CNOOC: China's Hidden Dragon

| About: CNOOC Limited (CEO)

Investopedia Advisor submits: It's been more than a year since China National Offshore Oil Corp – CNOOC (NYSE:CEO) unintentionally ignited a firestorm of political opposition in Washington when it made its audacious US $18 billion bid for Unocal. At the time, claims that the deal constituted a "national security threat" by virtue of the fact that CNOOC was 70% state-owned, made sure that the company's bid would be unacceptable to Washington. Realizing this, the company diplomatically stepped aside and let rival bidder Chevron (NYSE:CVX) buy up Unocal.

While the bitter memory of such a disappointment may have kept the company from attempting another strategic foreign acquisition, CNOOC has nevertheless been very busy finding energy assets in places other than the floor of the New York Stock Exchange.

Last May, the company, in partnership with Husky Energy (C.HSE), announced that it had successfully discovered a massive natural gas field right in its own backyard. The South China Sea discovery contains potential recoverable reserves of 4 to 6 trillion cubic feet - about 8% of the total probable gas reserves in all of China. With its 51% stake in the discovery, which the company earned at zero cost, given its position as the national oil company in the deal, CNOOC’s own gas reserves should be boosted by roughly 44% when it books the reserves later this year.

Chances that CNOOC could experience further exploration upside in the years ahead have been significantly enhanced with the company’s decision to dramatically increase its exploration capex.

So far this year, funds spent on finding new sources of energy are up 83% vs. the previous year. In addition to offshore China, where the company holds a “free option” by virtue of the no-cost participation right it has to any discovery by a foreign partner, CNOOC also holds exploration prospects in Kenya, Equatorial Guinea and offshore Australia.

Acquiring natural gas, either by discovery or securing offshore delivery contracts, is the primary focus for CNOOC these days. High oil prices and China’s rapidly growing appetite for energy has prompted the Chinese government to implement policies designed diversify its energy requirements away from oil to cheaper and relatively more plentiful natural gas. By 2010, the government hopes to more than double the share of gas in China’s energy mix.

To meet this target, CNOOC and its domestic rivals Sinopec (NYSE:SHI) and Petrochina (NYSE:PTR) have all heeded Beijing’s call and embarked on massive construction programs to build a string of liquified natural gas (NYSEMKT:LNG) terminals up and down China’s east coast. Last month, CNOOC brought on line the first of a total of ten plants it intends to build under the program. For their part, Sinopec and Petrochina are also planning to build an additional six plants.

There is, however, a major downside to all this activity. Anticipating the increased demand prompted by all this construction, global LNG suppliers have doubled the long-term contract price. With domestic energy prices in China still heavily regulated, it’s unclear how CNOOC or the other Chinese national energy companies will be able to effectively pass on these higher prices to their domestic customers.

All this underscores the conundrum faced by any investor looking to participate in China’s booming energy sector. While companies like CNOOC have done much to fashion themselves in the image and likeness of their western counterparts, and trade at attractive discounts relative to them, majority ownership by the state continues to ensure that the company’s strategic direction remains closely aligned to national goals mandated by Beijing’s central planners – a situation that at times runs counter to the purely commercial imperative expected by shareholders.

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By Eugene Bukoveczky, Contributor - Investopedia Advisor

At the time of release Eugene Bukoveczky did not own any shares in any of the companies mentioned in this article.

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