and PetroChina to participate in China's overseas oil acquisitions is to make the Sinopec and PetroChina more attractive as equity holdings, as the ability to move internationally is expected to expand Sinopec and PetroChina's reserve base substantially. Note that the author will follow up with an analysis of Sinopec and PetroChina as equity investments.

Thursday, March 20, 2008

CNOOC: Likely to Benefit from China's Overseas Quest for Oil, PetroChina -- Maybe, Sinopec -- Maybe Not

A compelling rationale for investment into China's three major oil firms is the ability to participate in China's overseas acquisition of oil and natural gas properties. "China's Quest for Overseas Oil" -- the title of a 2007 Brookings Institution report -- has been driven by China's voracious appetite for energy, and has been aided by Chinese state sponsorship and the relatively favorable attitude of many oil rich countries (particularly Middle Eastern countries) towards China verses towards the West.

Of the three listed Chinese Oil majors, PetroChina (PTR), Sinopec (SNP) and CNOOC Ltd (CEO), CNOOC Ltd is the Chinese firm most likely to directly participate in China's overseas oil quest, due to the fact that PetroChina and Sinopec's parent companies, CNPC and Sinopec Group, respectively, have complex, potentially confusing corporate structures, the net result of which removes most international oil and gas acquisitions from direct ownership of their publicly listed subsidiaries. Both PetroChina and Sinopec were set up and listed internationally in 2000 by their parent companies, CNPC and Sinopec Group, with the express purpose of developing mainly the domestic upstream and downstream sectors of mainland China. In contrast, CNOOC Ltd was expressly set up with the purpose of developing both domestic (Chinese) offshore and international properties. China National Offshore Oil Corporation (unlisted, the parent of CNOOC Ltd) holds CNOOC Ltd as its exclusive offshore exploration and production company. The history page of China National Offshore Corporation's website has more detail on this organizational structure. China National Offshore Oil Corporation also holds three other firms -- China Oilfield Services Ltd., CNOOC Engineering Ltd., and China BlueChemicals Co., Ltd -- in addition to CNOOC Limited, but CNOOC Limited holds the exclusive ability to develop and produce offshore oil and gas fields.

As such, CNOOC Limited already expressly owns oil and gas properties in Indonesia, Australia and Nigeria, and potentially -- in the author's opinion likely -- could be involved in Iran's massive Pars natural gas field, and further future international growth is likely. In contrast, the publicly listed Sinopec does not directly own any international oil and natural gas fields, while PetroChina only owns one major international oil field, the oil field assets of PetroKazakhstan, which it bought from its Parent, CNPC.

Relationship Between Sinopec Group (Parent) and Sinopec Corp (SNP, listed firm):

Sinopec Group's organizational structure can be found on its website. Sinopec specifically lists as the "Non-Listed Part" several subsidies, and probably the most important subsidiary for internationally minded investors, Sinopec International Petroleum Exploration and Production Corp (in the lower right hand corner), which is listed as a subsidiary that is expressly "non (publicly) listed." Sinopec International Petroleum Exploration and Production International Corporation has inked natural gas deals in Saudi Arabia, offshore oil deals in Angola and Australia, all of which are very promising, but due to the current corporate structure . Sinopec Group has signed an agreement with Iran for the development of the massive Yadavaran oil field (over 3.2 billion barrels of oil recoverable), but this most likely (90% probability, in the author's opinion) will not involve the listed company, Sinopec Corp, due to the fact that it is internationally based.

Relationship Between CNPC (Parent) and PetroChina (PTR, listed firm):

A similar relationship exists between CNPC and PetroChina as does that of its Southern neighbor, Sinopec Group and Sinopec Corp. CNPC directly acquires and controls oversees oil and gas properties -- the most infamous being the Sudan oil fields, which are not listed with the subsidiary firm, PetroChina. (note that if one searches PetroChina's 2006 20-F, there are no mentions of the Sudan since these oil and gas properties exist at the parent's level). To date, only CNPC has transfered only one major international oil property (PetroKazakhstan's Kuzmol oil fields) to PetroChina, through an acquisition by PetroChina, for which PetroChina had to pay CNPC over $US4Bn. It is unclear how many more properties CNPC transfered (or more exactly, will sell) to the listed PetroChina in the future.

The low level of participation by Sinopec and PetroChina in International areas does not mean, of course, that their parent firms, Sinopec and CNPC are not active in international acquisitions -- Sinopec Group and CNPC are very active internationally, as note that NPR has listed 74 major deals by CNPC and 32 deals internationally (reference: page 15 of this report by NPR). Many of the deals are of megaproject size and would be very attractive to investors. But it is not clear that investors into the listed firms Sinopec and PetroChina will benefit from such acquisitions. In the author's opinion, it is more likely that CNPC will sell overseas assets to PetroChina, as CNPC has already done so with its PetroKazakhstan assets -- to put the probability of such future sales (in the author's opinion only): 50%. Note further, that PetroChina will have to pay a price for the acquisition of the assets from CNPC -- although such an acquisition will likely be pay with by low interest loans from the Chinese government. Sinopec lacks a precedent of transfering overseas assets from its parent, Sinopec Group, so the author's opinion of the probability of the transfer/sale of assets would be approximately 20%.

Does the low probability of PetroChina and Sinopec Directly Participating in International Oil Acquisitions make them good short candidates?

The in author's opinion, no. Both PetroChina and Sinopec have substantial domestic oil and gas reserve bases -- although PetroChina's reserve base is approximately 5x the size of Sinopec Corp's reserve base, at approximately 19.0 Billion and 3.7 billion barrels, respectively) and huge domestic chemical, marketing and refining businesses. The refining businesses do have issues in that the domestic price of gasoline (Petrol) is fixed and therefore the refining segments are showing losses, but overall the businesses have shown very strong profit growth over the past 8 years, as the price of oil has increased. The Chinese government is also expected to raise the domestic price of petrol and offer subsidies to partially offset refining losses. Reserves at Sinopec Corp are expected to approximately double over the next year as Sinopec brings online its very large Puguang Gas field in southern China -- the largest gas field discovered in China's history -- with an estimated 2.0 to 3.0 billion barrels of oil equivalent of recoverable reserves.

Further, both PetroChina and Sinopec are unusual in the integrated oil majors universe in that they are both expected (with the publication of their 2007 20-F's) to be selling very close to their after-tax Standardized Measures, which is the future expected value of cash flows from sales of oil and gas, as required by FASB 69. Typically, integrated oil majors sell at large premiums -- between 100% to 300% -- to their standardized measures, due to the fact that the standardized measure does not take into account probable and possible oil reserves, and/or future discoveries of oil and natural gas, and does not account for other divisions (downstream) (although it is possible that the market is assuming huge losses within Sinopec and PetroChina's refining divisions, although a more thorough analysis of the company's refining divisions is the subject of a future article). Note that the author will publish the standardized measures once the 2007 20-F's have been published.