Sinopec Lays Another Block in China’s Shale Gas Foundation

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ConocoPhillips (NYSE: COP) is partnering with the second biggest Chinese oil and gas firm China Petrochemical (NYSE: SNP), otherwise known as Sinopec, to jointly work on development of shale gas resources in the Qijiang block at Sichuan Basin. The two will work together for two years to explore and develop shale gas reserves in the 3,918 square km block. While Sinopec will get a firsthand experience of working with a leading U.S firm that has expertise in extracting shale gas, ConocoPhillips is looking to tap into the growing Chinese shale gas sector. The country has already attracted Royal Dutch Shell (NYSE: RDS-A) that has planned to invest $1 billion in the country each year through its partnership with China National Petroleum Corp, the parent of PetroChina (NYSE: PTR), in a similar shale gas exploration and development venture in another block of Sichuan Basin.

In November 2012, the Chinese government conducted its second shale gas auction which was open to local and international firms. However, it received a lukewarm response from both domestic and international leading oil and gas companies. The discovery of China’s massive shale gas reserves -- the country has more reserves in just two blocks than U.S’s total reserves -- has caused several industry analysts to predict that the country would follow in the footsteps of the U.S and that Shale gas is going to rapidly change the market dynamics of China’s energy sector. But the current deal being offered by China’s government for these resources was not tempting enough for more international firms to bid on.  Most of the blocks awarded went to smaller domestic firms.

The change in China’s energy economy is not going to be as dramatic as that of the U.S. in the short term.  The former knows that it does not have the skills or technology to develop its reserves on its own and it has to rely on foreign players. At the same time, it does not want to hand over its blocks to American firms for nothing. The country is more interested in the transfer of technology and is willing to work with only those investors who are able to pump millions in FDI.

But, China’s current account surplus gives them the advantage of playing a waiting game the same way the U.S. did with its oil and gas reserves.  China’s economy is strong enough to absorb current oil prices and with the U.S. pulling back from being the world’s energy security force as its major players continue to repatriate assets and redeploy them domestically it will have less competition for central Asian, African and Middle Eastern oil and gas assets. 

Although China has set for itself an ambitious target to produce 60-100 billion cubic meters of gas by 2020 – which is about 40%-70% as much as the U.S did in 2010 – the current rate of progress suggests that it is highly unlikely that it will touch even half of its target. Even the short term target to produce 6.5 billion cubic feet by 2015 looks challenging. However, the good news is that the country has attracted three important players, ConocoPhillips, Shell and Chevron (NYSE: CVX). All three will be working closely with Sinopec for shale gas exploration and development. Sinopec clearly wants to become the biggest player in China’ shale gas sector. It does not have the necessary skills to carry out the work itself but it is aggressively trying to acquire them, which is evident in its joint ventures as well as the $2.44 billion acquisition of minority stakes in five of Devon Energy’s shale gas fields in America.

In the past six months, Sinopec has risen by 28.85% which is considerably more than its Western partners. The rise in its stock has raised its P/E to more than 11 which makes it an expensive buy at the moment.  But changes to the pricing for refined fuels in China have made refining a better business for them and this deal with Chevron will have large reverberations through the company’s future history.  China’s need for oil and oil equivalents over the next 15-20 years will rise by 50%.  Foundational moves made by SNP, CNOOC and PetroChina now are essential to that future.  This deal is one of them.  I expect we will see a few more like it in 2013 along with another block auction. 

<table> <tbody> <tr> <td> <p><strong> </strong></p> </td> <td> <p><strong>SNP</strong></p> </td> <td> <p><strong>COP</strong></p> </td> <td> <p><strong>RDS.A</strong></p> </td> <td> <p><strong>CVX</strong></p> </td> </tr> <tr> <td> <p><strong>Stock 6m</strong></p> </td> <td> <p>28.85%</p> </td> <td> <p>3.77%</p> </td> <td> <p>2.25%</p> </td> <td> <p>2.50%</p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>11.73</p> </td> <td> <p>7.12</p> </td> <td> <p>8.17</p> </td> <td> <p>8.87</p> </td> </tr> <tr> <td> <p><strong>Yield</strong></p> </td> <td> <p>2.40%</p> </td> <td> <p>4.60%</p> </td> <td> <p>4.70%</p> </td> <td> <p>3.30%</p> </td> </tr> <tr> <td> <p><strong>EPS</strong></p> </td> <td> <p>9.8</p> </td> <td> <p>8.14</p> </td> <td> <p>8.44</p> </td> <td> <p>12.19</p> </td> </tr> <tr> <td> <p><strong>ROA</strong></p> </td> <td> <p>5.10%</p> </td> <td> <p>9.79%</p> </td> <td> <p>6.90%</p> </td> <td> <p>10.25%</p> </td> </tr> <tr> <td> <p><strong>ROE</strong></p> </td> <td> <p>11.00%</p> </td> <td> <p>21.36%</p> </td> <td> <p>15.15%</p> </td> <td> <p>18.91%</p> </td> </tr> <tr> <td> <p><strong>Enterprise Value</strong></p> </td> <td> <p>$134.94B</p> </td> <td> <p>$94.01B</p> </td> <td> <p>$234.19B</p> </td> <td> <p>$202.40B</p> </td> </tr> </tbody> </table>


PeterPham8 has no position in any stocks mentioned. The Motley Fool recommends Chevron Corp. The Motley Fool owns shares of Devon Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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