The Only Way Is Up For Chinese Oil Company CNOOC

A quick recap on Tuesday's thoughts - Chinese stocks still look good over the long-term, but expect a burst in the short-run from overheating. Either way, Chinese energy stocks will still excel over the rest. I have my eyes on one in particular, CNOOC Limited (CEO). Tuesday we saw its ADRs jump after HSBC raised its targets for both energy companies, CNOOC Limited and and PetroChina Company (PTR). Here are some pointers:

Chinese Energy Industry Pointers:
Pointer #1: After researching how analysts monitor the Chinese energy industry, it's interesting to find out that the Chinese oil pricing benchmark is closely linked to the Indonesian Duri and the Malaysian Tapis (information pointer: It isn't their currencies, which are the Indonesian Rupiah and Malaysian Ringgit. The Duri is crude oil produced inland on the island of Sumatrain of Indonesia. Cargo sizes range from 50 to 700 thousand barrels and are typically sold with pricing based off of the Duri (Sumatran Heavy) Indonesian Crude Price [ICP]. Meanwhile the Tapis is a key Asian light sweet crude oil produced off the coast of Malaysia).

As of the end of May 2007, Duri prices had already risen 25% while the Tapis had already risen 19% since the beginning of the year. Meanwhile, the West Texas Intermediate crude oil (another information pointer: a benchmark for crude oil prices in the Americas), also rose about 13%. Chinese prices have lagged, and if the correlations remain true, most analysts already believe that average average crude selling prices should rise to approximately US$56 to US$59 a barrel, ultimately benefiting Chinese companies like CEO and PTR.

Pointer #2: In 2007, many analysts are expecting the Chinese government to focus on energy policies that will for the most part benefit the Chinese oil companies. With the rapid growing demand for oil coupled together with a slower growing supply, one of the government's energy policies appears to be more diversification in energy sources - encouraging greater energy efficiency and the use of cleaner fuel sources. Sounds good and all, but the bottom line will also mean an increase in product prices, which again is a benefit. Further, China oil companies have been increasing their exports of oil products to foreign countries to boost profits. I'd highly doubt that such a trend can be sustained without energy shortages domestically. Analysts have also come to think that the Chinese government will try to boost refining margin through subsidies and other measures to benefit the companies. Or on the other hand, to reduce shortage problems, just do like Bush - take over countries for oil.

CNOOC Limited Pointers:
Right off the bat, CNOOC is expected to have flat growth in 2007 (approx. 7%), and stronger growth in 2008. If 2007 does grow, that would be an extra perk. But chances are, with a drop of 1.2% in last quarter's production, the rest of 2007 looks to be more in-line. With oil companies, their oil reserves are split into two, one being "probable recoverable" and the other "proven recoverable." However, most of the Chinese energy companies only have the latter (i.e. proven recoverable) on their financial statements, which neglects a lot of the potential should the potential reserves be recovered.

The market naturally has an "estimated" or "assumed" pricing factored into the share prices for this, but it's important to also note that an improper or rather conservative recovery rate would undervalue their share prices. According to J.S. Herold, in 2006 the average value assigned to the "probable recoverable" category was US$6.31 a barrel, and industry statistics show that large scale companies like CEO have the equivalent amount of reserves in both categories. A 100% recovery would boost figures by 100%, and likewise, a 50%, by 50%. Chances are, a lot of undeveloped fields are left off their assets. With CNOOC, analysts have given an estimated an extra 5% to EPS if at least 50% of the unrecorded category was factored in.

What about outside of oil? CEO also supplies other energy sources, such as natural gas. In fact, Chinese natural gas prices are priced below international averages. PTR, Sinopec Shanghai Petrochemical Co. (SHI) and CEO sell their natural gas at prices less than half of their U.S. counterparts. Thing is, as China's own natural gas supplies don't meet the targeted natural gas use at 5% of overall energy consumption, the country will have to increase its purchase. With that said, industry experts, analysts and even the Chinese government have announced that a potential annual 8% rise in the gas prices will happen - better margins again for the Chinese oil companies.

CEO closed at $102.45 Tuesday, and I see close to another 14% rise to US$115.45 in the coming months.

CEO 1-yr chart:

Disclosure: I do not own CEO, SHI, PTR or any other Chinese-related energy stocks.

Comments

[john gaats]

Thanks for the good blog! We here at the big apple tend to undervalue foreign ADRs. For example, YTD return for TM is lower than both F and GM. In most cases, it is because we don't really understand where the opportunity is coming from. TM vs. F is an exception. Please keep us updated of your findings.

[john gaats]

Can you elaborate on PTR? what is the rise potential there (if any)?