Global StrategyEquity Research                         Hong Kong / China                                                  ...
April 7, 2011   Global Strategy                Investment Recommendation                                                  ...
April 7, 2011                                             Global Strategy                                                 ...
April 7, 2011                                                 Global Strategy  OPEC spare capacity off its seven-year high...
April 7, 2011                               Global Strategy                                             inventory drawdown...
April 7, 2011                               Global Strategy                                             Potentially Tighte...
April 7, 2011                              Global Strategy                                            Higher Crude Prices ...
April 7, 2011                                              Global Strategy                                                ...
April 7, 2011                                                Global Strategy                                              ...
April 7, 2011                                                Global Strategy                                              ...
April 7, 2011                                       Global Strategy                                                    Sto...
April 7, 2011   Global Strategy                margins. In addition, with its oil primarily sold to Sinopec, pricing power...
April 7, 2011                                                   Global Strategy                                           ...
April 7, 2011                                                   Global StrategyRelevant benchmarks: In North America the r...
April 7, 2011                                                    Global Strategyany securities or investments mentioned in...
April 7, 2011   Global Strategy                                                      16                Standard & Poor’s  ...
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China energy sector 110407 final

  1. 1. Global StrategyEquity Research Hong Kong / China Energy SectorApril 7, 2011 Brighter skies for oilU.S. 2011 GDP: +3.1%China 2011 GDP: +9.1% - +9.6%  S&P Equity Research analysts are positive on the outlook for the global oilWTI Oil Price 2011 Avg.: USD99 industry and are overweight the Energy sector.  Equity values of oil & gas companies under our Greater China coverage with well- positioned businesses should, in our view, rise alongside our forecasts for improved global economic growth and crude oil prices. Specifically for China, we expect 2011 GDP to grow by 9.4% and expanding by a further 9.3% in 2012. Our preference lies with PetroChina given its upstream leverage and integrated operations but we note E&P operator CNOOC Ltd should also benefit from the improved outlook. We are more cautious on Sinopec given its downstream-heavy business.  Crude oil prices have reached highs not seen since 2008, reflecting the disruption of exports from Libya and unrest in the Middle East and North Africa (MENA). The recent disaster in Japan has fueled further volatility, as Japan is the worlds third largest consumer and the second biggest importer. As of Mar. 16, using S&P revised estimates based on data from HIS Global Insight, West Texas Intermediate (WTI) spot oil prices were projected to average about USD99 per barrel in 2011 and USD96 in 2012, up from USD79 in 2010.  Higher oil prices and signs of modest utilization recovery have improved sentiment for the offshore drilling industry. However, global day rates and contract term lengths remain pressured. For COSL, we expect 2011 will see a gradual improvement in dayrates, on increased offshore China activities.This report encompasses views from:Stewart Glickman, CFA Hong Kong / China Oil & Gas Recommendations and Key RatiosAhmad Halim, CFAMichael Kay Share YTD EPS Div Bloomberg PER xLorraine Tan, CFA Company Name Price Recommend perf Growth Yield 3-Yr EPS Ticker 2011Christine Tiscareno LCY 2011 2011 2011 CAGR% 2883 HK China Oilfield Services Ltd 18.00 Buy 6.2% 14.9 11% 1.3% 17% 883 HK CNOOC Ltd 20.85 Hold 12.3% 12.5 15% 2.4% 18% 857 HK PetroChina 12.04 Strong Buy 17.7% 10.9 22% 4.1% 3% 386 HK Sinopec 7.89 Hold 5.4% 8.4 -4% 3.0% 5% Source: Factset, S&P Equity Research estimates This report is for information purposes and should not be considered a solicitation to buy or sell any security. Neither Standard & Poor’s nor any other party guarantees its accuracy or makes warranties regarding results from its usage. Redistribution is prohibited without written permission. Copyright © 2011. All required disclosures and analyst certification appears on the last 3 pages of this report. Additional information is available on request.
  2. 2. April 7, 2011 Global Strategy Investment Recommendation 2  S&P Equity Research has a positive view on the global energy sector and as of Apr. 1, 2011, we are Overweight the sector in all three regions (US, Europe and Asia).  Within the sub-industries, we have a preference for the integrated oil & gas and exploration & production companies. We see underlying strength in oil prices underpinned by improving global demand as conducive for the sector’s income performance over the near to mid term.  For Greater China, our preference lies with PetroChina, given the company’s upstream leverage, balanced integrated operations, and its status as a potential beneficiary of a long-touted gas price reform. We also like E&P player CNOOC Ltd, but given its strong outperformance YTD, we would recommend investors to buy on dips.  A quick resolution to MENA conflicts could send near term oil prices down and lead to a pullback in energy sector share prices but the improving demand outlook should provide support.  An increasingly pertinent issue for Greater China O&G stocks is rising cost pressures; given the regulated nature of China’s refined product market, pricing adjustments tend to lag increases in crude prices. This explains our cautious view on Sinopec, which we see will incur refining losses over the short-term as crude prices remain elevated.  While the US gas market remains soft, we see a more stable gas market globally, particularly with the potential interest in natural gas and LNG for thermal power generation. This follows recent worries over radiation contamination in the aftermath of the Great Tohoku earthquake’s impact on Japan’s Fukushima Daiichi nuclear power plant. Greater concern on the safety of nuclear power will also boost demand for natural gas in China, in our view, further pushing the agenda for pricing reform.  Our global views on the drilling and fabrication segments are more cautious. While the higher prices should boost confidence, capacity pressure remains on rig day rates. Still, we expect continuing strength in offshore China activity, signified by CNOOC Ltd’s +55% YoY increase in planned capex in 2011, to result in an increase in dayrates for 2011, potentially benefiting offshore services player COSL.  Risks to our recommendations and risks would come from slowdown in US economic growth that dampens the outlook for global demand. Higher than expected cost pressures that cannot be passed on will also dampen our earnings expectations. The sector is also subject to government regulatory risk particularly in the form of increased windfall taxes and heightened environmental charges. Standard & Poor’s Equity Research
  3. 3. April 7, 2011 Global Strategy Outlook: Oil Market 3 Fundamentals USD115/bbl level (Brent), indicates to us a world uncertain of itself. On the one hand, worries over a potential supply disruption from MENA remain; on theRising prices tempered by inflation other, a prolonged and significant rise in crude oil prices could ultimately pushimpact worries back the global economy into a recession and result in lower energy demand. S&P Economics thinks a USD10/bbl rise in oil prices would lower US real GDP by 0.5% after a two-year period. Oil markets tightened significantly in 4Q10… …and OECD inventories are approaching five-year average mbpd USD/bbl mbpd 5 160 2,900 4 140 2,800 3 2,700 120 2 2,600 100 1 2,500 80 0 2,400 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 60 -1 2,300 40 2,200 -2 -3 20 2,100 Jan-01 Jan-04 Jan-07 Jan-10 -4 0 Implied stock draws WTI (RHS) OECD commercial inventories Five-year average Source: EIA, S&P Equity Research estimates Source: EIA, S&P Equity Research estimates To a certain extent, we believe there is a fundamental basis for the current crudeMarket began to tighten in Sept 2010 run-up. Oil fundamentals had begun to shift as early as September 2010. As the global economy rebounded, there was a significant increase in demand for oil, especially in 2H10, but the supply response from OPEC lagged, hence pushing up crude oil prices (excluding WTI, which is plagued by high Cushing inventories). Implied stock draw for September 2010, according to data from the International Energy Agency (IEA), was the largest since November 2007, indicating a significant tightening of the global crude demand & supply. Events in MENA further aggravated the tightening market, as market participants began pricing in a risk premium on a potential MENA supply disruption. Standard & Poor’s Equity Research
  4. 4. April 7, 2011 Global Strategy OPEC spare capacity off its seven-year high… … leading to potentially the highest stock draw since 4Q07 4 mbpd USD/bbl Net stock draw, mbpd 8 160 3.0 7 140 2.5 2.0 6 120 1.5 5 100 1.0 4 80 0.5 Five-year average 3 60 0.0 1Q06 4Q06 3Q07 2Q08 1Q09 4Q09 3Q10 2Q11F 1Q12F 4Q12F 2 40 -0.5 1 20 -1.0 0 0 -1.5 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 -2.0 OPEC Spare Capacity WTI (RHS) US Other OECD Non-OECD Source: EIA, S&P Equity Research estimates Source: EIA, Bloomberg S&P Equity Research estimates S&P Global Crude Oil Price Outlook Based on a combination of data from EIA, IHS Global Insight and S&P Equity Research estimates, we expect 2011 oil consumption growth to average about 1.51 mbpd (+1.7% YoY), while 2012 oil consumption is expected to increase by 1.69 mbpd (+1.9% YoY). In 2010, much of the growth was accounted for by non- OECD countries, while the US was the only OECD country that saw significant growth. We expect this trend to continue into 2011-12, as non-OECD countries, including China, Brazil and countries in the Middle East region, are expected to lead worldGrowth to be led by non-OECD economic growth, albeit at a slower pace vs. 2010. Asia Pacific ex-Japan countriescountries, in particular China, Brazil and are likely to record GDP growth rates double that of the US and Eurozone, whichMid-East countries will remain hampered by slow consumption growth and high unemployment. OECD countries are not expected to show any significant growth in oil demand between now and 2012. Oil supply is expected to increase 0.97 mbpd (+1.1% YoY) in 2011, vs. a 2.12 mbpd growth in 2010. The slower growth is due a decline in OECD production, on2011 oil supply growth crimped by declines in Canadian and North Sea production. US production is expected to seeOECD production declines… a slight YoY contraction due to the lingering effects of the GoM drilling moratorium, while Mexico is expected to see a sharp 7.3% YoY decline in production due its ageing oilfields and infrastructure. Non-OECD production is expected to pick up the slack, with OPEC incremental production driving much of the YoY growth. OPEC production is expected to grow by 0.8 mbpd in 2011 (mainly from unregulated non-crude production such as NGL), with much of Libya’s lost oil…and aggravated by lost Libyan capacity production capacity (total production capacity of 1.8 mbpd) to be offset by Standard & Poor’s Equity Research
  5. 5. April 7, 2011 Global Strategy inventory drawdown and higher production from other OPEC members. 2012 5 production is expected to increase by a bumper 2.19 mbpd, mainly on higher OPEC production as lost production capacity in Libya come back online. World YoY demand and supply balance A tighter energy market in 2011 on mbp rebounding demand and supply shocks 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2006 2007 2008 2009 2010 2011F 2012F -0.5 -1.0 -1.5 -2.0 Incremental supply Incremental demand Source: EIA, S&P Equity Research estimates Overall, we see a relatively tight year for crude oil demand & supply in 2011, andOverall, a tight year ahead, before supply inventory drawdowns should be fairly high during the year, on Libyan productioneases in 2012 cuts and higher demand from quake-afflicted Japan. OPEC spare capacity is expected to decline to about 4 mbpd by end-2011, the lowest level since July 2009, indicating a significantly tighter market. Barring any further geopolitical disruptions, the situation should ease in 2012 as lost Libyan production comes back online and/or other OPEC countries boost supply. Our 2011 crude price assumption for WTI currently stands at USD99/bbl for 2011 and USD96/bbl for 2012. Standard & Poor’s Equity Research
  6. 6. April 7, 2011 Global Strategy Potentially Tighter Supply – Heightened MENA Risks 6 Political flare ups in the Middle East that impact supply send global oil prices upOil prices reflect supply risks and stock markets down are not new. There have been around five such major events since 1967. In fact, the big 1973/1974 stock market crash and recession was triggered in part by the Yom Kippur War that led to a mass embargo in oil exports to then Arab unfriendly states by Arab members of OPEC. For the most part, however, the shortfall in supplies is offset by other producing countries, albeit not without a significant oil price rise in the short term. We see the latest events to have a similar path in terms of impact to the market to the more recent oil supply shocks of 1990 and 2000. These had more subdued impact relative to the 1973 and 1979 supply shocks, according to economists, because of reduced US dependency on oil and the availability of stock piles. We also don’t expect political upheavals to spread to key oil producers – namely Iran, Saudi Arabia and the United Arab Emirates. Ongoing Yemeni and Syrian protest should have little fundamental impact while Bahrain is a small, albeit high quality, producer. According to a Mar. 15 report from the IEA, OPEC spare capacity was estimated at around 4.28 mbpd. Platts quotes sources as saying that Libyan production hasCurrent OPEC spare capacity may be trickled to 100,000-120,000 bpd. Libya normally produces 1.6 mbpd ofbelow 3 mbpd, lowest level since 2008 predominantly light, sweet crude or around 2% of global production. This would mean that OPEC’s EIA estimated spare capacity should now be reduced to around 2.8 mbpd from over 4 mln bpd in February, the lowest level since 2008. At the peak oil price of USD147/bbl, it was estimated that spare capacity at the time was around 1.5 mbpd. Current spare capacity, therefore, remains relatively comfortable above 2003-2008 levels. We believe current oil prices therefore reflect heightened risk of further supply shortfalls, more so than actual supply:demand fundamentals. But it should beOil prices are therefore reflecting lesser noted that OPEC excess capacity tends to be in heavy, sour crude which is not asupply flexibility, raising risk, implying direct substitute for light, sweet crude and not all refineries can adapt to takeupside to our oil price forecast sour crude. Also, oil prices are also reacting to economic data showing a stronger US demand recovery. We note that as current OPEC capacity is below our base case scenario of 4 mbpd, if Libyan production remains compromised, there may be upside to our oil price assumptions. Japan’s Great Tohoku earthquake is also likely to add demand factors in the short-mid term as the country relies more heavily on thermal power plants toDemand may also rise more than make up for the closures at some of its nuclear power plants. Platts’ sourcesexpected – Japan to import more crude indicate that they expect utility company Tokyo Electric Power Corp. (TEPCo)and fuel oil for power generation crude and fuel oil consumption to jump 60% in April from March levels. This has sent the prices of Asian burning oils – namely Minas – soaring. Standard & Poor’s Equity Research
  7. 7. April 7, 2011 Global Strategy Higher Crude Prices & the Impact on China Energy Players 7 Stronger YoY crude oil prices benefit upstream-heavy players like PetroChina andUpstream-heavy operators to benefit, but CNOOC Ltd. Despite the latter’s pure upstream exposure, and hence greaterCNOOC Ltd may see ASP dilution on leverage to oil prices, we see the impact of higher oil prices on CNOOC Ltd to beincreased Bridas contribution somewhat diluted by its Argentinian arm, 50%-owned Bridas, especially upon the consolidation of the additional 60% stake in Pan American Energy (Bridas’ main asset) purchased from BP plc in Nov 2010. We estimate Argentinian crude pricing (nett of sales tax and Petroleo Plus tax credits) to be some USD12-15/bbl below WTI prices, and this will dilute CNOOC Ltd’s ASPs from 2011 onwards, in our view. With Asian gas prices generally moving in line with crude oil (vs. depressed Henry Hub natural gas prices which are more linked to local US demand/supplyHigher international gas prices to spur conditions), and a tightening in the Asian spot LNG market as Japan deals withdomestic gas price reform? the impact of the Tohoku earthquake, we expect increasing pressure on the Chinese government to revise its pricing formula on natural gas, which at this point is fixed by government decree. Other push factors include the setting up of at least another 37.6 bl cu m annual LNG importing capacity till 2014, PetroChina’s ramp-up of gas imports via the WEP2 pipeline (the company targets to increase natural gas production to 50% of total oil equivalent production by 2015, from 30% currently) and increasing demand for the fuel (we estimate China consumed some 110 bln cu m in 2010, and this should increase to 135-140 bln cu m in 2011). Still, increasing inflationary concern is likely to be a weighty counterbalance to any potential pricing reform, which will push gas costs higher and eventually hitOr will inflationary pressures hold sway? the population via higher power, heating, fertiliser and food costs. Hence, in place of a general increase in wellhead gas price, we see the potential for a one- off subsidy by the government in 2011 to compensate PetroChina’s gas pipeline business (similar to that granted to refiners in 2008), before a long-term solution is put in place. Over the longer term, reform of the gas pricing mechanism (potentially set at the end-user level via a reference basket of alternative fuels, with a net-back formula used to calculate wholesale and wellhead gas prices, according to industry sources) will benefit PetroChina, given its dominance in gas production, and will also increase the monetisation of its unrivalled gas distribution network. The combination of higher input costs and price controls on the end product will also hit China’s refiners, although the impact will be lessened by the refinedRefining losses likely in 2011 product price mechanism currently in place. The mechanism allows for price adjustments to be made by the government based on a specified formula, but as can be seen in the two adjustments already made since the beginning of the year (including the 4.9%-5.6% increase for diesel and gasoline respectively, announced yesterday), in practice the adjustments can lag crude prices and hence depressing short-term margins. We expect both PetroChina and Sinopec’s refining arm to suffer losses this year, although we do not expect the quantum to match 2008’s losses. We expect marketing profits for China’s integrated oils to perform in line China’s economic growth, which we expect to reach 9.4% in 2011 (vs. 10.3% in 2010).Marketing and chemical profits should Chemical demand should also grow in line with the economy, although marginsgrow in line with economy may be under some pressure, due to increasing feedstock costs. Standard & Poor’s Equity Research
  8. 8. April 7, 2011 Global Strategy Higher crude prices will also boost confidence in oilfield services companies, 8 although we believe the key driver for companies such as COSL remains theHigher crude prices to boost confidence bullish prospects for offshore China. This will be driven by higher capexin oilfield services companies spending, mainly from parent CNOOC Ltd, and focusing on higher exploration work (+45% YoY increase in exploration budgets) and deepwater development. Strong M&A Environment to Continue Despite Volatility Global upstream transacted value for 2010 rose to USD228.2 bln, breaching theGlobal upstream M&A value reached a previous all time high of USD200.7 bln set in 1998, with much of the transactionsnew record of USD228.2 bln in 2010 being done at the asset level and led by national oil companies (NOCs), and mainly from China. Cross-border NOC & sovereign wealth fund (SWF) transactions reached close to USD44.2 bln in our estimates, or 19% of total global M&A transaction in 2010, while Chinese NOC’s were involved in USD24.6 bln worth of M&A deals, or 11% of the total global transaction in 2010. Given the strength in crude prices in 2010 vs. 2009, worldwide deal pricing for P2 (proved + probable) increased substantially, up 18% YoY to USD6.55/boe, basedImplied values increased in line with on data from IHS Herold. North American pricing dipped from USD16.45/boe incrude price strength 2009 to USD10.50/boe in 2010, but this was skewed by opportunistic purchases of conventional gas assets in Canada. NOC/SWF purchases driving worldwide M&A… … as implied values climb on higher crude prices USD/boe Chinese NOC 18 11% 16 Other NOC/SW Fs 14 9% 12 10 8 6 4 2 0 Other 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 buyers World US 80% Source: IHS Herold, S&P Equity Research estimates Source: IHS Herold, S&P Equity Research estimates. Values are based on 2P reserves. Despite increasing crude price and geopolitical volatility, we expect global M&AExpect continuing strength in global activity to continue to remain strong, driven by ample liquidity and cashed-upM&A in 2011 balance sheets at oil majors and NOCs, especially those with large oil exposures worldwide and/or gas exposure outside North America. Further, slow organic reserve growth and, especially for NOCs, increasing energy security concerns amidst greater resource nationalism and restricted access to acreage will continue to spur the global search for available assets. Standard & Poor’s Equity Research
  9. 9. April 7, 2011 Global Strategy 9 Global upstream M&A breaches previous record on ample liquidity USD mln 250,000 200,000 150,000 100,000 50,000 0 2011 YTD 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: IHS Herold, S&P Equity Research estimates Top 10 M&A deals by transaction value in 2010 Transaction Reserve Reserve Implied value (USD Value size value Date Buyer Seller Deal level Region bln) (USD bln) (mmboe) % gas R/P ratio (USD/boe) Sep-10 Petrobras Brazil Government Asset LatAm 42.5 42.5 5,000 0% N/A 8.50 ^ Aug-10 Vedanta Cairn Energy Corporate Asia Pacific 9.9 8.0 204 1% 12.5 39.03 * Nov-10 Bridas, CNOOC Ltd BP plc Asset LatAm 7.1 7.1 858 33% 17.3 8.23 Mar-10 AFK Sistema Sberbank Rossii Corporate FSU 6.1 4.6 1,300 0% 6.6 3.53 May-10 Royal Dutch Shell East Res, KKR Corporate United States 4.7 4.3 2,000 100% N/A 2.16 # Apr-10 Apache Corp Mariner Energy Corporate United States 4.7 3.4 181 53% 9.6 18.76 Apr-10 Sinopec Group ConocoPhillips Asset Canada 4.7 3.5 248 0% 29.5 14.02 Nov-10 Chevron Corp Atlas Energy Corporate United States 4.3 1.5 141 99% 27.9 10.33 Oct-10 Sinopec Group Repsol YPF Asset LatAm 4.3 4.0 480 25% N/A 8.24 ^ Mar-10 PetroChina, Shell Arrow Energy Corporate Asia Pacific 3.9 1.9 590 100% 183.1 3.24 * Source: IHS Herold, S&P Equity Research estimates. Reserve size and metrics based on 1P reserves, unless otherwise noted. *based on 2P reserves. ^based on contingent resources. #based on total recoverable reserves. Standard & Poor’s Equity Research
  10. 10. April 7, 2011 Global Strategy 10 Notable deals so far in 2011 Transaction Reserve Reserve Implied value (USD Value size value Date Buyer Seller Deal level Region bln) (USD bln) (mmboe) % gas R/P ratio (USD/boe) Jan-11 Rosneft BP plc Corporate Diversified 11.8 5.9 619 54.3% 9.1 9.57 @ Jan-11 BP plc Rosneft Corporate FSU 9.0 5.6 1,325 0.0% 15.3 4.26 @ Feb-11 BP plc Reliance Industries Asset South Asia 7.2 5.3 582 96.0% 17.7 9.02 * Feb-11 PetroChina Encana Asset Canada 5.5 4.4 217 92.5% 10.7 20.25 * Feb-11 BHP Billiton Group Chesapeake Energy Asset United States 4.8 4.0 400 100.0% 15.8 9.98 Mar-11 Total SA Novatek OAO Corporate FSU 4.1 4.1 1,512 91.5% 29.7 2.70 * Mar-11 KNOC Anadarko Asset United States 1.6 1.6 150 27.0% N/A 10.33 # Mar-11 CNOOC Limited Tullow Oil plc Asset Africa 1.5 1.5 333 0.0% N/A 4.41 # Mar-11 Total SA Tullow Oil plc Asset Africa 1.5 1.5 333 0.0% N/A 4.41 # Source: IHS Herold, S&P Equity Research estimates. Reserve size and metrics based on 1P reserves, unless otherwise noted. *based on 2P reserves. ^based on contingent resources. #based on total recoverable reserves. @ Transaction blocked by Russian arbitration body. Excludes CNOOC acquisition of 33.3% stake in Chesapeake’s 800,000 acre Niobrara Shale acreage for USD1.27 bln due to lack of reserve value and information. The M&A focus for 2011, in our view, will be in onshore North America, due to a number of reasons:North American onshore assets to be inprime focus  Continuing strife in the MENA region will move investments by risk-averse majors and independents away from the area. NOCs with deeper pockets and potentially higher risk tolerance (especially given energy security concerns) may see expansionary opportunities in MENA, albeit at a higher risk level and potential overall cost than previous excursions.  Similarly, ongoing regulatory concerns on the Gulf of Mexico operations will push oil majors and independents into onshore US.  Depressed North American gas prices provide an opportunity for oil majors and NOCs to snap up weaker prey in the onshore US gas market. This is a particularly attractive proposition for gas-hungry NOCs e.g. those from China, given their deep pockets, access to cheap funding, the potential to secure cheap gas for their LNG imports and their long-run bullish view on gas.  Development of unconventional plays such as tight oil/gas and oil sands are streets ahead in the US and Canada compared to the rest of the world. With increasing risk aversion on MENA plays, we believe the virtually zero exploratory risks and large resources in place for tight oil/gas and oil sands will make it an attractive proposition for asset buyers, especially at current crude prices. Given these attractions and looking into 2011, we expect deal pricing for onshore North America acreage to remain at a premium to worldwide pricing. We expect the Chinese companies to continue to cautiously inch their way into North America via joint-ventures and equity stakes, to avoid potential political backlash (e.g. Unocal). Standard & Poor’s Equity Research
  11. 11. April 7, 2011 Global Strategy Stock Recommendations 11 S&P Hong Kong / China Oil & Gas Recommendations and Key Ratios EPS Bloomberg Share Price YTD perf PER x Company Name Recommend Growth Div Yield 3-Yr EPS P/BV ROE Net Gearing Ticker LCY 2011 2011 2011 2011 CAGR% 2011 2011 2011 2883 HK China Oilfield Services Ltd 18.00 Buy 6.2% 14.9 11% 1.3% 17% 2.3 17% 86% 883 HK CNOOC Ltd 20.85 Hold 12.3% 12.5 15% 2.4% 18% 3.0 26% Net Cash 857 HK PetroChina 12.04 Strong Buy 17.7% 10.9 22% 4.1% 3% 1.8 17% 26% 386 HK Sinopec 7.89 Hold 5.4% 8.4 -4% 3.0% 5% 1.2 15% 51% Source: S&P Equity Research estimates COSL (HKD18.00, 4-STARS, 12-mo TP: HKD18) Despite lower revenue recorded in 2010 (primarily due to a one-off reversal of deferred revenue booked in 2009 for the cancellation of the drilling contract for COSL Pioneer), greater integration synergies with Awilco and lower asset impairment charges vs. 2009 meant margins and net profit improved significantly. We expect 2011 will see more strength on a significant increase in parent CNOOC Ltds capex investments (+55.5% YoY), stronger dayrates on increased offshore activities, new capacity deliveries (2 jackups and 1 semi), and a new management contract for the ultra-deepwater HYSY981 (owned by CNOOC Ltd). Risks to our recommendation and target price may arise from a fall in crude prices and financial difficulties at clients that may hurt returns. In addition, COSL’s acquisition of Awilco in 2008 has raised the group’s net gearing to close to 100%, reducing flexibility on future investment. An issuance of new A-shares remains pending, but the impact should already be discounted by the market. / Ahmad Halim, CFA CNOOC Ltd (HKD20.85, 3-STARS, 12-mo TP: HKD19) 2010 was a record year for CNOOC Ltd, both in terms of profits and production growth. We expect 2011 production growth to moderate from +45% YoY in 2010 to about 11% YoY. While this remains strong vs other E&P players, other headwinds should limit outperformance for the year: costs are expected to increase on greater deepwater activities, higher DDA charges as newer, more costly fields commence operations and crude ASPs should see some dilution effect from greater Bridas contribution. Recent acquisition of a 33.3% stake in Tullow’s Uganda blocks is positive for reserve replacement but production impact during the forecast period is negligible. Funding remains ample, with CNOOC Ltd carrying a net cash balance. Risks to our target price and recommendation come from potentially lower U.S. product consumption that would send oil prices lower. Further, higher-than-expected lifting costs will eat into CNOOC Ltds Standard & Poor’s Equity Research
  12. 12. April 7, 2011 Global Strategy margins. In addition, with its oil primarily sold to Sinopec, pricing power may be 12 more limited. / Ahmad Halim, CFA PetroChina (HKD12.04, 5-STARS, 12-mo TP: HKD14) 2010 results indicate some pressure on margins for both its refining and chemical (R&C) unit and its pipeline unit. For 2011, we expect its R&C unit will book losses in 2011, if product prices are not adjusted more aggressively vs. current levels. Pipeline profits could continue to be pressured in 2011, before a rebound in 2012, as we do not expect city gate prices to respond quickly enough to cover higher input costs. Still, we think that PetroChina should benefit from higher oil prices given its substantial upstream leverage, while a possible wellhead gas price hike could also boost E&P profits. Risks to our recommendation and earnings forecasts include prolonged reluctance by the PRC government to address pricing inefficiencies. Policy uncertainty may also diminish earnings quality, and at worst, destroy value for PetroChina. The company’s share price may also be subject to swings in the oil price, despite the greater balance in its downstream earnings. / Ahmad Halim, CFA Sinopec (HKD7.89, 3-STARS, 12-mo TP: HKD8) Slow product price adjustments hit Sinopec’s earnings hard in 2010; despite a significant 97% EBIT growth from the E&P division on new Puguang gas production, overall net profit only grew by 13.7% YoY due to substantially lower refining margins. We expect Sinopec will book in refining losses in 2011, as short- term concerns on inflation will cap aggressive price adjustments, in our view, although over the longer term we expect Sinopec’s refining arm to return to profitability as China slowly moves more toward a market-based price mechanism. Risks to our target price and recommendation would come from national interests that may supersede shareholder interests. The potential for higher marketing competition may also eat into profitability, while Sinopecs status as a net buyer of oil means a higher risk premium is warranted. / Ahmad Halim, CFA Standard & Poor’s Equity Research
  13. 13. April 7, 2011 Global Strategy FFO- Funds From OperationsGlossary FY- Fiscal Year P/E- Price/Earnings 13 PEG Ratio- P/E-to-Growth RatioS&P STARS - Since January 1, 1987, Standard & Poor’s Equity Research Services PV- Present Valuehas ranked a universe of U.S. common stocks, ADRs (American Depositary Receipts), R&D- Research & Developmentand ADSs (American Depositary Shares) based on a given equity’s potential for ROE- Return on Equityfuture performance. Similarly, Standard & Poor’s Equity Research Services has used ROI- Return on InvestmentSTARS® methodology to rank Asian and European equities since June 30, 2002. ROIC- Return on Invested CapitalUnder proprietary STARS (STock Appreciation Ranking System), S&P equity analysts ROA- Return on Assetsrank equities according to their individual forecast of an equity’s future total return SG&A- Selling, General & Administrative Expensespotential versus the expected total return of a relevant benchmark (e.g., a regional WACC- Weighted Average Cost of Capitalindex (S&P Asia 50 Index, S&P Europe 350® Index or S&P 500® Index)), based on a12-month time horizon. STARS was designed to meet the needs of investors looking Dividends on American Depository Receipts (ADRs) and American Depositoryto put their investment decisions in perspective. Shares (ADSs) are net of taxes (paid in the country of origin).S&P Quality Rankings (also known as S&P Earnings & Dividend Rankings)-Growth and stability of earnings and dividends are deemed key elements inestablishing S&P’s earnings and dividend rankings for common stocks, which are Disclosures/Disclaimersdesigned to capsulize the nature of this record in a single symbol. It should be noted, Required Disclosureshowever, that the process also takes into consideration certain adjustments andmodifications deemed desirable in establishing such rankings. The final score foreach stock is measured against a scoring matrix determined by analysis of the scores In contrast to the qualitative STARS recommendations covered in this report, whichof a large and representative sample of stocks. The range of scores in the array of are determined and assigned by S&P equity analysts, S&P’s quantitativethis sample has been aligned with the following ladder of rankings: evaluations are derived from S&P’s proprietary Fair Value quantitative model. InA+ Highest B+ Average C Lowest particular, the Fair Value Ranking methodology is a relative ranking methodology,A High B Below Average D In Reorganization whereas the STARS methodology is not. Because the Fair Value model and theA- Above Average B- Lower NR Not Ranked STARS methodology reflect different criteria, assumptions and analytical methods, quantitative evaluations may at times differ from (or even contradict) an equityS&P Issuer Credit Rating - A Standard & Poor’s Issuer Credit Rating is a current analyst’s STARS recommendations. As a quantitative model, Fair Value relies onopinion of an obligor’s overall financial capacity (its creditworthiness) to pay its history and consensus estimates and does not introduce an element of subjectivityfinancial obligations. This opinion focuses on the obligor’s capacity and willingness as can be the case with equity analysts in assigning STARS meet its financial commitments as they come due. It does not apply to any specificfinancial obligation, as it does not take into account the nature of and provisions ofthe obligation, its standing in bankruptcy or liquidation, statutory preferences, or the S&P Global STARS Distributionlegality and enforceability of the obligation. In addition, it does not take into account In North Americathe creditworthiness of the guarantors, insurers, or other forms of credit As of March 31, 2011, research analysts at Standard & Poor’s Equity Researchenhancement on the obligation. Services U.S. recommended 37.5% of issuers with buy recommendations, 54.9% with hold recommendations and 7.6% with sell recommendations.S&P Core Earnings - Standard & Poors Core Earnings is a uniform methodology foradjusting operating earnings by focusing on a companys after-tax earnings In Europegenerated from its principal businesses. Included in the Standard & Poors definition As of March 31, 2011, research analysts at Standard & Poor’s Equity Researchare employee stock option grant expenses, pension costs, restructuring charges from Services Europe recommended 35.6% of issuers with buy recommendations, 47.0%ongoing operations, write-downs of depreciable or amortizable operating assets, with hold recommendations and 17.4% with sell recommendations.purchased research and development, M&A related expenses and unrealized In Asiagains/losses from hedging activities. Excluded from the definition are pension gains, As of March 31, 2011, research analysts at Standard & Poor’s Equity Researchimpairment of goodwill charges, gains or losses from asset sales, reversal of prior- Services Asia recommended 46.7% of issuers with buy recommendations, 46.7%year charges and provision from litigation or insurance settlements. with hold recommendations and 6.6% with sell recommendations.S&P 12 Month Target Price – The S&P equity analyst’s projection of the market Globallyprice a given security will command 12 months hence, based on a combination of As of March 31, 2011, research analysts at Standard & Poor’s Equity Researchintrinsic, relative, and private market valuation metrics. Services globally recommended 38.0% of issuers with buy recommendations,Standard & Poor’s Equity Research Services – Standard & Poor’s Equity Research 52.9% with hold recommendations and 9.1% with sell recommendations.Services U.S. includes Standard & Poor’s Investment Advisory Services LLC; 5-STARS (Strong Buy): Total return is expected to outperform the total return of aStandard & Poor’s Equity Research Services Europe includes Standard & Poor’s LLC- relevant benchmark, by a wide margin over the coming 12 months, with sharesLondon; Standard & Poor’s Equity Research Services Asia includes Standard & rising in price on an absolute basis.Poor’s LLC’s offices in Singapore, Standard & Poor’s Investment Advisory Services 4-STARS (Buy): Total return is expected to outperform the total return of a relevant(HK) Limited in Hong Kong, Standard & Poor’s Malaysia Sdn Bhd, and Standard & benchmark over the coming 12 months, with shares rising in price on an absolutePoor’s Information Services (Australia) Pty Ltd. basis.Abbreviations Used in S&P Equity Research Reports 3-STARS (Hold): Total return is expected to closely approximate the total return ofCAGR- Compound Annual Growth Rate a relevant benchmark over the coming 12 months, with shares generally rising inCAPEX- Capital Expenditures price on an absolute basis.CY- Calendar Year 2-STARS (Sell): Total return is expected to underperform the total return of aDCF- Discounted Cash Flow relevant benchmark over the coming 12 months, and the share price is notEBIT- Earnings Before Interest and Taxes anticipated to show a gain.EBITDA- Earnings Before Interest, Taxes, Depreciation and Amortization 1-STARS (Strong Sell): Total return is expected to underperform the total return ofEPS- Earnings Per Share a relevant benchmark by a wide margin over the coming 12 months, with sharesEV- Enterprise Value falling in price on an absolute basis.FCF- Free Cash Flow Standard & Poor’s Equity Research
  14. 14. April 7, 2011 Global StrategyRelevant benchmarks: In North America the relevant benchmark is the S&P 500 organizations, including organizations whose securities or services they mayIndex, in Europe and in Asia, the relevant benchmarks are generally the S&P Europe recommend, rate, include in model portfolios, evaluate or otherwise address. 14350 Index and the S&P Asia 50 Index. S&P and/or one of its affiliates has performed services for and receivedFor All Regions: compensation from this company during the past twelve months.All of the views expressed in this research report accurately reflect the researchanalysts personal views regarding any and all of the subject securities or issuers. No S&P has received compensation from one or more institutions, each in the range ofpart of analyst compensation was, is, or will be, directly or indirectly, related to the HKD 78,000 to HKD 390,000, for the right to distribute and co-brand S&P’s researchspecific recommendations or views expressed in this research report. on this company.S&P Global Quantitative DisclaimersRecommendations Distribution With respect to reports issued to clients in Japan and in the case of inconsistencies between the English and Japanese version of a report, the English version prevails.In Europe With respect to reports issued to clients in German and in the case ofAs of March 31, 2011, Standard & Poor’s Quantitative Services Europe recommended inconsistencies between the English and German version of a report, the English46.2% of issuers with buy recommendations, 21.4% with hold recommendations and version prevails. Neither S&P nor its affiliates guarantee the accuracy of the32.4% with sell recommendations. translation. Assumptions, opinions and estimates constitute our judgment as of theIn Asia date of this material and are subject to change without notice. Past performance is not necessarily indicative of future results.As of March 31, 2011, Standard & Poor’s Quantitative Services Asia recommended47.0% of issuers with buy recommendations, 18.0% with hold recommendations and Standard & Poor’s, its affiliates, and any third-party providers, as well as their35.0% with sell recommendations. directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness or adequacy of this material, and S&PGloballyAs of March 31, 2011, Standard & Poor’s Quantitative Services globally Parties shall have no liability for any errors, omissions, or interruptions therein,recommended 46.7% of issuers with buy recommendations, 19.3% with hold regardless of the cause, or for the results obtained from the use of the information provided by the S&P Parties. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS ORrecommendations and 34.0% with sell recommendations. IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY, SUITABILITY OR FITNESS FOR A PARTICULAR PURPOSE ORAdditional information is available upon request. USE. In no event shall S&P Parties be liable to any party for any direct, indirect,Other Disclosures incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income orThis report has been prepared and issued by Standard & Poor’s and/or one of its lost profits and opportunity costs) in connection with any use of the informationaffiliates. In the United States, research reports are prepared by Standard & Poor’s contained in this document even if advised of the possibility of such damages.Investment Advisory Services LLC (“SPIAS”). 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Standard & Poor’s ratings should not be reliedSingapore by Standard & Poor’s LLC, which is regulated by the Monetary Authority on and are not substitutes for the skill, judgment and experience of the user, itsof Singapore; in Malaysia by Standard & Poor’s Malaysia Sdn Bhd (“S&PM”), which management, employees, advisors and/or clients when making investment andis regulated by the Securities Commission; in Australia by Standard & Poor’s other business decisions. Standard & Poor’s rating opinions do not address theInformation Services (Australia) Pty Ltd (“SPIS”), which is regulated by the Australian suitability of any security. Standard & Poor’s does not act as a fiduciary. WhileSecurities & Investments Commission; and in Korea by SPIAS, which is also Standard & Poor’s has obtained information from sources it believes to be reliable,registered in Korea as a cross-border investment advisory company. 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As a result, certain business units of Standard & Poor’s may havepricing or other services to, or otherwise have a financial interest in, certain issuers of information that is not available to other Standard & Poor’s business units.securities, including exchange-traded investments whose investment objective is to Standard & Poor’s has established policies and procedures to maintain thesubstantially replicate the returns of a proprietary Standard & Poors index, such as confidentiality of certain non-public information received in connection with eachthe S&P 500. In cases where Standard & Poors or an affiliate is paid fees that are tied analytical the amount of assets that are invested in the fund or the volume of trading activity Standard & Poor’s Ratings Services did not participate in the development of thisin the fund, investment in the fund will generally result in Standard & Poors or an report. 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  15. 15. April 7, 2011 Global Strategyany securities or investments mentioned in this report may fall against the interestsof the investor and the investor may get back less than the amount invested. Where 15an investment is described as being likely to yield income, please note that theamount of income that the investor will receive from such an investment mayfluctuate. Where an investment or security is denominated in a different currency tothe investor’s currency of reference, changes in rates of exchange may have anadverse effect on the value, price or income of or from that investment to theinvestor. The information contained in this report does not constitute advice on thetax consequences of making any particular investment decision. This material is notintended for any specific investor and does not take into account your particularinvestment objectives, financial situations or needs and is not intended as arecommendation of particular securities, financial instruments or strategies to you.Before acting on any recommendation in this material, you should consider whetherit is suitable for your particular circumstances and, if necessary, seek professionaladvice.This document does not constitute an offer of services in jurisdictions whereStandard & Poor’s or its affiliates do not have the necessary licenses.For residents of the U.K. –this report is only directed at and should only be relied onby persons outside of the United Kingdom or persons who are inside the UnitedKingdom and who have professional experience in matters relating to investments orwho are high net worth persons, as defined in Article 19(5) or Article 49(2) (a) to (d) ofthe Financial Services and Markets Act 2000 (Financial Promotion) Order 2005,respectively.For residents of Singapore - Anything herein that may be construed as arecommendation is intended for general circulation and does not take into accountthe specific investment objectives, financial situation or particular needs of anyparticular person. Advice should be sought from a financial adviser regarding thesuitability of an investment, taking into account the specific investment objectives,financial situation or particular needs of any person in receipt of therecommendation, before the person makes a commitment to purchase theinvestment product.For residents of Malaysia - All queries in relation to this report should be referred toChing Wah Tam.For residents of Indonesia - This research report does not constitute an offeringdocument and it should not be construed as an offer of securities in Indonesia, andthat any such securities will only be offered or sold through a financial institution.For residents of the Philippines - The securities being offered or sold have not beenregistered with the Securities and Exchange Commission under the SecuritiesRegulation Code of the Philippines. Any future offer or sale thereof is subject toregistration requirements under the Code unless such offer or sale qualifies as anexempt transaction.STANDARD & POOR’S, S&P, S&P 500, S&P Europe 350 and STARSare registered trademarks of Standard & Poor’s Financial ServicesLLC. Standard & Poor’s Equity Research
  16. 16. April 7, 2011 Global Strategy 16 Standard & Poor’s Equity Research