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China's NOCs start to feel the pinch

The country’s oil giants aren’t in the rosiest financial health, but remain ready to scoop up assets elsewhere

The latest numbers from China’s national oil companies (NOCs) signal more pain ahead as they grapple with an international oil-price slump at the same time as demand softens for their product at home. But their appetite for foreign acquisitions lingers on.

China’s big oil companies may all ultimately be controlled by the government and have the same goals – to produce or buy enough oil and gas to feed China’s economy while turning a healthy profit to keep investors happy – but they’re far from equal. 

While the big two oil companies – China National Petroleum Corporation (CNPC) and China Petroleum and Chemical Corporation (Sinopec) – saw their profits significantly dented last year, China National Offshore Oil Corporation’s (Cnooc’s) “laser-like focus on costs” helped it grow profits despite falling crude prices, noted Neil Beveridge, a Hong-Kong-based oil and gas specialist at investment research firm Bernstein.

By comparison, he said that CNPC and Sinopec, both of which remain very much state-run rather than commercially-led, still have not gone far enough to resolve issues like high capital spending levels that suppress profits. The pair has arguably more to gain through radical reform, but they have yet to rise to the challenge, he added.  

CNPC, the nation’s biggest oil and gas producer by volume and reserves, watched its profits shrink some 17% to 107bn yuan ($17.2bn) in 2014 compared to the year before. It was the company’s lowest profit level in five years. A combination of lower oil prices and paltry growth in production cut earnings. Stubbornly high costs at the company – which with around 550,000 employees has a workforce more than seven times the size of ExxonMobil’s – is also a huge drag. The NOC said it would trim spending by 9% to 266bn yuan this year, the third consecutive year of cuts. 

Exceeding predictions

While on paper PetroChina – CNPC’s main operating arm and listed offshoot – surpassed ExxonMobil’s market capitalisation, albeit only briefly in early April, it is not bigger than ExxonMobil when it comes to what matters: oil and the technology to pull it out of the ground. 

The US giant is ranked the fourth biggest integrated oil and gas company in the world with some 5.3m barrels of oil equivalent production (boe/d), whilst PetroChina sits in sixth spot with 4.4m boe/d production. 

When it comes to oil, ExxonMobil has more of it. But when it comes to money, China has the US supermajor beat. In terms of total equity, PetroChina had 1.2 trillion yuan ($204.8bn) to start 2014 and ExxonMobil had $180.4bn. The NOC had 51.4bn yuan ($8.2bn) in cash – almost double the amount of its US competitor.

Still, PetroChina is actively seeking to swap its North American assets with international oil companies: an effort to staunch losses on high-cost deposits after the collapse in crude prices. An asset swap is more tax efficient than an outright sale. But it does not help protect the value of the assets, said Beveridge.

The Chinese NOCs have invested some $100bn in oil and gas assets around the world since 2011, data from Dealogic show. But the drop in oil prices, as well as a government anti-corruption push targeting PetroChina and more recently Sinopec, has prompted a pullback. 

Nonetheless, Wang Dongjin, PetroChina’s vice president, is not ruling out new purchases “once the time is right” and he said the company is “actively following a few quality assets”.

Beveridge thinks the Chinese will remain net buyers in the market. “Our view is that they are likely to be patient – maybe the BG-Shell deal changes their interest levels – but I would have thought it will take more time before they get back in,” he told Petroleum Economist. 

Valerie Marcel, a specialist in NOCs at UK-based think-tank Chatham house, agreed that the cash-rich Chinese NOCs will be more cautious, but said they are uniquely positioned to scoop up good acquisition deals as they arise.

Among the big three, Sinopec has the most liquidity at the moment – given the marketing sell down of its retail unit for $17.4bn last year. But so far Sinopec has been cautious.

“Now it is only the time to observe, not to buy (overseas assets),” said Fu Chengyu, before he stepped down as Sinopec’s chairman in early May. “If we wait for another half a year, some companies might run into financial troubles”.

Sinopec has been forced to slash its capital expenditure too, after the slide in crude prices knocked nearly one-third from its 2014 profit compared with 2013 to 46.5bn yuan– its lowest level since 2008. Sinopec, which focuses on refining oil into diesel and gasoline, has also been vulnerable to slack demand for oil products at home, particularly diesel, as China’s economic growth slows. 

As a result, China’s second-largest oil group aims to cut 2015 capital expenditure to 136bn yuan, down 12% compared with the previous year. 

A bright spot in China’s oil patch is Cnooc, the smallest of the three leading NOCs and the most market orientated. A lower cost base versus CNPC and Sinopec has helped Cnooc weather the fall in oil prices better. The company’s 2014 net profit jumped 6.6% to 60.2bn yuan.

Still, Cnooc has pledged to slash spending by one-third as falling energy prices are testing its ability to maintain its rapid production growth of recent years, while maintaining its aggressive cost controls that have made it an investor favourite. 

This mixed bag of results is feeding into the wider debate in China over proposals to merge the state-owned oil companies. International oil assets bought when the market was at historic highs are proving hard to digest, fueling the debate. 

But big is not always better – as the systemic challenges facing CNPC and Sinopec already show. Perhaps its time they take a leaf from their far smaller commercially minded rival Cnooc.

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