The Big Three in Chinese Energy
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One of the leading Chinese energy companies and the continent’s biggest refiner, China Petroleum and Chemical Corp (NYSE: SNP), also known as Sinopec Group, has decided to temporarily shut down three plants in China - two refineries with a total production capacity of 370,000 bpd and a petrochemical plant- over environmental concerns after state media reported some irregularities. This news highlights the government’s change in attitude towards environmental problems that are now being taken seriously after increasing pressure from the public. These plant closures, located in Guangdong province, are expected to cut diesel supply by 400,000 metric tons, more than 61% of the province’s total demand, and will result in fuel shortages in the region for about 20 days.
Sinopec is also working with Airbus to develop clean jet fuel in China as the airline industry aims to cut its carbon emissions by half from 2005 by 2050. Sinopec is the only Chinese company that can produce jet fuel commercially from biomass.
In the meantime, Sinopec’s slightly bigger rival and the country’s largest offshore oil firm by production, CNOOC (ADR) (NYSE:CEO), through its Argentinean joint venture, has acquired ExxonMobil (NYSE: XOM)’s refinery in Argentina and more than 700 gas stations in Argentina, Paraguay and Uruguay. The details of the deal weren’t disclosed but industry estimates the deal was worth $800 to $850 million. CNOOC’s $15.1 billion bid for Canada’s oil producer NexenCorp moved forward last month when CNOOC’s executives met Ottawa’s elected leaders in which the provincial authorities supported CNOOC’s bid, that already have shareholder approval. The company is willing to pay a 60% premium price per share, will retain the entire workforce, get a secondary listing in the Toronto stock exchange and establish its American headquarters in Calgary. Industry analysts have called this a “test” for North America that will show its willingness to open up its strategic assets to cash rich Chinese firms. The deal is expected to be decided any time now.
While CNOOC continues expanding, China’s biggest energy producer and the world’s second largest oil and gas firm by market cap, PetroChina (NYSE: PTR) has offered 10 blocks for oil and gas exploration to foreign companies; invitation only. This is a unique opportunity for foreign oil and gas firms to join in China’s upstream oil and gas development and to work with the industry leader. However, PetroChina has a history of doing most of the heavy lifting themselves and when they do enter into partnerships; it’s almost always because of the unattractive nature of the project- except in the case of Shale gas when they simply did not have the technology. In this case, the blocks are located in remote areas of Xinjiang and very little research has been done to support the investment.
From the revenues front, it appears that Sinopec has outperformed its peers by consistently improving its numbers both sequentially and annually but net income, which includes the impact of price cap, offers a clearer picture. Where CNOOC and PetroChina’s profits have remained fairly steady, Sinopec’s have fallen from $6.5 billion in H2 2011 to $5.1 billion in H1 2012 to the present $3.9 billion representing a 40% drop in one year. In H2 2012, the total refining loss extended to $3 billion from $2 billion in H1.
In fact, Sinopec Group, which is much bigger than CNOOC in terms of market cap and earns more than nine times its revenues (as shown above), is less profitable than CNOOC and this is where the impact of price caps is most evident. In the second half of 2011, CNOOC and Sinopec group generated almost similar net income but this year, CNOOC has beaten its much bigger rival.
This trend is also evident in the YTD share prices where Sinopec group has dropped by 11.5% as opposed to CNOOC and PetroChina’s rise by 16% and 5% respectively. Both PetroChina and CNOOC are continuing with their overseas acquisitions strategy while all three will be participating in the second round of Shale gas auction scheduled later this month.
Sinopec is focused on building the $5.5 billion oil pipeline that extends from Alberta to British Columbia. Earlier this year, it also got approval from the US to purchase a one-third stake in Ohio-based Devon Energy Corp for $900 million that was mainly focused towards shale gas. The company is also planning to spend $1.6 billion in drilling costs, including shale, in Alabama, Mississippi, Ohio and Michigan. Sinopec is clearly looking to expand in Shale but at the moment, it is the smallest of the three big Chinese oil and gas firms and earns most of its revenues from refining in China. Getting into drilling is a way to offset the price cap on refined fuels. But the government has finally come in support by increasing gasoline price by 6% and diesel by 6.5% in mid-September, which should help Sinopec in recovering from their massive refining losses.
The stocks of the three Chinese giants are for the long term investors and are poised to grow following the Chinese shale gas exploration, the Nexen deal, the increase in fuel prices and increase in Chinese growth numbers. CNOOC looks most attractive out of the three and has so far given highest returns to its investors while its stock has outperformed even the SPDR S&P 500 ETF (NYSEMKT: SPY) which is up 15% YTD.
As of the second quarter ending June 30th, CNOOC offered the highest return on average assets (ROAA) and return on average equity (ROAE) for the second quarter of the current year, whereas overall, the company also leads in 2011 ROA and ROE. CNOOC’s Nexen bid, if approved, will have a significant impact on the share price and looks ideal for the long term investor. All three companies have their advantages. I like SNP’s ability to raise their dividend yields even in the face of a price control mismatch and the market has it priced well. Building an O&G portfolio with any two of these three along with a U.S. bellwether like ExxonMobil which is trading at similar valuations – P/E ~9, 2.8% yield – gives an investor exposure to a broad swath of the next phase of the oil and gas bull market.
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