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Cnooc ambitious growth strategy comes under fire

The Chinese company needs to expand internationally if it is to hit 2015 output targets

Coming off the back of a $15 billion acquisition of Canadian producer Nexen, the biggest overseas takeover ever by a Chinese oil company, one might expect state-run China National Offshore Oil Corporation’s (Cnooc) mergers and acquisitions team to take a breather.

But as domestic production continues to decline, the company’s international expansion will have to continue apace if the company is to hit its ambitious 2015 output targets and continue to grow through the rest of the decade. That growth, though, could come at the expense of profitability, analysts have warned.

Cnooc, the smallest of China’s big three national oil companies, is playing catch-up with its compatriots China National Petroleum Corporation (CNPC) and Sinopec. In a presentation in late October, the company reiterated its ambitious production growth target of between 6% and 10% a year from 2011 through 2015. Including production from Nexen, Cnooc is targeting output for 2013 between 1.09 million barrels of oil equivalent a day (boe/d) 1.12m boe/d.

The company’s ambitious expansion targets, encouraged by policymakers in Beijing, have driven its strategy over recent years.

One part of that strategy has included stepped up exploration in its own offshore, where Cnooc holds a monopoly. The domestic investment has resulted in a number of new discoveries and projects. The company brought two new offshore projects on stream in the second half of this year – Wenchang 19-1N and Weizhou 12-8W, bringing the total to four this year. Cnooc has a further five projects it expects to bring online this year, and another early next year.

Yet these projects have only brought modest new volumes into production and have not been enough to stem the decline in the company’s domestic production. Offshore output in China has fallen each quarter this year, with declines especially pronounced in Bohai Bay, the company’s domestic workhorse oil province.

With limited growth potential in China, Cnooc has looked abroad for growth in recent years. The company has snapped up stakes in unconventional oil and gas fields across North America, heavy and shale oilfields in Latin America and major discoveries in Uganda and elsewhere in Africa. 

Earlier this year, Cnooc closed a $15bn takeover of Canada’s Nexen, a deal which saw it step up its footprint in Canada’s oil sands and acquire fields in the North Sea, Colombia and elsewhere.

It followed that deal this month by joining a consortium that won its bid to develop Brazil’s multi-billion barrel Libra pre-salt field. Cnooc’s 10% stake in the field means it will pay $700m up front for a signing bonus and probably more than $10bn in development costs over the course of the project, with significant production unlikely until late this decade at the earliest.

While the company’s minority investors have generally welcomed the aggressive growth strategy in recent years, it is starting to come under fire.

“Cnooc’s main challenge is whether the business can achieve higher production growth and maintain returns in the current oil price outlook or continues to spend to deliver growth with risk of returns erosion,” said analysts at JP Morgan in a recent research note.

With its core assets at home depleting, say analysts at Jeffries, Cnooc should be consolidating and looking to build value for shareholders. But the company has a “political growth imperative” that is driving it expansion abroad, the analysts say.

“A commercial company with depleted assets would cut [capital expenditure], allow production to decline and buy back shares, increasing production per-share,” argued Jeffries analysts Yu Laban and Jack Lu in a recent research note.

Instead, Cnooc continues to push volume over value, the analysts argue. “Cnooc will hit growth targets through intense spending on depleted shallow water oil fields, low margin deepwater natural gas and even lower margin production from Iraq service contracts. To grow production past 2015, we believe Cnooc needs to continue and perhaps accelerate overseas acquisitions.”

That could be bad news for minority shareholders. The company has consistently been criticised for overpaying for assets abroad. It paid more than a 60% premium over Nexen’s share price at the time that deal was announced, far higher than other similar deals in the industry.

As long as Beijing pushes its state oil companies to expand production and reserves above all, management at Cnooc will continue its growth strategy. “Cnooc is not in the business of being a medium sized, high-return, oil and gas company; it is in the business of becoming China's third super-major and shareholders are more than welcome to support the cause.”

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