Bullish on China Oil and Gas Play CNOOC (CEO)

| About: CNOOC Limited (CEO)

Former Goldman Sachs trader Robert Hsu who now runs Absolute Return Capital Advisors is focused on China investments. One of his favorite stock picks is oil and gas company CNOOC (ticker: CEO). While he typically avoids companies with large Chinese government equity ownership he is comfortable with CNOOC because it has a number of independent directors including Kenneth S. Courtis, Managing Director of Goldman Sachs and Vice Chairman of Goldman Sachs Asia. Furthermore, he says that geologists believe that there are huge oil reserves in the South China Sea that have yet to be tapped. Coupled with the unbelievably favorable terms set by CNOOC in its production sharing contracts Hsu sees future upside to the stock.

From a recent CNOOC 6-K:


For production sharing contracts in the PRC, the foreign parties to the contracts ("foreign partners") are normally required to bear all exploration costs during the exploration period and such exploration costs can be recovered according to the production sharing formula after commercial discoveries are made and production begins.

After the initial exploration stage, the development and operating costs are funded by the Group and the foreign partners according to their respective participating interest.

In general, the Group has the option to take a up to 51% participating interest in a production sharing contract and may exercise such option after the foreign partners have independently undertaken all the exploration risks and costs and made viable commercial discoveries.

After the Group exercises its option to take a participating interest in a production sharing contract, the Group accounts for the oil and gas properties using the "proportional method" under which the Group recognises its share of development costs, revenues and expenses from such operations based on its participating interest in the production sharing contract. The Group does not account for either the exploration costs incurred by its foreign partners or the foreign partners' share of development costs and revenues and expenses from such operations.

Part of the Group's annual gross production of oil and gas in the PRC is distributed to the PRC government as settlement of royalties which are payable pursuant to a sliding scale. The Group and the foreign partners also pay a production tax to the tax bureau at a pre-determined rate. In addition, there is a pre-agreed portion of oil and gas designated to recover all exploration costs, development costs, operating costs incurred and related interest according to the participating interests between the Group and the foreign partners. Any remaining oil after the foregoing priority allocations is first distributed to the PRC government as government share oil on a pre-determined ratio pursuant to a sliding scale, and then distributed to the Group and the foreign partners based on their respective participating interests. As the government share is not included in the Group's interest in the annual production, the net sales of the Group do not include the sales revenue of the government share oil.

The foreign partners have the right either to take possession of their allocable remainder oil for sale in the international market, or to negotiate with the Group to sell their allocable remainder oil to the Group for resale in the PRC market.

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