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A Closer Look at CNOOC

By Peter Staas on April 6, 2012

Although less-informed elements in the US media continue to extrapolate global trends from statistics related to domestic oil demand, serious energy investors realize that rising oil consumption in China and other emerging markets has helped keep the price of crude elevated.

As you can see in this graph, the Asia-Pacific region has accounted for much of the growth in global oil demand over the past decade. (If you prefer animation to a still image, check out this awesome time-lapse video of global oil demand put together by the Energy Information Administration.)

Source: BP Statistics Review of World Energy 2011

Asia surpassed North America as the world’s leading oil consumer in 2008, with rising demand in China leading the way. In 2010 oil demand in Mainland China surged by 10.4 percent to 9.05 million barrels of oil per day, whereas US oil consumption has remained relatively flat.

Some readers might also be surprised to learn that China is also home to three of the world’s 10 largest oil companies by market capitalization: CNOOC Ltd (Hong Kong: 883, NYSE: CEO), China Petroleum & Chemical Corp (Hong Kong: 386, NYSE: SNP) and PetroChina Co Ltd (Hong Kong: 857, NYSE: PTR).

Source: Bloomberg

After my recent articles on the promise and pitfalls of shale gas development in the Mainland (see Shale Oil and Gas in China, Part 1 and Part 2), I received a number of questions about China’s three national oil companies. In this issue of The Energy Letter, we’ll analyze CNOOC’s operations and growth prospects.

Whereas PetroChina and China Petroleum & Chemical Corp have been hamstrung by their downstream operations, CNOOC Ltd–the publicly traded arm of China National Offshore Oil Corp–focuses primarily on exploration and production (E&P). CNOOC Ltd’s government-owned parent, on the other hand, operates more than two dozen subsidiaries throughout every link in the energy and petrochemical supply chain.

Between 2005 and 2010, China’s leading offshore oil and gas producer grew its hydrocarbon output at an average annualized rate of 16.3 percent, thanks to upstream projects that contributed a massive 44.4 percent upsurge in production in 2010.

Although higher oil and gas price realizations enabled CNOOC Ltd to a record RMB70.2 billion (USD11.1 billion) last year, a number of missteps and execution problems limited the upstream giant’s 2011 production growth to 0.7 percent.

Source: Bloomberg

Choppy waters damaged CNOOC Ltd’s Haiyangshiyou 102 floating, production, storage and offloading (FPSO) unit in April 2011, halting operations at four oil fields and resulting in the loss of 3.1 million barrels of oil equivalent production through July. Meanwhile, typhoon-related shut-ins lowered the firm’s annual output by another 3.3 million barrels of oil equivalent.

These operational challenges were overshadowed by persistent oil leakages at the Peng Lai 19-3 oil field, which was discovered in 1999 and entered production in 2002. Operators ConocoPhillips (NYSE: COP) owns a 49 percent interest in the play–China’s largest offshore oil field–while CNOOC Ltd owns a 51 percent stake.

Source: Upstream

Oil seeped unabated from two ConocoPhillips-operated platforms in Bohai Bay from June 2011 until the end of September, when the oil company finally stopped the leak. China’s maritime regulator forced the oil companies to completely shut down production in the field on Sept. 2, 2011.

This debacle cost CNOOC Ltd another 5.9 million barrels of oil equivalent in production and prompted the firm to lower its full-year output guidance to between 331 and 341 million barrels of oil equivalent from 335 to 365 million barrels of oil equivalent.

These operational disappointments were compounded by CNOOC Ltd’s failure to purchase BP’s (LSE: BP, NYSE: BP) 60 percent stake in Argentina-based producer Pan American Energy, a deal that became critical to boosting production in light of the firm’s operational challenges. On the year, CNOOC Ltd flowed 331.8 million barrels of oil equivalent–barely meeting the management’s updated guidance.

CNOOC Ltd’s outlook for 2012 did little to assuage investors’ concerns, with management calling for production to range from 330 million barrels of oil equivalent to 340 million barrels of oil equivalent. This disappointing forecast likely reflects ongoing questions about when Penglai 13 will come onstream and concerns about development program that includes no blockbuster projects in the coming year. That being said, an acquisition in international markets is always a possibility and could help production surprise to the upside.

Management’s current development plans include an “adjustment” project in one of CNOOC Ltd’s maturing shallow-water plays that aims to offset production declines and extend the life of the field. Three new projects offshore China are also expected to come onstream in 2012, while management also expects incremental contributions from the firm’s 35 percent equity interests in the Long Lake Canada’s Athabasca oil sands and a technical service contract in Iraq’s Missan oil field.

Although the company’s 2012 forecast calls for little production growth, management stuck by its forecast for output to increase at an average annual rate of 6 percent to 10 percent between 2011 and 2015. With much of this growth likely to come in the back half of this period–CNOOC Ltd has 16 projects in development–some analysts have expressed concerns that a disappointing 2011 and above-average decline rates on some of its domestic fields (about 80 percent of annual revenue) could hamper the firm’s ability to meet this target.

Investors should expect CNOOC Ltd’s capital expenditures to mount in coming years as the company takes the lead on its own deepwater projects, incurring higher expenses related to exploration and development.

In 2012 the firm will sink three independent wells in the Pearl River Mouth Basin offshore, where the company is drilling Liuhua 29-2-1, its first independents deepwater exploratory well. These efforts will build off Canadian operator Husky Energy’s (TSX: HSE) past successes in the area.

We also expect CNOOC Ltd to continue to add international assets both to help meet targeted production growth and gain valuable experience exploiting deepwater and onshore unconventional fields.

Although this transition into deeper waters and the addition of international assets will entail higher operating expenses, these investments are essential to growing future production.

Meanwhile, investors shouldn’t overlook CNOOC’s Ltd’s almost exclusive right to secure production sharing contracts (PSC) with international operators that drill successful exploratory wells offshore China. Chevron Corp (NYSE: CVX) is working on three wildcat wells in deepwater blocks off the Chinese coast. One of these sites reportedly encountered hydrocarbons, and further success could lead to a PSC.

Some investors will avoid CNOOC Ltd because of the firm’s lack of near-term production growth and rising operating expenses. However, those with a longer time horizon who can stomach the company’s inevitable operational slipups could be well-rewarded by its growth spurts when new projects come onstream.

Investors should also note that of the publicly traded arms of China’s three national oil companies, CNOOC Ltd alone lacks significant downstream exposure–a key advantage in a market where the government fixes domestic diesel and gasoline prices but can’t control global oil prices. We’ll analyze PetroChina Co Ltd and China Petroleum & Chemical Corp’s operations and growth prospects in coming installments of The Energy Letter.

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