The Chinese Oil Dynasty
Upstream beats downstream when the government sets quotas and prices.
China's oil and gas companies--PetroChina (PTR), China Petroleum & Chemical Corporation (SNP) (commonly known as Sinopec), and CNOOC, Ltd. (CEO)--play an important part in fueling the country's economic growth ambitions, controlling the majority of exploration, production, and refining activities. While they are in the same league with Western supermajors, we think the Chinese firms' function will remain more compartmentalized rather than integrated. Upstream growth will be realized through offshore oil exploration in the near term, with increasing efforts to increase natural gas production over the long term. Refining activities will continue to suffer losses over time, as governmental authorities balance price increases of refined products with the desire to suppress inflationary pressures. The disparity of assets among firms and the resulting roles they play in China's overall development plans will lead to very different returns for each firm, though acquisition activity could equalize these factors over time.
We favor CNOOC, Ltd. as the best positioned of the three, based on the high weighting (80%) of oil in its production mix, lack of downstream activities, and favorable market price versus our fair value estimate. We think it offers the best combination of return expectations and margin of safety. We think the shares are undervalued by about 30%. In contrast, PetroChina, which is similarly undervalued, has a production mix of 70% oil but also has significant refining operations that we believe will curtail profitability.
Robert Bellinski, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.