CNOOC: Chinese Energy Stock Worth a Close Look

Oct.12.06 | About: CNOOC Limited (CEO)

If you thought that the oil and gas plays were a thing of the past, you may want to rethink that and look into China National Offshore Oil Company (NYSE:CEO).

Business Overview
China National Offshore Oil Company, popularly dubbed CNOOC, is engaged in the exploration and production of oil and natural gas. CNOOC has more than 2.2 billion barrels of oil equivalents in total reserves, most located inside China.

In addition to its internal exploration and production (E&P) program, the company has partnered with foreign firms to explore for oil and gas both inside and outside of China.

Competitive Advantages
China's government prevents foreigners from investing directly in China. Instead, if a foreign company wants to develop Chinese reserves, then it must partner with a local Chinese company through a production-sharing contract. This effectively means that all foreign companies wishing to develop offshore reserves in China must work with a local company like CNOOC. In the short run, this gives CNOOC a partial, government-sponsored monopoly on the Chinese offshore oil industry.

Over the next three years, China will gradually change the law to allow more foreign direct investment in the industry. The oil and gas business will also be opened up to smaller localized players. However, CNOOC will likely still retain a major advantage. By working closely with foreign firms, CNOOC has already gained significant expertise and is now considered a world-class energy firm. In addition, the company is very familiar with China's geology -- thus it will likely remain a partner of choice for foreigners.

Growth Drivers
Going forward, CNOOC's growth will be fueled by two main factors -- rising energy prices and developing new reserves. China's tremendous demand for energy being driven by increased car ownership and general economic growth and development. It's clearly one factor behind a global up-tick in energy prices over the past few years. Higher energy prices, of course, make CNOOC's reserves more valuable.

And CNOOC is also looking to expand its reserves portfolio abroad. Most recently, that's meant trying to acquire a foreign oil firm with significant reserves. Although the company's deal to buy U.S.-based Unocal fell through under political pressure, more deals are sure to be in the pipeline. CNOOC will likely grow via acquisitions in the coming years.

Valuation and Outlook
CNOOC trades at roughly nine times next year's earnings -- one of the lowest valuation levels of any major independent producer anywhere in the world. Meanwhile, the company's long-term growth rate is estimated at more than +36% annualized. That gives the stock an enticing PEG ratio of just 0.24.

Given that most international oil companies trade at a PEG of roughly 0.70 to 1.0, this stock could see a great deal of appreciation as its valuation level catches up to global norms.

Disclosure: Author has no position in CEO