Just a few years ago it seemed that China’s national oil companies (NOCs) – CNOOC, PetroChina and Sinopec – could have it all:
- almost unchecked power at home,
- a monopoly over the world’s largest
- emerging market,
- carte blanche to forage anywhere to buy oil and gas properties, and
- some of the most successful IPOs in recent memory.
But the news is no longer that rosy, bringing forward the fundamental contradiction that was always present but now can no longer be ignored: What are these companies? Business entities subject to the same rules of scrutiny used to analyze mega-corporations everywhere, or mere carriers of Chinese international politics?
Piling Up Debt
China boasts the world’s largest cash reserves, $3.3 trillion as of 2012 and growing, so why is it that in public disclosures the country’s NOCs are racking up billions in debt to fund overseas mergers and acquisitions? For example, CNOOC’s (China National Offshore Oil Company) purchase of Canada’s Nexen for $15.1 billion was finally approved in February. That same month Sinopec (China’s biggest oil refiner) bought a stake in Chesapeake Energy’s U.S. shale assets for $1 billion.
China’s other oil major, PetroChina, is also in a buying frenzy. Publically traded PetroChina and its state-owned parent China National Petroleum Corp. (CNPC) have already announced plans to spend about $7 billion in the next six months on assets from Mozambique to Australia, according to data compiled by Bloomberg. (See sidebar for a listing of Chinese M&A activity over the last two years, unparalleled in the international oil and gas business.)
Here’s the take: Unlike Western oil companies, whose sole purpose is to make money, the goals of China’s NOCs are to (a) appease energy policy makers in Beijing, (b) secure as much oil and gas as possible, both domestically and overseas, and (c) supply China with the fuel it needs – with little or no regard for profits.
This fact is not lost on Wall Street, where PetroChina’s stock has taken a hit in recent months. Late last year HSBC Securities downgraded the stock from Neutral to Underweight, and in April Zacks Investment Research downgraded it to a Sell. Zacks said it expected PetroChina to perform below its peers in coming months. Hard-nosed analysis can only reach these conclusions.
The Wall Street Journal also addressed the problem recently. It said China’s three state-owned oil giants have raised billions of dollars from global bond markets in recent weeks, bringing their debt levels to multiyear highs. Analysts claim that as Chinese NOCs continue to buy assets overseas, their ability to buy big will be limited – unless, of course, the Chinese government provides the needed “grants,” which is all too possible.
In 2007 PetroChina’s debt-to-capital ratio was around ten percent, but by March of this year it had grown to 47 percent and could break 50 percent by 2015, said Neil Beveridge, Hong Kong-based lead analyst for oil and gas in the Asia-Pacific region at Sanford C. Bernstein & Co. Beveridge said PetroChina will increasingly have to make the choice between growth, dividends, or raising additional capital to fund growth. “Given the infrastructure investment over the next decade on gas, pursuit of overseas growth and unconventional growth, it seems inevitable PetroChina will have to make some unpleasant choices ahead,” he explained.
Cash flow is another problem. As PetroChina experiences lower domestic profit margins, cash flow will suffer, particularly as commodity prices flatten. In fact, the company’s cash flow from operating activities has dropped three years in a row. PetroChina is rated below average in cash flow from operations among related companies.
Interference from Beijing
China’s National Development and Reform Commission (NDRC) sets the price for fuel products at home, and the result has been particularly hard for PetroChina, whose domestic operations remain a drag on profits. PetroChina Vice President Sun Longde said in March that government price controls dampened his company’s margins, especially for natural gas. The company’s natural gas and pipeline business lost 2.11 billion yuan in 2012 compared with a 15.5 billion yuan profit in 2011.
However, on March 26 the NDRC announced that it had launched a more market-oriented domestic fuel pricing system to better reflect costs and adapt to fluctuations in global oil prices. Though it was a step in the right direction and will curb the chance for operating losses going forward, most analysts think it still doesn’t go far enough to realize full marketization. Until then, China’s NOCs, particularly PetroChina (which accounts for 60 to 70 percent of the country’s total oil and gas output) will scramble to offset weak domestic profits with more profitable product exports in addition to more overseas oil and gas M&As, funded mostly by debt.
In fact, PetroChina’s situation is forcing it to raise cash by selling some of its domestic assets. On May 31 the Shanghai Daily reported that PetroChina is set to sell minority stakes in domestic oil and gas fields and in gas pipeline projects in West China to raise cash for overseas acquisitions. Quoting an industry insider familiar with the plans, the newspaper said the pipelines offer near double-digit investment returns and that talks are taking place with several parties and could fetch billions of yuan. On May 23, PetroChina Chairman Zhou Jiping said the company needs more private capital in its domestic oil and gas businesses to relieve the financing burden.
In a sign of PetroChina’s financial plight, news broke in early May that the company may have actually tried to force the NDRC to raise domestic natural gas prices. On May 7, Xinhua reported that PetroChina’s Huabei subsidiary had restricted gas supplies to customers by 25 percent from May 2 in “an effort to urge Beijing to raise natural gas prices.” Gas customers in some provinces, including Shandong, Shanxi and Hebei, received notices about the lack of gas supplies.
PetroChina denied the allegations while Platts, reporting on the news, said the problem was worse because supply is curbed during the second and third quarters of the year when demand is typically lower compared with the colder winter months.
Yet PetroChina’s financing problems will likely worsen unless the NDRC removes fixed domestic fuel prices altogether, which will usher in full marketization, allowing the NOCs to make healthier profits and reduce their over-reliance on debt. So it seems that China, with all of its recent adventures in capitalism and associated media hype, still has more to learn before it comes full circle.
Mergers & Acquisitions, 2012-2013
May 6, 2013: CNOOC announced agreements with BG Group for the purchase of interests in the Queensland Curtis LNG project in Australia for $1.93 billion and the purchase of five million tons per annum of LNG for 20 years.
February 26, 2013: CNOOC announced that it finalized the $15.1 billion acquisition of Canada’s Nexen.
October 1, 2012: Argentine oil and gas company Bridas Corp. (jointly owned by CNOOC) and Argentina’s Bulgheroni family completed the acquisition of ExxonMobil’s Campana refinery in Argentina and filling stations in South America for an estimated $800-$850 million.
June 13, 2013: Sinopec announced it is negotiating to join a $20 billion LNG project run by Russia’s Novatek, which would be the biggest foray yet by a Chinese firm into Russia’s Arctic.
February 25, 2013: Sinopec signed an agreement with Chesapeake Energy Corporation to buy 50 percent of the latter’s share of an oil and gas reserve in northern Oklahoma for $1 billion.
December 17, 2012: Talisman Energy UK announced Sinopec has invested $1.5 billion for a 49 percent stake in Talisman’s North Sea properties.
October 15, 2012: Sinopec completed the purchase of 20 oil wells belonging to France’s TOTAL in Southern Nigeria in a deal worth $2.45 billion.
January 4, 2012: Sinopec agreed to buy a one-third stake in five Devon Energy Corp. exploratory oil projects in the U.S. for $900 million to expand its shale reserves. Sinopec agreed to pay $900 million in cash and as much as $1.6 billion to cover future drilling costs.
June 7, 2013: BHP Billiton announced the sale of its 8.33 percent interest in the East Browse Joint Venture and 20 percent interest in the West Browse Joint Venture, located offshore Western Australia, to PetroChina International Investment (Australia) for $1.63 billion.
May 8, 2013: CNPC in talks to acquire Barra Energia Petroleo e Gas, a Brazilian oil startup, for about $2 billion.
March 14, 2013: Italy’s Eni agreed to sell a 20 percent stake in Area 4 off Mozambique to CNPC for $4.21 billion.
February 20, 2013: PetroChina acquired stakes in two exploration assets in Western Australia from ConocoPhillips, which will offload a 20 percent working interest in the Poseidon offshore discovery and a 29 percent working interest in the Goldwyer Shale, onshore Canning Basin. PetroChina declined to comment on the financial details.
December 20, 2012: Calgary-based Encana Corp. announced a C$2.18 billion deal with Phoenix Duvernay Gas, a wholly owned subsidiary of PetroChina, to jointly develop Encana’s Duvernay natural-gas-and-liquids play in west-central Alberta. The deal gives PetroChina a 49.9 percent stake in exchange for an initial C$1.18 billion with the remainder payable over four years.
February 2, 2012: PetroChina signed binding agreements to buy a stake in a Royal Dutch Shell shale-gas asset in Canada and completed the acquisition of a 20 percent stake in Shell’s 100 percent-owned land and assets in Groundbirch, northeastern British Columbia, estimated to be worth just over $1 billion.
January 3, 2012: Athabasca Oil Sands exercised its option to sell its 40 percent stake in the MacKay River oil sands project in Alberta to joint owner PetroChina for $669 million.