Asia China Energy
11 June 2012 Coverage Change
Credit Credit China Oil and Gas Research Team Colin Tan, CFA Research Analyst Initiating coverage on CNOOC, (+852) 2203 5720 [email protected]
Gene Cheon CNPC and Sinopec Research Analyst (+65) 64236967 [email protected]
Sector looks attractive relative to international peers We initiate sector coverage focusing on the three major issuers CNOOC, CNPC, and Sinopec. Overall, we think the sector looks attractive relative to international peers given their strategic role in securing China’s future energy demand, dominant market position, strong ties with the PRC government and solid standalone credit fundamentals. The 5-year and 10-year notes offer best relative value On a fundamental basis we think the 5-year and 10-year notes offer the best Global Markets Research relative value in the sector as they currently trade closer to their BBB-rated peers. Furthermore for the buy-and-hold investor the 10-year notes are now implying default probabilities akin to what we’ve historically seen for a Ba or lower-rated credit instead of solid IG names with strong government support. On average the 10-year notes are pricing in default probabilities of around 18%, 22% and 28% under recovery assumptions of 0%, 20% and 40%, respectively. The longer-dated bonds are more fairly priced, in our view. Similar but not equal … CNOOC our top sector pick While we expect all three companies to receive government support in the unlikely event of a financial distress, our preference for CNOOC reflects the company’s solid stand-alone credit quality. CNOOC has the strongest financial position and free cash flow performance out of the three. CNOOC also has the strongest operating margins given the pure E&P focus. In comparison, Sinopec and CNPC are both highly integrated along the energy supply chain with the former having the weakest margins due to government price controls around refined products. The aggressive upstream expansion and capex strategy has also been a negative drag on Sinopec’s and CNPC’s free cash flows and we don’t believe this is about to change anytime soon. Bond structures and credit enhancements Sinopec’s USD bonds are irrevocably guaranteed by onshore parent China Petroleum Corp (100% owned by the SASAC). While we recognise the rarity of onshore guarantees (and in Sinopec’s case effectively a guarantee from the PRC Government), we believe this is somewhat already in the price. Given we think there is a low probability that these credit enhancements will be triggered, we’d argue that the stand alone credit quality of these individual issuers should be a more relevant consideration for investors. CNOOC’s USD bonds are guaranteed by its offshore parent CNOOC Ltd. The ‘Keepwell Arrangement’ in CNPCCH bonds is a relative weak form of credit enhancement in our view. Key investment risks Reduced State support due to government policy change; Higher leverage arising from a significantly more aggressive debt-funded capex/acquisition strategy; Geopolitical, regulatory and environmental risks arising from upstream E&P activities. Key investment recommendations (see figure 7 for more detail) • CreditBuy: CNOOC ’21, CNOOC’22, SINOPE’ 22, CNPC ’22 • CreditHold: CNOOC ’41, CNOOC ’42, SINOPE ’42 • Bond switch idea: Buy CNPC ’17 and Sell SINOPE ’17; pick up z+22bps
Deutsche Bank AG/Hong Kong All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single
factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 072/04/2012. Error! Unknown document property name. Error! Unknown document property name. Error! Unknown document property name.
Valuation CreditBuy: CNOOC ’21, CNOOC’22, SINOPE’ 22, CNPC ‘22
On a fundamental and relative value basis we think the 5-year and 10-year notes offer the best value in the sector as they currently trade closer to their BBB-rated peers (Figure 1). For the buy-and-hold investor, we think the 10-year bonds offers compelling valuation as current spread implies a cumulative default probability of around 18%, 22% and 28% under a recovery assumption of 0%, 20% and 40%, respectively. These default probabilities are more akin to what we’ve historically seen for a Ba or lower-rated credits rather than solid IG names with strong government support.
Figure 1: China’s oil & gas credit curve versus peers Figure 2: Peers Z-spread (bps) by ratings (10 year)
320 350 280 PTTEPT 5.692 '21 240 300 200 ENIIM 4.15 '20 PETBRA 5.375 160 250 '21
z-spread 120 CNOOC 4.25 SINOPE 3.9 200 '21 APC 8.7 '19 80 '22 PETMK 7.785 CNPCCH 3.95 '22 40 CNOOC 3.875 '22 CNQCN 3.45 150 - '22 '21 DVN 3.25 '22 5-year 10-year 30 year China average (AA-/A+) Apache (A-) 100 APA 3.25 '22 Petrobras (BBB) Statoil (AA-) Anadarko (BBB-) Devon (BBB+) STLNO 3.15 Encana (BBB) 50 '22 345678910AA- A+ A A- BBB+ BBB BBB- Source: Deutsche Bank, Bloomberg Finance LP Source: Deutsche Bank, Bloomberg Finance LP
CreditHold: CNOOC ’41, CNOOC ’42, SINOPE ’42
The longer-dated bonds are more fairly priced, in our view. Indeed we believe the 30-year notes have performed well mainly supported by demand from the duration-seeking investors.
Figure 3: Peers Z-spread (bps) by ratings (>10 year) Figure 4: China oil & gas curve Z-spread x duration (USD bonds) SINOPE 4.875 400 240 PTTEPT 6.35 '42 '42 350 220 CNOOC 5.0 PETBRA 6.75 CNPCCH 3.95 CNOOC 5.75 '42 '41 '41 200 '22 300 CNOOC 4.25 '21 SINOPE 3.9 APC 6.2 '40 '22 180 250 CNOOC 5.0 CNOOC 3.875 '42 SINOPE 4.875 '22 '42 CNOOC 5.75 160 200 CNPCCH 2.75 '41 APA 5.25 '42 '17 140 SINOPE 3.9 150 '17 STLNO 4.25 '41 120 100 4 5 6 7 8 9 1011121314151617 345678910AA- A+ A A- BBB+ BBB BBB- Duration Source: Deutsche Bank, Bloomberg Finance LP Source: Deutsche Bank, Bloomberg Finance LP
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Bond switch idea: Buy CNPC ’17 and Sell SINOPE ‘17 and pick up z+22bps
The outperformance in SINOPE ’17 relative to CNPCCH’17 offers investors to switch out of the SINOPEs into CNPCCHs and pick up a spread of around z+22bps (after crossing bid/ask). We believe the differential is largely driven by the stronger bond protection offered in SINOPE’s bonds via a direct onshore guarantee from the SASAC-owned China Petroleum Corporation. Whilst we acknowledge the superior strength of onshore guarantee relative to the Keepwell Agreements in CNPCCH’s bonds, we think the differential is now on the wide side given the comparable credit profiles of the two issuers. Given we think there is a low probability that these credit enhancements will be triggered, the stand alone credit quality of these individual issuers should be a more relevant consideration for investors.
Figure 5: SINOPE ’17 has outperformed CNPCCH ‘17 Figure 6: Peers Z-spread (bps) by ratings (5 year)
190 250
180 PETBRA 3.5 200 '17
170 CNPCCH 2.75 APC 6.375 '17 150 '17 160 SINOPE 3.9 '17
150 100 CNQCN 5.5 '17 DVN 1.875 '17
140 APA 5.625 '17 50 STLNO 3.125 '17 130 CNPCCH 2 ¾ '17 SINOPE 2 ¾ '17 - 120 345678910AA- A+ A A- BBB+ BBB BBB- 16-Apr-12 30-Apr-12 14-May-12 28-May-12 Source: Deutsche Bank, Bloomberg Finance LP Source: Deutsche Bank, Bloomberg Finance LP
Figure 7: Key investment recommendations Issue Mdy/S&P Mid Px ($) Mid Z-spd (bps) Mid yield DB view CNOOC 4.25 '21 Aa3/AA- 105.1 190 3.51% CreditBuy CNOOC 3.875 '22 Aa3/AA- 101.7 185 3.62% CreditBuy CNPCCH 3.95 '22 A1/A+ 102 189 3.66% CreditBuy SINOPE 3.9 '22 Aa3/A+ 101.5 190 3.68% CreditBuy CNPCCH 2.75 '17 A1/A+ 100.6 161 2.60% CreditBuy SINOPE 3.9 '17 Aa3/A+ 100.5 137 2.37% CreditSell Source: Deutsche Bank
Testing the hedges: China CDS seems to be a good macro hedge
There is limited time-series data to test the robustness of this relationship but using what is available (CNOOC ‘21s) we find that China’s sovereign CDS appears to be a good macro hedge for bond investors. The CDS-bond basis narrowed to around 20bps in October last year on the back of European macro concerns. The basis has since widened back to around 60bp currently and is closer to the top of the 10-70bp range seen since February 2011. A simple linear regression of this relationship since February 2011 yielded a R-square of 83% (Figures 8 and 9).
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Figure 8: CNOOC 4.25 ‘21s versus China 5yr Sov CDS Figure 9: Simple linear regression between CNOOC 4.25 ‘21s and China 5yr Sov CDS since Feb 2011
250 250 CNOOC 4 ¼ '21 China Sovereign 5-year CDS 230
210 200 190
170 150 150
130 100 110 y = 0.985x + 47.045 90 R² = 0.8347
50 70
50 Jul-11 Jul-12 Apr-11 Apr-12 Jan-12 Jun-11 Oct-11 Jun-12 Feb-11 Feb-12 Sep-11 Mar-11 Mar-12 Dec-11 Aug-11 Nov-11 50 75 100 125 150 175 200 May-11 May-12 Source: Deutsche Bank, Bloomberg Finance LP Source: Deutsche Bank, Bloomberg Finance LP
Industry and credit overview Background and history
The three Chinese national oil companies (NOC) originated from the same set of parents - the former Ministry of Petroleum Industry and former Ministry of Chemical Industry. These ministries were responsible for allocating resources and setting prices specified by the State before converting them into state-owned enterprises in the early 1980s.
The predecessor of CNPC was the Ministry of Petroleum Industry founded in 1955 with a mandate to supervise the exploration and development of oil and gas resources. In 1988 the Ministry of Petroleum Industry was dissolved and the China National Petroleum and Natural Gas Corporation was established to take control of the onshore oil and gas upstream assets. The offshore assets upstream assets of the Ministry of Petroleum were spun off into CNOOC. Away from upstream activities, China Petrochemical Corporation (Old Sinopec) was founded in 1983 by the PRC State Council as a ministerial level enterprise with primary responsibility of developing the refining and petrochemical industry in China.
In 1998 Beijing undertook a restructuring of the petroleum industry Beijing which saw the redistribution and reorganization of the upstream assets of CNPC and the downstream assets of Sinopec. That gave birth to the vertically-integrated structures of the CNPC and Sinopec that we see today. In 1999 PetroChina was incorporated which saw CNPC transfer most of its assets and businesses to. PetroChina was subsequently listed on the NYSE and HKSE in 2000. China Petroleum & Chemical Corp (Sinopec Corp) was incorporated in 2000 and listed later in the same year on the NYSE and HKSE. CNOOC Ltd was established in 1999 and listed on the NYSE and HKSE in 2001.
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Figure 10: Key credit highlights Credit strengths Credit weaknesses CNOOC • Strong ties with the PRC • Exposure to volatility in international government oil and gas prices • Large and increasingly diversified • Large capex/F&D raises project reserves portfolio execution risks • Good production and exploration • Deepwater exploration increases track record environmental and litigation risks (eg • Low cost structure and strong Penglai 19-3 spill) margins • Some rising geopolitical exposure to • Not exposed to government price unstable regions controls around refined products given pure E&P focus • Strong financial position and cash flow generation CNPC • Strong ties with the PRC • Increasing Finding & Development government cost and capex driven by acquisitive • Size and market dominance in strategy onshore E&P • Exposed to geopolitical and • Vertically integrated operation execution risks related to its • Sound financial risk profile expansion in West Africa and Middle East • Exposure to volatility in international oil and gas prices • Pressure in refinery margins due to a delay in gas price market reforms Sinopec • Strong ties with the PRC • Refining losses largely remains a government subject of government policy • Dominant market position in China’s • Most acquisitive among the 3 refinery and chemicals segment Chinese oil companies • Highly integrated structure • Weakest operating margins amongst peers • Significant capex plan ahead likely to be ongoing drag on free cash flows • Geopolitical and environmental risks Source: Deutsche Bank
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Figure 11: Three Chinese National Oil Companies in a glance Bond issuer Sinopec Group Overseas CNPC (HK) Overseas Capital CNOOC Finance 2012 Ltd Development (2012) Limited Limited (BVI) Bond guarantor China Petroleum Corporation CNPC Finance (HK) Limited CNOOC Ltd Keepwell provider NA CNPC and China Petroleum Finance NA Company Limited Bond ratings (Moody’s/S&P) Aa3/A+ A1/A+ Aa3/AA- Covenants Change of Control at 101, Negative Change of Control at 101, Negative Negative pledge, Limitation on sale pledge, Limitation on certain sale of pledge, Merger restrictions, and leaseback, Limitation on certain assets, Merger restrictions Limitation on certain sale of assets sale of assets, Merger restrictions Largest listed company China Petroleum & Chemical Corp Petrochina Ltd (857.HK) CNOOC Ltd (883.HK) (386.HK) Market cap HKD676bn (US$87bn) HKD2,035bn (US$262bn) HKD653bn (US$84bn) Key operating statistics (FY 2011) Oil production (mmbl) 475 1,103 249 Gas production (bcf) 552 3,115 378 Total oil equivalent production (mmboe) 567 1,622 314 Oil reserves (mmbl) 4,551 11,958 1,969 Gas reserves (bcf) 7,702 67,618 5,627 Total oil equivalent reserves (mmboe) 5,835 23,227 3,190 Overseas Reserves 1,948 1,838 705 Overseas Reserves as a % of total 33% 8% 22% Reserves replacement ratio 101% 103% 158% Estimated reserve life 9.3 yrs 17.3 yrs 9.0 yrs Average realised price - Oil ($/bbl) 95 103.6 109.75 Average realised price - Gas ($/mcf) 5.5 6.42 5.15 Refining capacity (mm tonnes) 249 219.4 NA Actual refined (mm tonnes) 219 179.6 NA Utilisation rate 88% 82% NA Key financial items (RMB millions) Revenue 2,551,951 2,381,278 240,944 EBITDA 221,993 353,857 121,150 Gross interest expense -11,763 -13,976 -1,707 Capex -242,632 -376,908 -36,823 Cash & cash equivalents 77,261 278,417 23,678 Total assets 1,745,307 3,027,876 384,264 Gross debt 436,912 479,186 37,995 Net debt 359,651 200,769 14,317 Equity 722,342 1,700,682 262,856 Key operating ratios EBITDA margin 9% 15% 50% ROC (EBIT) 11% 9% 31% ROE (NIT) 12% 8% 27% Capex/sales 10% 16% 15% Capex/EBITDA 109% 107% 30% Key credit metrics Gross Debt/EBITDA 2.0 x 1.4 x 0.3 x Net Debt/EBITDA 1.6 x 0.6 x 0.1 x FFO/Debt 47% 69% 254% EBITDA/Interest 18.9 x 25.3 x 71.0 x Gross Debt/Total capitalisation 38% 22% 13% Source: Deutsche Bank, Company data, Bloomberg Finance LP
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Benchmarking CNOOC, CNPC and Sinopec against international peers
The table below shows how the three credits compare against their international peers. Three key observations:
• While CNOOC is the smallest amongst the three in terms of production level and reserves, it enjoyed the best cost structure, EBITDA margins and reserve replacement ratio in 2011. CNOOC’s lifting costs and margins also compare favourably against international peers (Figure 13 and 14). CNOOC’s production volumes and reserves are also comparable with its global E&P peer group.
• CNPC is one of the largest integrated energy companies by production volumes and reserves. Indeed CNPC produced 3,522 MBOE/Day in 2011 and had reserves of 22,237 MMBOE at the end of last year – only behind Exxon Mobil’s volumes and reserves.
• Sinopec had one of the worst margins last year as its refinery focus was negatively affected by government’s price controls policy.
Figure 12: Global peer comparison Average Proved Reserve Ratings Production Total E&P reserve Reserves Replacement Lifting EBITDA Company (S&P/Moody's/Fitch) NOC Country (MBOE/Day) Spend life MMBOE) Ratio cost margin CNOOC AA-/Aa3/A Y China 909 11,408 9.0 3,190 158% 9.0 50% CNPC A+/NR/A Y China 3,522 26,098 17.3 22,237 103% 11.5 15% Sinopec Aa3/A+/A+ Y China 1,168 11,156 9.3 3,966 101% 15.4 9% Exploration & production companies Apache A-/A3/A- N US 748 10,792 11.0 2,990 133% 13.8 75% PTTEP BBB+/Baa1/NR Y Thailand 304 1,659 9.9 1,102 102% 4.1 71% Noble energy BBB/Baa2/NR N US 221 4,499 15.0 1,210 245% 8.3 64% Encana BBB/Baa2/NR N US 580 4,960 10.8 2,273 83% 6.2 60% Devon Energy BBB+/Baa1/BBB+ N US 658 6,943 12.5 3,005 154% 7.7 58% Woodside Petroleum BBB+/Baa1/BBB+ N Australia 177 4,103 20.0 1,292 75% 15.2 57% Canadian Natural BBB+/Baa1/NR N Canada 599 4,996 21.7 4,736 239% 27.8 54% Anadarko BBB/Baa3/BBB- N US 680 5,641 10.2 2,539 148% 14.8 54% Marathon Oil BBB/Baa2/NR N US 399 8,140 12.4 1,800 212% 15.6 46% Oil & Natural Gas Corp NR/Baa1/NR Y India 977 5,713 19.4 6,928 78% NA 33% Integrated oil companies Statoil AA-/Aa2/NR Y Norway 1,850 23,208 7.9 5,331 118% 8.1 41% Petrobras BBB/A3/BBB Y Brazil 2,463 13,166 14.3 12,883 114% 18.7 25% ENI A/A2/A+ Y Italy 1,581 14,267 12.3 7,114 192% 10.3 23% Chevron AA/Aa1/NR N US 2,673 27,397 11.5 11,236 171% 15.3 22% Gazprom Neft BBB-/Baa3/NR Y Russia 1,155 3,224 19.7 8,319 288% NA 20% TOTAL AA-/Aa1/AA N France 2,346 28,601 13.3 11,423 185% 5.8 20% Exxon Mobil AAA/Aaa/NR N US 4,506 31,980 15.2 24,932 107% 9.4 16% ConocoPhillips A/A1/A N US 1,619 13,507 14.2 8,387 122% 12.6 11% BP A/A2/A N UK 3,454 22,447 14.1 17,748 75% 12.7 10% Source: Deutsche Bank, Company data, Bloomberg Finance LP. NOC = National Oil Company
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Figure 13: FY 11 Lifting cost ($/BOE) lower than average Figure 14:… strong EBITDA margins (FY11) versus peers
30.0 80% 70% 25.0 60% 20.0 50% 15.0 Peer average lifting cost US$/BOE 40% Peer average FY11 EBITDA margin 30% 10.0 20% 5.0 10% 0% … … - … … … BP ENI BP ENI CNPC Statoil PTTEP TOTAL Encana CNPC Statoil Apache PTTEP Sinopec CNOOC TOTAL Chevron Encana Apache Canadian Canadian Sinopec Anadarko CNOOC Chevron Petrobras Woodside Canadian Canadian Anadarko Petrobras Woodside Exxon Mobil Exxon Oil & Natural Natural & Oil Marathon Oil Marathon Noble energy Noble Exxon Mobil Exxon ConocoPhilli Gazprom Neft Devon Energy Devon Marathon Oil Marathon Noble energy Noble ConocoPhillips Devon Energy Devon Source: Deutsche Bank, Company Data, Bloomberg Finance LP Source: Deutsche Bank, Company Data, Bloomberg Finance LP
China oil and gas industry overview
China became a net importer of oil in 1993 and has transformed into the world’s second largest oil consumer and the fastest growing user of oil and gas. According to the BP Statistical Review, China’s oil consumption grew from 4.9million barrels per day in 2001 to 9.1mbpd in 2010, a CAGR of 7.2%. Despite the growth in energy demand domestic oil production growth has been stagnant. Oil production only grew from 3.3mbpd in 2001 to 4.07mbpd in 2010, a CAGR of 2.3%.
Figure 15: China oil supply and demand since 1996
Source: Deutsche Bank, CNPC 2012 bond offering documentations, BP Statistical Review of World Energy June 2011
Looking ahead the IEA expects China’s net imports to exceed 12.5millon bpd by 2035, up almost 8million bpd from the current level. The IEA also expects China to important about 79% of the oil it consumes by 2030. Middle East and Africa accounted for more three quarters of China’s source of foreign crude oil back 1H 2010.
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Figure 16: Long term outlook for China’s oil production Figure 17: 2010 H1 China crude import by region and imports 16 12% 14 Middle East
12 44% Asia Pacific Net imports 10 8 Western mbd 6 Domestic Hemisphere production 4 32% Africa
2 Russia/FSU 0 8% 2008 2015 2020 2030 4% Source: Deutsche Bank, IEA Source: Deutsche Bank, Xinhua News Agency, IEA study
Natural gas consumption has grown from 2.7 bcf/d in 2001 to 10.5 bcf/d in 2010, representing a CAGR of 16.6%. While natural gas production in China has largely kept with demand (a CAGR of 13.8% during the same period) demand has outstripped production since 2007. Going forward, the IEA expects China to be one of the fastest growing natural gas consumers and account for 25% of global gas demand growth by 2035.
Figure 18: China gas supply and demand
Source: Deutsche Bank, Sinopec bond offering documentations, BP Statistical Review of World Energy June 2011
Government policies
The PRC government controls prices of refined products in the country. Under the current fuel pricing mechanism introduced in 2009, the NDRC may adjust the retail prices of gasoline and diesel when the moving average of the basket of international crude grades changes more than 4% within a 22-day period. Given the time lag in passing through input costs, refinery margins usually suffer during a period of high and rising international crude prices.
Brent crude prices have fallen around 20% off its recent peak in March and the commodity is now trading at around levels last seen in October 2011. International natural gas prices have also declined sharply over the last two years on oversupply concerns. Following the recent fall in international energy prices, the PRC Government lowered fuel prices for the second time in a month on 8th June 2012. Retail gasoline and diesel prices were cut by 530yuan and 510yuan per tone respectively.
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Figure 19: Brent US$/bbl Figure 20: Natural Gas US$/mcf
140 7.0
130 6.0 Brent $/bbl Natural gas $ mcf 120 5.0
110 4.0
100 3.0
90 2.0
80 1.0
70 0.0 Jul 2010 Jul Jul 2011 Jul Jul 2010 Jul Jul 2011 Jul Jan 2010 Jan Jan 2011 Jan Jan 2012 Jan Jan 2010 Jan Jan 2011 Jan Jan 2012 Jan Sep 2010 Sep Sep 2011 Sep Sep 2010 Sep Sep 2011 Sep Mar 2010 Mar Mar 2011 Mar Mar 2012 Mar Mar 2010 Mar Mar 2011 Mar Mar 2012 Mar Nov 2010 Nov Nov 2011 Nov Nov 2010 Nov Nov 2011 Nov May 2010 May May 2011 May May 2012 May May 2010 May May 2011 May May 2012 May Source: Deutsche Bank, Bloomberg Finance LP Source: Deutsche Bank, Bloomberg Finance LP
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Business Description CNOOC Limited is an upstream company focusing in the exploration, development and production of oil and natural gas. The company is the dominant oil and natural gas producer in offshore China and the third largest energy company in the PRC following CNPC and Sinopec. CNOOC Ltd is also one of the largest independent exploration and production companies in the world in terms of reserves and production. CNOOC Ltd is 64.45% owned by its parent, China National Offshore Oil Corporation (CNOOC), a wholly-owned subsidiary of the PRC government under the control of the State-owned Assets Supervision and Administration Commission (SASAC). CNOOC Limited was established in 1999 and listed in 2001 on both the HKSE and the NYSE.
The issuer, CNOOC Finance (2012) Limited is a wholly-owned subsidiary incorporated in the British Virgin Islands and is guaranteed by parent CNOOC Limited.
Figure 21: CNOOC’s organizational structure
Source: Deutsche Bank, Company data
The company derives its revenue from the following three main sources
Crude oil sales: prices are mainly driven by prices of international crude benchmark of similar quality with certain premium or discounts depending on prevailing market conditions. Prices are quoted in USD but customers in China usually pay RMB. Company sells 3 types of crude - light crude, medium crude and heavy crude, benchmarked by Tapis, Daqing and Duri respectively. Major crude customers in China are CNOOC, Sinopec and Petrochina.
Natural gas sales: Prices are determined by negotiations with its customers. Sales agreements are generally long term take or pay contracts which normally provide period price
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adjustment mechanism. These contracts also contain protective force majeure provisions. Main customers primarily located on the southeastern coast of China. LNG sourced from NWS in Australia and Tangguh LNG in Indo is mainly based on long term supply contracts and sold to various customers in Asia Pac (incl LNG Terminals in Guangdong Dapeng and Fujian)
Marketing revenues: Mainly the sale of oil and gas purchased from the foreign partners under the production sharing contracts. Revenues from the trading of oil and gas through the company's subsidiaries.
Figure 22: CNOOC’s revenue composition Figure 23: Revenue history (RMB millions)
300,000 0.50% Other income 21% 250,000 Marketing revenues Natural gas sales 200,000 Crude oil sales Crude oil sales 150,000 5% Natural gas sales Marketing revenues 100,000 Other income
50,000 73%
0 2007 2008 2009
Source: Deutsche Bank, Company data Source: Deutsche Bank, Company Data
Key credit considerations Strengths:
• Strong ties with the PRC government given strategic importance • Large and increasingly diversified reserves portfolio • Good production and exploration track record • Favourable cost structure and margins relative to peers • Not exposed to government price controls around refined products given pure E&P focus • Strong financial position and cash flow generation Weaknesses:
• Exposure to volatility in international oil and gas prices • Large capex/F&D raises project execution risks • Deepwater exploration increases environmental and litigation risks (e.g. Penglai 19-3 spill) • Some rising geopolitical exposure to unstable regions An update on Penglai accident Penglai’s oil spill incident last year highlights this risk. In September 2011, the PRC Government ordered the complete shutdown of Penglai 19-3 oilfield in Northern China due to
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an oil spill. In January this year 29 fishermen initiated legal action against JV partner ConocoPhillips (49%) and CNOOC (51%). A few weeks later CNOOC Ltd announced that an agreement had been reached that Conoco will put up RMB1billion as settlement.
Figure 24: Geographic diversity in oil and gas reserves Figure 25: Net proved reserves in offshore China
8% 3% Bohai 6% Offshore China 4% Asia 23% Western South 3% Oceania China Sea Africa 7% North America Eastern South China Sea South America 48%
26% East China Sea 71%
Source: Deutsche Bank, Company Data. Note includes equity method investee Source: Deutsche Bank, Company Dat. Note includes equity invested projects
Figure 26: CNOOC’s key operating regions in offshore China
Source: Deutsche Bank, Company website
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Figure 27: Good production track record - Net Figure 28: Reserve replacement ratio (%) production volumes (BOE/Day)
1,000,000 South America 220% 900,000 North America 200% Africa 800,000 Oceania 180% Asia 160% 700,000 Offshore China 600,000 140% 500,000 120% 400,000 100% 300,000 80% 200,000 60% 100,000 40% - 20% 2007 2008 2009 2010 2011 0% 2007 2008 2009 2010 2011 Source: Deutsche Bank, Company data. Note includes equity invested projects Source: Deutsche Bank, company data. Note includes equity invested projects
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Figure 29: CNOOC Financial Summary Year ended 31 December (RMB millions) Income statement 2009 2010 2011 Oil & gas sales 83,914 146,134 189,279 Marketing revenues 20,752 32,446 50,469 Other income 529 1,456 1,196 Total operating revenues 105,195 180,036 240,944 Total operating expenses (48,920) (82,108) (119,794) EBITDA 56,275 97,928 121,150 Depreciation & Amort (15,943) (26,756) (30,521) Other non-recurring income/expenses 386 1,935 2,447 Interest income 638 618 1,196 EBIT 41,356 73,725 94,272 Gross interest expense (535) (1,122) (1,707) Profit before tax 40,821 72,603 92,565 Tax expense (11,335) (18,193) (22,310) Net profit after tax 29,486 54,410 70,255 Cash flows 2009 2010 2011 Cash flows from operating activities 49,624 70,883 116,171 Working capital changes (1,705) 13,542 (19,758) FFO 47,919 84,425 96,413 Capex (39,376) (28,332) (36,823) Other investing activities 2,069 (35,871) (62,213) Free cash flow 12,317 6,680 17,135 Dividends paid (14,175) (14,390) (20,877) Equity raised/(purchased) 00(256) Other financing cash inflow/(outflow) 4,772 12,780 887 Discretionary cash flows 2,914 5,070 (3,111) Balance sheet 2009 2010 2011 Cash and cash equivalents 22,615 27,287 23,678 Other assets 219,654 291,143 360,586 Total assets 242,269 318,430 384,264 Short term debt 122 21,194 19,919 Long term debt 18,570 9,859 18,076 Other liabilities 49,641 71,611 83,413 Total liabilities 68,333 102,664 121,408 Shareholder equity/net assets 173,936 215,766 262,856 Key operating ratios 2009 2010 2011 EBITDA margin 53% 54% 50% ROC (EBIT) 21% 30% 31% ROE (NIT) 17% 25% 27% Capex/sales 37% 16% 15% Capex/EBITDA 70% 29% 30% Dividends/NPAT 48% 26% 30% Credit metrics 2009 2010 2011 Gross Debt/EBITDA 0.3 x 0.3 x 0.3 x Net Debt/EBITDA NA 0.0 x 0.1 x FFO/Debt 256% 272% 254% EBITDA/Interest 105.2 x 87.3 x 71.0 x Gross Debt/Total capitalisation 10% 13% 13% Source: Deutsche Bank, Company data
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Business Description CNPC is one of China’s key state-owned enterprises (SOEs) under the supervision of the SASAC. CPNC is China’s largest oil and gas producer and supplier by production and sales volume. CNPC is also a leading integrated energy companies and a major oilfield and engineering services provider. PetroChina is the largest listed company within the CNPC group, listed on the HK Stock Exchange with a market capitalization of c.US$262bn (11 June 2012)
The issuer, CNPC General Capital Ltd (incorporated in the British Virgin Islands), is a wholly owned subsidiary of China Petroleum Finance Company Limited (CPF) (incorporated in PRC). CNPC has an indirect stake of around 93% in CPF. CPF is also regulated by the CBRC under the direction of the State Council.
Figure 30: CNPC organizational structure
Source: Deutsche Bank, Company data
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CPF’s or CPF (HK)’s obligations are not guaranteed by CNPC and there are no cross-default provisions between CPF/CPF (HK)’s debt and other CNPC’s group debt. The Keepwell arrangements act as a credit enhancement for noteholders but they are weaker than guarantees in our view.
Under the Keepwell Agreements, CNPC and CPF agree that (amongst other things) they will ensure CPF (HK) will have a consolidated net worth of at least US$1 at all times and will have sufficient liquidity to ensure timely payment of any amounts payable in respect of the bonds.
It is also worth highlighting that “Under the urgent circumstance of insufficient disbursement, CNPC will increase the registered capital of the company according to need” according to Article 41 of CPF’s articles of association.
Article 3A in CPF (HK)’s articles of association notes that “If the company had insufficient funds to make any payment under any of its contractual or other obligations then CPF is obligated to make capital contribution or take other action to enable the company to meet its contractual or other payment obligations when due”.
Figure 31: Keepwell agreement and relationships among CNPC, CPF and the Issuer
Source: Deutsche Bank, Company data
The company derives its revenue from the following sources
Exploration and production: Upstream arm of the company which accounted for c.60% of the total crude oil and natural gas production of China in 2011. CPNC also owns c.65% and 73% of the total proved crude oil and natural gas reserves in China, respectively.
Refining and Chemicals: CNPC operates a number of refineries in China and overseas with a total crude oil processing capacity of 219.4million tones pa.
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Marketing: CNPC markets a wide range of refined oil products (gasoline, diesel, kerosene etc) via its extensive sales and distribution network across China. CNPC markets its products through c. 19,362 gas stations (c.18, 792 owned and operated by CNPC).
Trading: International trading business which trades crude oil and refined products in 40 countries/regions by way of commission agency, self-support import/export activities, transit and consigned processing for exports.
Natural gas and pipeline: CNPC is the largest transporter and seller of natural gas by sales volume and accounts for c.70% of total natural gas volumes in China. Natural gas are primarily sold to industrial firms, power generation company, fertilizer and chemical companies, commercial users and municipal utilities.
Oilfield Engineering/Construction and oil equipment manufacturing: Provides a range of oilfield and engineering services, oil and gas field related construction, and oil equipment manufacturing.
Finance and others: Conducts financial services including those conducted by CPF and the Company. CPF acts as the sole treasury center for CNPC and functions as settlement, financing, and cash management center.
Figure 32: CNPC’s revenue composition
4% E&P 7% 20% 4% Refining and chemicals Marketing and trading
Natural gas and pipelines Engineering 21% services/construction 45% Finance & others
Source: Deutsche Bank, Company data. Note: Composition above represents revenue breakdown as a % of total revenue before intersegment elimination
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Figure 33: CNPC’s footprint in China…mostly concentrated in the North and Northwest
Source: Deutsche Bank, Company website
Key credit considerations Strengths:
• Strong ties with the PRC government given strategic importance • Size and market dominance in China • One of the leading vertically integrated oil companies globally • Sound financial risk profile Weaknesses:
• Increasing finding & development cost and capex driven by acquisitive strategy • Exposed to geopolitical and execution risks related to its expansion in West Africa and Middle East • Exposure to volatility in international oil and gas prices • Pressure in refinery margins due to a delay in gas price market reforms
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Figure 34: CNPC’s Financial Summary Year ended 31 December (RMB millions) Income statement 2009 2010 2011 Total operating revenues 1,220,488 1,720,885 2,381,278 Total operating expenses (963,951) (1,394,484) (2,027,421) EBITDA 256,537 326,401 353,857 Depreciation & Amort (121,338) (141,272) (166,226) Other non-recurring income/expenses (4,622) (7,786) 4,625 EBIT 130,577 177,343 192,256 Gross interest expense (5,948) (8,664) (13,976) Interest income 3,791 3,978 3,444 Profit before tax 128,420 172,657 181,724 Tax expense (41,196) (48,473) (51,196) Net profit after tax 87,224 124,184 130,528 Cash flows 2009 2010 2011 Cash flows from operating activities 197,254 283,006 308,137 Working capital changes 38,664 18,752 24,331 FFO 235,918 301,758 332,468 Gross Capex (315,248) (362,049) (376,908) Cash inflows from investing activities (28,471) (49,188) 65,784 Free cash flow (146,465) (128,231) (2,987) Balance sheet 2009 2010 2011 Cash and cash equivalents 257,976 235,670 278,417 Other assets 1,963,629 2,394,286 2,749,459 Total assets 2,221,605 2,629,956 3,027,876 Gross debt 328,816 417,357 479,186 Other liabilities 471,628 644,488 848,008 Total liabilities 800,444 1,061,845 1,327,194 Shareholder equity/net assets 1,421,161 1,568,111 1,700,682 Key operating ratios 2009 2010 2011 EBITDA margin 21% 19% 15% ROC (EBIT) 7% 9% 9% ROE (NIT) 6% 8% 8% Capex/sales 26% 21% 16% Capex/EBITDA 123% 111% 107%
Credit metrics 2009 2010 2011 Gross Debt/EBITDA 1.3 x 1.3 x 1.4 x Net Debt/EBITDA 0.3 x 0.6 x 0.6 x FFO/Debt 72% 72% 69% EBITDA/Interest 43.1 x 37.7 x 25.3 x Gross Debt/Total capitalisation 19% 21% 22% Source: Deutsche Bank
.
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Business Description Sinopec is a state-authorised and invested entity and one of China’s key state-owned enterprises under the supervision of the SASAC. Sinopec is the largest integrated petroleum and petrochemical company and the largest refined oil producer in China. Sinopec is also the largest distributor of refined oil products in China by sales volumes. Sinopec runs the largest number of service stations in China. The largest listed entity within the group, Sinopec Corp (China Petroleum & Chemical Corp), is listed on a HK Stock Exchange (386.HK) with a current market capitalization of $86bn.
The issuer, Sinopec Group Overseas Development (2012) Limited, is a BVI incorporated entity and is effectively a wholly owned subsidiary of the SASAC. The notes are guaranteed by China Petrochemical Corporation, a wholly owned entity of the SASAC/State Council of China.
Figure 35: Sinopec’s organizational structure
Source: Deutsche Bank, Company data
The company operates in the following key segments:
• Exploration and production: consists of exploring for, developing, producing and selling crude oil and natural gas • Refining: consists of purchasing crude oil from exploration and production segment and from third parties. Processing crude oil into refined oil products and selling refined oil products principally to marketing and distribution • Chemicals: purchasing chemical feedstock from refining segment and producing, marketing and selling chemical products
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• Marketing and Distribution: Purchasing refined oil products from refining segment and third parties and market/sell/distribute to wholesale and retail customers • Oil and Petrochemical Engineering Technical Services: provide oilfield services including geophysical exploration, drilling, well logging, etc • Others: principally the international trade, R&D and other businesses
Figure 36: Sinopec’s revenue composition
6% E&P
28% 26% Refining
Chemicals
Marketing & distribution 10% 29% Engineering and others
Source: Deutsche Bank, Company data. Note: Composition above represents revenue breakdown as a % of total revenue before intersegment elimination
Figure 37: Operating profit by segments… Figure 38: …refining margins collapsed in 2011 due to government price controls 200,000 7.00 E&P Refining margin 6.00 150,000 (US$/bbl) Refining 5.00
100,000 4.00 Chemicals 50,000 3.00
Marketing and 2.00 - distribution 1.00
-50,000 Engineering 0.00 and others 2009 2010 2011 2009 2010 2011 Source: Deutsche Bank, Company data Source: Deutsche Bank, Company data
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Figure 39: Sinopec Corp’s footprint in China…mostly concentrated along the South and East coast
Source: Deutsche Bank, Company website
Key credit considerations Strengths:
• Strong ties with the PRC government given strategic importance • Largest refinery and dominant market position in China • Highly integrated structure Weaknesses:
• Refining losses largely remains a subject of government policy • Most acquisitive among the 3 Chinese oil companies • Weakest operating margins amongst peers • Significant capex plan ahead likely to be ongoing drag on free cash flows • Geopolitical and environmental risks
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Figure 40: Sinopec’s Financial Summary Year ended 31 December (RMB millions) Income statement 2009 2010 2011
Total operating revenues 1,391,952 1,969,042 2,551,951 Total operating expenses (1,221,416) (1,757,968) (2,329,958) EBITDA 170,536 211,074 221,993 Depreciation & Amort (69,607) (87,012) (98,791) Other non-recurring income/expenses (10,689) (9,645) 7,158 EBIT 90,240 114,417 130,360 Gross interest expense (9,610) (9,611) (11,763) Interest income 806 861 1,522 Profit before tax 81,436 105,667 120,119 Tax expense (23,578) (33,092) (36,979) Net profit after tax 57,858 72,575 83,140 Cash flows 2009 2010 2011 Cash flows from operating activities 161,688 193,199 202,734 Working capital changes (1,007) 2,573 3,468 FFO 160,681 195,772 206,202 Gross Capex (199,523) (250,229) (242,632) Cash inflows from investing activities 2,849 11,306 11,603 Free cash flow (34,986) (45,724) (28,295) Balance sheet 2009 2010 2011 Cash and cash equivalents 30,796 35,398 77,261 Other assets 1,260,541 1,450,293 1,668,046 Total assets 1,291,337 1,485,691 1,745,307 Gross debt 329,521 384,673 436,912 Other liabilities 416,594 471,906 586,053 Total liabilities 746,115 856,579 1,022,965 Shareholder equity/net assets 545,222 629,112 722,342 Key operating ratios 2009 2010 2011 EBITDA margin 12% 11% 9% ROC (EBIT) 10% 11% 11% ROE (NIT) 11% 12% 12% Capex/sales 14% 13% 10% Capex/EBITDA 117% 119% 109%
Credit metrics 2009 2010 2011 Gross Debt/EBITDA 1.9 x 1.8 x 2.0 x Net Debt/EBITDA 1.8 x 1.7 x 1.6 x FFO/Debt 49% 51% 47% EBITDA/Interest 17.7 x 22.0 x 18.9 x Gross Debt/Total capitalisation 38% 38% 38% Source: Deutsche Bank, Company data
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Important Disclosures Additional information available upon request
Disclosure checklist Company Disclosure CNOOC Ltd 6 Sinopec NA PetroChina 1,7,SD11
*Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies.
Important Disclosures Required by U.S. Regulators Disclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States. See “Important Disclosures Required by Non-US Regulators” and Explanatory Notes. 1. Within the past year, Deutsche Bank and/or its affiliate(s) has managed or co-managed a public or private offering for this company, for which it received fees. 6. Deutsche Bank and/or its affiliate(s) owns one percent or more of any class of common equity securities of this company calculated under computational methods required by US law. 7. Deutsche Bank and/or its affiliate(s) has received compensation from this company for the provision of investment banking or financial advisory services within the past year.
Important Disclosures Required by Non-U.S. Regulators Please also refer to disclosures in the “Important Disclosures Required by US Regulators” and the Explanatory Notes. 1. Within the past year, Deutsche Bank and/or its affiliate(s) has managed or co-managed a public or private offering for this company, for which it received fees. 6. Deutsche Bank and/or its affiliate(s) owns one percent or more of any class of common equity securities of this company calculated under computational methods required by US law. 7. Deutsche Bank and/or its affiliate(s) has received compensation from this company for the provision of investment banking or financial advisory services within the past year.
Special Disclosures 11. Deutsche Bank AG and/or an affiliate(s) acted as a Financial Advisor to PetroChina Company Limited on the acquisition of the entire share capital of Singapore Petroleum Company.
For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr.
Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst about the subject issuers and the securities of those issuers. In addition, the undersigned lead analyst has not and will not receive any compensation for providing a specific recommendation or view in this report. Colin Tan/Gene Cheon
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Deutsche Bank debt rating key
CreditBuy (“C-B”): The total return of the Reference Credit Instrument (bond or CDS) is expected to outperform the credit spread of bonds / CDS of other issuers operating in similar sectors or rating categories over the next six months. CreditHold (“C-H”): The credit spread of the Reference Credit Instrument (bond or CDS) is expected to perform in line with the credit spread of bonds / CDS of other issuers operating in similar sectors or rating categories over the next six months. CreditSell (“C-S”): The credit spread of the Reference Credit Instrument (bond or CDS) is expected to underperform the credit spread of bonds / CDS of other issuers operating in similar sectors or rating categories over the next six months. CreditNoRec (“C-NR”): We have not assigned a recommendation to this issuer. Any references to valuation are based on an issuer’s credit rating. Reference Credit Instrument (“RCI”): The Reference Credit Instrument for each issuer is selected by the analyst as the most appropriate valuation benchmark (whether bonds or Credit Default Swaps) and is detailed in this report. Recommendations on other credit instruments of an issuer may differ from the recommendation on the Reference Credit Instrument based on an assessment of value relative to the Reference Credit Instrument which might take into account other factors such as differing covenant language, coupon steps, liquidity and maturity. The Reference Credit Instrument is subject to change, at the discretion of the analyst.
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David Folkerts-Landau Managing Director
Global Head of Research
Guy Ashton Marcel Cassard Stuart Parkinson Head Global Head Associate Director Global Research Product Fixed Income Research Company Research
Asia-Pacific Germany Americas Europe Fergus Lynch Andreas Neubauer Steve Pollard Richard Smith Regional Head Regional Head Regional Head Regional Head
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