China Oilfield Services (2883 HK) China Oilfiel D Ser Vices

China Energy 22 April 2020

China Oilfield Services (2883 HK) China Oilfiel d Ser vices

Target price: HKD6.30 Share price (22 Apr): HKD5.83 | Up/downside: +8.1%

Initiation: deep-value domestic offshore OFS play Dennis Ip, CFA (852) 2848 4068  CNOOC’s new capex release at end-April likely a positive for COSL [email protected]  A domestic play relatively immune to global oil capex cuts Anna Lu, CFA (852) 2848 4465  Initiating with an Outperform (2) rating and TP of HKD6.3 [email protected]

Investment case: We initiate on China Oilfield Services Limited (COSL), Share price performance

Asia’s largest oilfield equipment and services (OFS) company, with an (HKD) (%) Outperform (2) rating. With c.80% of its revenue derived from affiliate 13 165 CNOOC (883 HK, HKD8.24, Hold [3]), COSL’s profitability is dependent on 11 144 CNOOC’s domestic capex commitment. We believe further clarification 9 123 7 101 from CNOOC on its capex in late April will be a potential catalyst for COSL, 5 80 leading it to rerate from 0.62x 2020E PBR to a 0.68x 2020E PBR. Apr-19 Jul-19 Oct-19 Jan-20

Ch Olfield (LHS) Relative to HSI (RHS) CNOOC’s domestic capex likely upbeat. During the previous oil crisis in 2015-17, COSL’s net profit turned negative as CNOOC cut domestic capex 12-month range 5.18-13.00 significantly, leading to serious underutilisation of COSL’s assets (rig Market cap (USDbn) 3.59 utilisation rate of 40% vs. c.90% in previous years). In the current crisis, we 3m avg daily turnover (USDm) 19.83 Shares outstanding (m) 4,772 believe CNOOC will keep domestic capex intact in response to the Central Major shareholder CNOOC Group (50.5%) Government’s call for national energy security. We note CNOOC has already vowed to keep its domestic production target unchanged, which is Financial summary (CNY) feasible, in our view, given its low all-in cost. We think COSL’s current Year to 31 Dec 20E 21E 22E share price reflects the worst outcome for CNOOC’s capex, and that its Revenue (m) 28,504 26,701 35,322 capex update in late-April will support a slight share-price recovery. Operating profit (m) 3,717 2,300 3,858 Net profit (m) 1,866 1,202 2,250 Core EPS (fully-diluted) 0.391 0.252 0.472 Asset-light transformation paying off. The revenue contribution of its EPS change (%) (14.1) (35.6) 87.2 asset-light and counter-cyclical well services segment rose from 30% in Daiwa vs Cons. EPS (%) (38.4) (62.6) (42.8) PER (x) 13.6 21.2 11.3 2015 to 48% in 2019, thus injecting stability into COSL’s profitability. Dividend yield (%) 2.8 1.8 3.1 Meanwhile for its asset-heavy drilling segment, which saw negative EBIT of DPS 0.147 0.095 0.167 CNY10,076m back in 2016, we expect positive EBIT for 2020E given PBR (x) 0.6 0.6 0.6 CNY8,261m was actually impairment losses in 2016, and we do not believe EV/EBITDA (x) 4.4 4.9 3.7 ROE (%) 4.9 3.0 5.4 substantial booking of impairments will be needed this time as COSL has Source: FactSet, Daiwa forecasts not booked any significant impairment reversal since 2016.

Unjustifiably low valuation. COSL’s share price has corrected by 52% YTD vs. Jereh’s 32% and Anton’s (3337 HK, HKD0.48, Hold [3]) 47% correction YTD, which we view as unjustified as COSL should be relatively immune to global oil capex cuts given its domestic focus (with 78% of revenue from China). COSL-H is also trading at a 228% discount to COSL- A (601808 CH) (vs. a 179% past-12-year discount).

Catalysts: 1) Higher-than-anticipated domestic capex of CNOOC, and 2) higher-than-market-anticipated rig utilisation rate.

Valuation: We initiate on COSL with an Outperform (2) rating and TP of HKD6.3, on a 2020E PBR of 0.68x, or 1.34SD below its past-16-year average. Risks: Lower-than-expected domestic capex for CNOOC; lower- than-expected oil prices.

See important disclosures, including any required research certifications, beginning on page 33

China Oilfield Services (2883 HK): 22 April 2020

Table of contents

All eyes on CNOOC's capex ...... 6 CNOOC’s capital discipline in 2015-17 oil down-cycle ...... 6 Why this time is different? CNOOC’s loss is COSL’s gain...... 7 Asset-light transformation paying off ...... 13 Well services: the stable earnings contributor ...... 14 Drilling services: workload will be okay but day rates under pressure ...... 16 Marine support services: cut back of charted fleet is unavoidable ...... 21 Geophysical acquisition & surveying services: victim of exploration capex cut ...... 21 Financials ...... 23 Healthy gearing with aggressive capex plan ...... 24 Valuation ...... 26 Initiating with an Outperform (2) rating and TP of HKD6.3 ...... 26 Investment risks ...... 27 Larger-than-expected decline in CNOOC’s capex ...... 27 Larger-than-expected decline in oil prices ...... 27 ESG Activities ...... 28 Appendix I: company background ...... 27

China Oilfield Services (2883 HK): 22 April 2020

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook COSL: EBIT by segment

We forecast COSL to see a mild 5% YoY decline in EBIT (CNYm) for 2020E as it is likely to see a substantial decline in day 5,000 rates for rig services and its geophysical acquisition and 0 surveying services segments upon contract renewal in 2H20E. We look for a further 38% YoY decline in EBIT for (5,000)

2021E, assuming the current oil-price weakness prevails (10,000) for a long period of time. Nonetheless, we see significant upside for COSL’s EBIT if there is a major turnaround in oil (15,000) 2015 2016 2017 2018 2019 2020E 2021E 2022E prices. Geophysical acquisition & surveying services Marine Support Services Drilling Services Well Services Source: Company, Daiwa forecasts

Valuation COSL: PBR band

COSL-H shares are trading currently at a 0.62x 2020E PBR (x) PBR, which is 1.46SD below its past-12-year average. 3.0 COSL-A (601808 CH), its dual listed A-share entity listed 2.5 on the Shanghai Stock Exchange, is trading currently at a 2.0 2.0x Avg+2SD 1.5x 2020E PBR. The 228% A-H premium for the same company’s PBR valuation (past-12-year historical average: 1.5 1.6x Avg+1SD 1.2x Avg 179%) suggests that COSL-H is undervalued vis-a-vis 1.0 different markets. We see COSL as a deep-value play for 0.8x Avg-1SD 0.5 investors looking for over-corrected oil names after the

outbreak of the oil price war. 0.0

May-… May-… May-… May-… May-…

May-…

Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20

Sep-15 Sep-16 Sep-17 Sep-18 Sep-19 Sep-14 Source: Bloomberg, Daiwa forecasts

Earnings revisions COSL: Bloomberg-consensus EPS forecast

The market revised up COSL’s 2020-22E earnings (HKD) throughout 2019. Nonetheless, the street then cut its EPS 1.2 forecasts in 2020 as oil prices retreated significantly with 1.0 Brent diving from c.USD65/bbl earlier this year to 0.8 c.USD25-35/bbl due to COVID-19 and the oil-price war. 0.6

Our 2020-22E EPS are 38-63% below the consensus, 0.4 likely due to our lower day rate assumptions for the drilling segment and marine support segment due to our more 0.2

pessimistic global oil price outlook.

Jun-19

Mar-19 Mar-20

Sep-18 Dec-18 Sep-19 Dec-19 2020E EPS 2021E EPS 2022E EPS

Source: Bloomberg

China Oilfield Services (2883 HK): 22 April 2020

Financial summary Key assumptions Year to 31 Dec 2015 2016 2017 2018 2019 2020E 2021E 2022E CNOOC domestic capex (CNYbn) 34.7 21.3 24.7 36.2 50.8 50.6 70.0 71.0 Jack-up utilisation (%) 74 56 61 67 81 85 80 80 Semi-sub utilisation (%) 62 40 45 68 71 65 55 70 Jack-up day rate (000'USD/day) 94 68 71 65 69 62 61 67 Semi-sub day rate (000'USD/day) 296 185 204 173 172 163 160 176

Profit and loss (CNYm) Year to 31 Dec 2015 2016 2017 2018 2019 2020E 2021E 2022E Well Services 6,913 5,568 6,996 9,793 15,030 14,732 14,338 20,016 Drilling Services 12,040 6,499 6,341 7,750 10,825 10,113 8,939 10,872 Other Revenue 4,222 3,019 4,122 4,344 5,221 3,659 3,424 4,434 Total Revenue 23,174 15,086 17,459 21,887 31,076 28,504 26,701 35,322 Other income 242 153 324 284 352 323 303 400 COGS (15,387) (19,221) (10,517) (15,748) (21,222) (18,689) (20,262) (23,226) SG&A 0 0 0 0 0 0 0 0 Other op.expenses (6,399) (7,385) (5,798) (5,780) (6,311) (6,420) (4,441) (8,638) Operating profit 1,632 (11,368) 1,468 644 3,895 3,717 2,300 3,858 Net-interest inc./(exp.) (595) (917) (1,001) (975) (1,051) (709) (618) (725) Assoc/forex/extraord./others 360 477 (124) 1,038 628 1,856 406 546 Pre-tax profit 1,396 (11,807) 342 706 3,472 4,863 2,088 3,678 Tax (288) 348 (261) (618) (944) (1,322) (568) (1,000) Min. int./pref. div./others (35) 3 (38) (18) (26) (36) (16) (27) Net profit (reported) 1,074 (11,456) 43 71 2,502 3,505 1,505 2,651 Net profit (adjusted) 831 (11,609) (251) (543) 2,172 1,866 1,202 2,250 EPS (reported)(CNY) 0.225 (2.401) 0.009 0.015 0.524 0.734 0.315 0.556 EPS (adjusted)(CNY) 0.174 (2.433) (0.053) (0.114) 0.455 0.391 0.252 0.472 EPS (adjusted fully-diluted)(CNY) 0.174 (2.433) (0.053) (0.114) 0.455 0.391 0.252 0.472 DPS (CNY) 0.068 0.050 0.060 0.070 0.160 0.147 0.095 0.167 EBIT 1,632 (11,368) 1,468 644 3,895 3,717 2,300 3,858 EBITDA 5,845 (6,848) 5,957 4,906 8,857 9,061 8,060 10,072

Cash flow (CNYm) Year to 31 Dec 2015 2016 2017 2018 2019 2020E 2021E 2022E Profit before tax 1,396 (11,807) 342 706 3,472 4,863 2,088 3,678 Depreciation and amortisation 4,213 4,520 4,489 4,263 4,962 5,344 5,760 6,214 Tax paid (288) 348 (261) (618) (944) (1,322) (568) (1,000) Change in working capital (3) 3,251 (2,624) (1,173) (1,000) (2,886) (2,103) (1,295) Other operational CF items 1,237 6,430 3,528 972 475 352 415 371 Cash flow from operations 6,556 2,741 5,474 4,150 6,966 6,350 5,592 7,968 Capex (7,867) (3,489) (2,298) (2,398) (3,173) (3,973) (4,158) (4,371) Net (acquisitions)/disposals 59 32 1,050 407 26 25 24 25 Other investing CF items 4,492 (1,221) 3,826 (5,045) 1,995 4,683 137 212 Cash flow from investing (3,316) (4,678) 2,578 (7,036) (1,152) 735 (3,996) (4,135) Change in debt 230 (13,697) (3,551) (693) (3,582) (4,400) (1,537) (1,019) Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (2,290) (324) (239) (286) (334) (701) (451) (795) Other financing CF items 5,492 9,099 (1,090) (2,081) (1,736) (690) (649) (752) Cash flow from financing 3,432 (4,922) (4,880) (3,060) (5,652) (5,791) (2,637) (2,567) Forex effect/others 470 356 (234) 107 32 0 0 0 Change in cash 7,142 (6,503) 2,938 (5,839) 194 1,294 (1,042) 1,266 Free cash flow (1,311) (748) 3,176 1,752 3,793 2,378 1,434 3,597 Source: FactSet, Daiwa forecasts

China Oilfield Services (2883 HK): 22 April 2020

Financial summary continued … Balance sheet (CNYm) Year to 31 Dec 2015 2016 2017 2018 2019 2020E 2021E 2022E Cash & short-term investment 12,574 6,071 9,009 3,170 3,364 4,658 3,616 4,881 Inventory 1,328 1,158 1,149 1,327 1,425 2,166 2,284 2,108 Accounts receivable 6,653 4,796 6,258 8,015 10,306 12,997 15,570 16,866 Other current assets 6,846 9,527 3,461 9,197 7,936 3,425 3,425 3,425 Total current assets 27,401 21,552 19,877 21,709 23,030 23,245 24,894 27,280 Fixed assets 60,388 57,457 52,632 51,533 51,419 50,022 48,395 46,529 Goodwill & intangibles 3,864 427 430 290 62 62 62 62 Other non-current assets 1,871 1,108 1,003 1,155 1,591 1,758 1,856 2,026 Total assets 93,525 80,544 73,941 74,687 76,102 75,088 75,207 75,896 Short-term debt 11,452 5,296 563 5,069 4,419 3,559 3,053 8,619 Accounts payable 8,081 9,304 8,134 8,896 10,284 10,831 11,418 11,244 Other current liabilities 1,526 2,115 3,420 3,046 5,126 5,126 5,126 5,126 Total current liabilities 21,059 16,716 12,117 17,011 19,829 19,515 19,596 24,988 Long-term debt 23,873 27,337 25,905 21,858 18,677 15,137 14,106 7,521 Other non-current liabilities 1,764 1,195 1,232 1,141 686 686 686 686 Total liabilities 46,696 45,248 39,254 40,010 39,192 35,338 34,388 33,195 Share capital 4,772 4,772 4,772 4,772 4,772 4,772 4,772 4,773 Reserves/R.E./others 41,970 30,435 29,793 29,758 31,963 34,766 35,820 37,677 Shareholders' equity 46,741 35,206 34,565 34,530 36,734 39,538 40,591 42,450 Minority interests 87 90 123 148 176 212 228 255 Total equity & liabilities 93,525 80,544 73,941 74,687 76,102 75,088 75,207 75,899 EV 48,281 52,096 43,025 49,348 45,352 39,694 39,214 36,957 Net debt/(cash) 22,751 26,562 17,459 23,757 19,733 14,038 13,543 11,259 BVPS (CNY) 9.796 7.378 7.244 7.237 7.699 8.286 8.507 8.898

Key ratios (%) Year to 31 Dec 2015 2016 2017 2018 2019 2020E 2021E 2022E Sales (YoY) (29.8) (34.9) 15.7 25.4 42.0 (8.3) (6.3) 32.3 EBITDA (YoY) (52.1) n.a. n.a. (17.6) 80.5 2.3 (11.0) 25.0 Operating profit (YoY) (80.6) n.a. n.a. (56.2) 505.3 (4.6) (38.1) 67.7 Net profit (YoY) (88.6) n.a. n.a. n.a. n.a. (14.1) (35.6) 87.2 Core EPS (fully-diluted) (YoY) (88.6) n.a. n.a. n.a. n.a. (14.1) (35.6) 87.2 Gross-profit margin 33.6 n.a. 39.8 28.0 31.7 34.4 24.1 34.2 EBITDA margin 25.2 n.a. 34.1 22.4 28.5 31.8 30.2 28.5 Operating-profit margin 7.0 n.a. 8.4 2.9 12.5 13.0 8.6 10.9 Net profit margin 3.6 (77.0) (1.4) (2.5) 7.0 6.5 4.5 6.4 ROAE 1.8 n.a. n.a. n.a. 6.1 4.9 3.0 5.4 ROAA 0.9 n.a. n.a. n.a. 2.9 2.5 1.6 3.0 ROCE 2.1 n.a. 2.3 1.0 6.4 6.3 4.0 6.6 ROIC 1.9 (17.8) 0.6 0.1 4.9 4.9 3.1 5.2 Net debt to equity 48.7 75.4 50.5 68.8 53.7 35.5 33.4 26.5 Effective tax rate 20.6 (2.9) 76.4 87.4 27.2 27.2 27.2 27.2 Accounts receivable (days) 109.3 138.5 115.6 119.0 107.6 149.2 195.3 167.6 Current ratio (x) 1.3 1.3 1.6 1.3 1.2 1.2 1.3 1.1 Net interest cover (x) 2.7 n.a. 1.5 0.7 3.7 5.2 3.7 5.3 Net dividend payout 30.2 n.a. 669.4 471.8 30.5 20.0 30.0 30.0 Free cash flow yield n.a. n.a. 12.5 6.9 14.9 9.3 5.6 14.1 Source: FactSet, Daiwa forecasts

Company profile

COSL is a leading oilfield services company, whose majority stake (50.53%) is controlled by CNOOC Group. Its major business lines include drilling services, well services, marine support services and geophysical & surveying services.

China Oilfield Services (2883 HK): 22 April 2020

All eyes on CNOOC’s capex

COSL derives c.80% of Being a subsidiary of the CNOOC Group, COSL has close ties with its listed sister revenue from CNOOC company, CNOOC. With the lion’s share of its revenue coming from CNOOC (c.80% as of 2019), COSL can be regarded as a capex proxy for CNOOC with its revenue and profitability hinging strongly on CNOOC’s capex policy. As a result, in the first section of this report, we discuss CNOOC’s capex history and our take on its future capex, which is ultimately of paramount importance to the likely direction of COSL’s share price.

COSL: revenue vs CNOOC’s domestic capex COSL: revenue breakdown (CNYbn) (CNYbn) (CNYbn) 40 70 100% 35 60 80% 30 50 25 60% 40 20 30 15 40% 20 10 20% 5 10 0 0 0% 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 CNOOC Group Others CNOOC's Domestic capex (RHS) CNOOC Group Others

Source: Company, Daiwa Source: Company Note: The historical correlation between COSL’s total revenue and CNOOC’s domestic capex is 0.95.

CNOOC’s capital discipline in 2015-17 oil down-cycle Oil prices slumped Following 3 years of relative price stability with Brent trailing above USD100/bbl, oil prices sharply from June 2014 declined sharply from June 2014 as Saudi Arabia flooded the market in an attempt to break American shale producers’ hold on the market. The steep price decline lasted until both Brent and WTI hit a 13-year low in early 2016 when the OPEC cartel finally decided to negotiate for cooperation on a supply cut. Despite efforts conducted by OPEC to cap production, global oil prices were unable to regain momentum with Brent hovering around USD50-70/bbl, which is much lower than the price range of USD100-130/bbl it had traded before the price war initiated by Saudi Arabia commenced.

Brent: 2011-19 historical prices (USD/bbl) 140 120 100 80 60 40 20 0 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Brent Average

Source: Bloomberg

CNOOC demonstrated In view of the mounting financial pressure inflicted by low oil prices, CNOOC capital discipline with a responded quickly by cutting capex. In 2015, CNOOC slashed its capex by 40% YoY to sharp cut in capex CNY66.5bn in 2015 from CNY107.1bn in 2014. Then, CNOOC trimmed its capex further by 26% YoY to CNY49bn in 2016. The capital discipline was also reflected in the capex hit ratio, with actual capex being 82-95% of the lower band of capex guidance for 4 consecutive years throughout 2015-18, regardless in times of oil price upcycle or down- cycle.

China Oilfield Services (2883 HK): 22 April 2020

CNOOC: actual capex CNOOC: actual capex vs capex guidance (CNYm) (CNYbn) 40% 140 100 30% 50 20% 120 10% 0 0% 100 (10%) (50) (20%) 80 (100) (30%) (40%) 60 (150) (50%) 2014 2015 2016 2017 2018 2019 40 2014 2015 2016 2017 2018 2019 2020E Production Development Exploration Others YoY (RHS) capex Guidance (lower band) Guidance (upper band)

Source: Company Source: Company

Capex cuts by CNOOC The capex cut moved COSL’s net profit into negative territory in 2016. Given 60-70% back in 2015-17 had of COSL’s revenue came from CNOOC back in 2015-16, CNOOC’s significant slashing of been a major negative its capex (including the domestic segment which COSL mainly serves) directly translated for COSL into a slump in COSL’s total revenue, which recorded a 32% per annum decline over 2014- 16. COSL’s asset-heavy drilling segmental revenue, which accounted for c.50% of revenue back in 2015, was hardest hit, declining by 39% per annum over 2014-16, as CNOOC reduced development capex on domestic offshore projects. Given the high fixed D&A expenses of the drilling segment, COSL registered negative EBIT of CNY11.4bn in 2016 in which the drilling segment contributed to a negative CNY10.1bn (ie, 89% of the total).

COSL: revenue by source vs CNOOC’s domestic capex CNOOC: domestic capex by activity (CNYbn) (CNYbn) (CNYbn) 40 70 70 20% 35 60 50 10% 30 50 30 0% 25 40 10 (10%) 20 30 15 (10) (20%) 10 20 (30) (30%) 5 10 (50) (40%) 0 0 (70) (50%) 2014 2015 2016 2017 2014 2015 2016 2017 CNOOC Group Others CNOOC's Domestic capex (RHS) Exploration Development YoY (RHS)

Source: Company, Daiwa Source: Company Note: The historical correlation between COSL’s total revenue and CNOOC’s domestic capex is 0.95.

COSL: revenue by segment COSL: EBIT by segment (CNYm) (CNYm) 50% 10 600% 26 0 100% 0% (10) -400%

(24) (50%) (20) -900% 2014 2015 2016 2017 2014 2015 2016 2017 Geophysical acquisition & surveying services Geophysical acquisition & surveying services Marine Support Services Marine Support Services Drilling Services Drilling Services Well Services Well Services YoY (RHS) YoY (RHS) Source: Company Source: Company

Why is this time different? CNOOC’s loss is COSL’s gain Another oil crisis has The world is now enmeshed in another oil crisis in 2020 – one that has come faster and unfolded in 2020 more furiously, created not only by a human-inflicted supply increase due to the Saudi Arabia-Russia split, but also against the background of pandemic-induced demand

China Oilfield Services (2883 HK): 22 April 2020

destruction. Both oil-price benchmarks, Brent and WTI, have dived by c.60% from their peak in January 2020 in less than 3 months. Despite a seemingly harsher external environment for COSL, we note some key fundamental differences, suggesting the company is better placed to survive the downturn this time round.

Brent: historical price Brent: price movement during negative shocks 120 150 100

100 80

60 50 40

20 0

2020 Oil Crisis 0

52 69 86 18 35

120 137 154 171 188 205 222 239 256 273 290 307 324 341 358 375 392 409 426 (50) 103 Jan-10 Apr-11 Jul-12 Oct-13 Jan-15 Apr-16 Jul-17 Oct-18 Jan-20 (Days) Brent WTI 2010s Oil Glut 2020 Oil Crisis

Source: Company Source: Company; Note: Rebased to 100 as of 25 April 2014 and 6 January 2020

No.1: CNOOC’s Seven-Year Action Plan National energy security CNOOC’s capex has become largely policy-driven since President Xi Jinping’s call remains a top for national energy security in 2018. Facing pressure from the China-US trade war, government priority President Xi told government agencies and oil majors to study and quickly implement amid the country’s rising measures to increase domestic oil and natural gas exploration and production to ensure import reliance on both national energy security in July 2018. The big-3 oil majors, PetroChina (857 HK, HKD2.86, oil and gas Outperform [2]), Sinopec (386 HK, HKD3.76, not rated) and CNOOC, then rushed to boost domestic O&G production. While the former 2 are mainly focused on inland shale gas development, CNOOC shoulders the responsibility for the development of offshore O&G projects. Despite efforts to raise domestic production of O&G in China, the rise in domestic supply is still lagging behind the growth of apparent O&G demand, thus leading to a continuous rise in the ratio of the import reliance for crude oil and natural gas to 73% and 43% respectively for 2019 from 49% and 1% back in 2008. We see this lag in the development of domestic production as a positive sign for COSL as it indicates that capex on domestic E&P will still likely remain in an upswing to reverse the trend.

China: import reliance ratio for crude oil and natural gas 80%

60%

40%

20%

(20%)

(40%)

1999 2004 1995 1996 1997 1998 2000 2001 2002 2003 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Crude Oil Natural Gas

Source: National Bureau of Statistics of China, Daiwa

CNOOC aims to double The “Seven-year Action Plan” formulated by CNOOC will remain intact in the long domestic E&P by 2025 term, with a capex catch-up despite a decline in 2020. In January 2019, CNOOC initiated “a Seven-Year Action Plan” in response to the Central Government’s call for national energy security. The plan is divided into 2 major parts. 1) Double-Doubling: Doubling CNOOC’s proven reserves to 10bnboe by 2025E (from 4.96bnboe in 2018) as well as doubling the level of exploration activities. 2) Double-20million: Boosting its gas production to 20mcm (or 0.132mmboe) per year in the western South China Sea and its oil production to 20mtpa (or 143mmboe) in the eastern South China Sea.

China Oilfield Services (2883 HK): 22 April 2020

CNOOC’s domestic The “Seven-Year Action Plan” directly translates into an increase in domestic capex increase was a offshore E&P capex. In 2019, CNOOC spent CNY79.6m to support reserves and direct outcome that production growth, which almost touched the upper band of its capex guidance. In January benefited COSL 2020, CNOOC’s management set high production targets of 525mmboe for 2020, 555mmboe for 2021 and 590mmboe for 2022E, while guiding for capex of CNY85-95bn for 2020E (13 January 2020 memo). Thanks to the surge in CNOOC’s capex, COSL also saw a marked increase in revenue and EBIT for 2019. In view of the oil-price crisis in 2020, CNOOC suggested that it would revise its capex plan, which was based on an assumption that oil prices would remain at USD65/bbl (25 March 2020 Memo), but we believe the impact on domestic capex will be much smaller than the market anticipates, thus providing a share-price catalyst for COSL, which is the main OFS subcontractor for CNOOC’s domestic offshore E&P activities.

CNOOC: actual capex vs capex guidance CNOOC: actual production and production guidance (CNYbn) (mmboe) 140 700 590 555 600 507 525 120 496 477 470 475 500 433 242 228 180 189 100 400 172 166 167 166 163 300 80 200 323 326 336 327 348 269 311 303 309 60 100 0 40 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E 2014 2015 2016 2017 2018 2019 2020E Domestic Overseas capex Guidance (lower band) Guidance (upper band) Guidance (Domestic) Guidance (Overseas) Source: Company Source: Company

COSL: revenue from the CNOOC Group COSL: EBIT by segment (CNYbn) (CNYbn) 30 15 24.4 25 21.6 5

20 16.7 15.6 (5) 15 13.1 10.5 10 (15) 2014 2015 2016 2017 2018 2019 5 Geophysical acquisition & surveying services Marine Support Services 0 Drilling Services 2014 2015 2016 2017 2018 2019 Well Services

Source: Company Source: Company

Domestic development The Seven-Year Action Plan is an “unchanged commitment to the government “unchanged regardless regardless of whether oil prices go up or down”, according to management. During of oil prices”, according its post-2019 results briefing, when asked about the prospect of the “Seven-Year Action to CNOOC’s Plan” under the current low oil-price environment, CNOOC’s management replied that the management Seven-Year Action Plan is “a commitment to the government that CNOOC will hold unchanged regardless if oil prices go up or down”. This statement is in line with our belief that CNOOC’s domestic capex will likely remain resilient despite the company facing cash flow pressure under the low oil-price environment.

CNOOC revealed its plan to keep its domestic production target in 2020 unchanged, while capex was cut by 10-15% on its official WeChat account. While a detailed capex and production plan will likely be provided in its post-1Q20 results analysts’ briefing in late April, we see the preliminary results released on CNOOC’s official WeChat platform providing insight into the company’s capex plan (Weixin, 7 April 2020). In a post on 7 April, CNOOC stated that the company would keep its domestic O&G production target unchanged for 2020, while aiming to cut capex by 10-15%. It also outlined a plan to cut total costs by no less than 10%, including a CNY5bn cost cut through efficiency

China Oilfield Services (2883 HK): 22 April 2020

enhancement and another CNY5bn cost cut on the overhaul of loss-making segments. These moves again reaffirm our conviction that a cut in domestic capex by CNOOC would at most be mild in order to achieve the domestic O&G production target. CNOOC’s 10-15% capex cut to be formally announced is at the lower-end of the street’s anticipation, which will likely be a positive surprise for COSL as a smaller-than-expected capex cut would translate into a smaller YoY revenue decline.

Limited space for Domestic capex in 2020 likely to be at least flat YoY despite 2020 actual capex of a CNOOC’s capex cut mere CNY63.25bn. We forecast CNOOC’s 2020 capex at CNY63.25bn, which is 25% shy of the original lower band of the 2020 capex announced by CNOOC in January 2020 at CNY85bn and c.10-20% below the latest unofficial guidance announced on 7 April, given: 1) CNOOC has a track record of having actual capex below the lower band of guidance during an oil-price down-cycle, and 2) some overseas projects may see unanticipated delays due to capex cuts by CNOOC’s overseas oil partners. Yet, it is noteworthy that this conservative assumption is still higher than CNOOC’s capex of CNY62.6bn in 2018.

CNOOC: actual capex and capex forecast (CNYbn) 130 120 110 100 90 80 70 60 50 40 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E capex Guidance (lower band) Guidance (upper band) Daiwa's forecast

Source: Company and Daiwa’s forecasts

We expect CNOOC’s We also believe CNOOC’s domestic capex will be flat YoY for 2020E while most of 2020 domestic capex to the cut will be on overseas capex. As national energy security remains one of the top be an upbeat surprise to priorities of China’s government, we believe CNOOC will prioritise domestic E&P projects the market over overseas projects. Indeed, we note that CNOOC has shifted its focus back to domestic E&P in recent years due to the Central Government’s call for national energy security, as evidenced by the higher growth rate of its domestic capex since 2017. While CNOOC has yet to announce the revised distribution of capex, we have already seen some indications from CNOOC’s recent decisions.

In April, CNOOC put the planned drilling of an exploratory well off Canada on hold (2 April 2020 upstream), ostensibly citing a lack of safety because of the COVID-19 pandemic, but we see this as the “first step” in the company’s overseas capex cut and expect further such reports to follow, while for the domestic segment, we have seen E&P development in offshore China remain unaffected by the low-oil price environment, as evidenced by CNOOC’s announcement of the discovery of Kenli 6-1 in Bohai with output of 1,178bpd. We expect CNOOC to announce a marked decline in overseas capex during its 1Q20 results announcement, while domestic capex, to the surprise of many, will likely prove resilient. We expect its domestic capex to remain flat for 2020E despite the low oil-price environment.

China Oilfield Services (2883 HK): 22 April 2020

CNOOC: actual capex YoY change and forecasts CNOOC: actual capex by geography and forecasts 100% (CNYbn) 120 Overseas focus Domestic focus 50% 100 43 80 15 14 35 0% 28 60 13 18 31 26 40 25 (50%) 63 27 70 71 55 51 51 20 42 35 36 21 25 (100%) 0 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E Domestic Overseas Domestic Overseas Domestic (Daiwa's forecast) Overseas (Daiwa's forecast) Domestic (Daiwa's forecast) Overseas (Daiwa's forecast) Source: Company and Daiwa’s forecasts Source: Company and Daiwa’s forecasts

No.2: CNOOC’s all-in cost declining streak Low all-in cost enables An improvement in all-in cost underpins CNOOC’s ability to maintain production CNOOC to maintain during low oil prices. Since 2013, CNOOC has been conducting a series of cost-cutting production levels under efforts to reduce its all-in cost from USD45.02/bbl for 2013 to USD29.78/bbl for 2019. the oil price war Besides, CNOOC’s management suggests that all of its new oil projects have gone through a “USD35/bbl stress test” (25 March 2020 Memo), which is one of the reasons for the continual decline in all-in cost. The much lower all-in cost should enable CNOOC’s existing production to remain commercially viable despite low oil prices, thus there should be no need for CNOOC to cut production, as it did in 2015-17, in the face of oil-price weakness.

CNOOC: all-in cost breakdown CNOOC: actual production and production guidance (USD/boe) (mmboe) 50 45.02 50 42.30 700 590 39.82 555 600 507 525 34.67 496 477 475 40 32.55 40 470 30.39 30.43 30.16 500 433 29.78 29.50 242 228 180 189 30 30 400 172 166 167 166 163 300 20 20 200 323 326 336 327 348 269 311 303 309 10 10 100 0 0 0 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E Domestic Overseas Lifting cost Taxes ex.income tax DD&A Dismantlement SG&A Guidance (Domestic) Guidance (Overseas) Source: Company, Daiwa forecasts Source: Company

Cost competitiveness Among the big-3 oil majors, CNOOC also has the greatest cost competitiveness and also forces CNOOC to will likely be the last man standing. CNOOC’s all-in cost is now the lowest among the 3 shoulder the NOCs thanks to its cost-cutting mission since 2013. We believe this cost advantage has responsibility of afforded CNOOC the clout to restart its production growth mission should oil prices post a domestic production recovery later this year. Due to the oil-price war, PetroChina and Sinopec’s E&P segments are likely to be more adversely impacted by the price crash and are more likely to scale back capex or even reduce production at uneconomical fields given their already-higher lifting and all-in costs, let alone the inherently shorter life-cycle of shale gas projects that PetroChina and Sinopec focus on. In fact, PetroChina has already shut down 262 oil wells and water injection wells in Tarim Oilfield that are no longer profitable (Reuters, 7 April 2020). Against this backdrop, CNOOC will have to shoulder most of the responsibilities of enhancing China’s energy security through the development of new domestic projects, thus limiting space for CNOOC to slow its pace of domestic production growth.

China Oilfield Services (2883 HK): 22 April 2020

China oil majors: all-in costs for operations of O&G activities China oil majors: lifting costs (USD/boe) (USD/boe) 60 20

50 15 40

30 10

20 5 10

0 0 2013 2014 2015 2016 2017 2018 2019 2013 2014 2015 2016 2017 2018 2019 CNOOC PetroChina Sinopec CNOOC PetroChina Sinopec

Source: Company Source: Company Note: All-in costs for operations are based on the cost of operations of oil and gas activities only. For all-in costs of the whole E&P segment, PetroChina all-in costs would be c.USD45/boe and Sinopec USD60/boe (vs. CNOOC’s c.USD30/bbl.)

Domestic exploration CNOOC will also have to maintain a high level of capex on exploration activities in needs to continue in order to avoid DD&A costs from going up too significantly. CNOOC’s depreciation, order to drive down depletion and amortisation (DD&A) costs are calculated based on the company’s proved DD&A costs reserves. As some uneconomical fields under the current low oil-price environment have to be removed, should the weak oil-price environment prevail till the end of this year, based on the GAAP standard, DD&A costs will shoot up if there is insufficient addition of proven reserves. During the post-2019 analysts’ conference call, management suggested that the company will “try to boost our reserve side”. Although we believe CNOOC will eventually see an increase in its all-in cost in 2020 due to a 13% YoY increase in DD&A costs in the same year, it is likely CNOOC will still step up its efforts in exploration activities (particularly domestic offshore shallow-water projects, like Kenli 6-1 in Bohai Bay), in an attempt to contain its DD&A costs.

CNOOC: DD&A costs (USD/boe) 25

23.53 21.03 21.30 22.12 10 19.89 19.05 16.42 16.87 17.70 17.50 5

0 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E

Source: Company, Daiwa forecasts

China Oilfield Services (2883 HK): 22 April 2020

Asset-light transformation paying off

Technology segment a COSL is the largest OFS company in Asia and is engaged in the provision of well services, focus for COSL after the drilling services, marine support services as well as geophysical services. After recording a previous down-cycle significant net loss of CNY11,456m for 2016, COSL created a “Double-50%” strategy in 2017 with 2 main focuses: 1) Technology/equipment: Deriving 50% of revenue from the technology segment (well services) and 50% of revenue from the equipment segment (drilling services, marine transportation services and geophysical and surveying segments). 2) Domestic/overseas: Deriving 50% of revenue from China and 50% of revenue from the rest of the world.

As of 2019, the technology segment (ie, well services) accounted for 48% of total revenue, up from 30% in 2015. The counter-cyclical nature of the technology segment, together with CNOOC’s overriding ambition for domestic development, should enable COSL to be more resilient this time in terms of profitability, in our view.

COSL: value chain Exploration Development Production

Seismic - Drilling fluids - Drilling fluids - Directional drilling - Directional drilling - Cementing - Cementing - Well workovers - Logging - Logging - Production logging

Survey - Well completion - Well completion

well services well Geophysical & Geophysical

Well workover team Platform Producing Wildcat well Appraisal Development installation installation drilling well drilling well drilling rd rd

Drilling (3 party) (3 party)

- FPSO - Shuttle tankers - Towing and - Towing and management - Standby achoring achoring - Terminal vessels

Shipping - Supply - Supply management - Supply vessels - Support team - Support team - Support - Crew boats team

Source: Daiwa

COSL: revenue by segment COSL: revenue breakdown (CNYm) 100% 40,000

30,000

50%

20,000 57%

10,000 54%

52%

48%

45%

40%

37%

30% 29% 0 0% 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E Geophysical acquisition & surveying services Geophysical acquisition & surveying services Marine Support Services Marine Support Services Drilling Services Drilling Services Well Services Well Services Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

China Oilfield Services (2883 HK): 22 April 2020

Well services: a stable earnings contributor Well services likely to The well services segment is COSL’s most stable, profitable and rapidly-growing segment. see mild downside Its services include logging, drilling and completion fluids, directional drilling, cementing during the oil-price and well completion. With c.92% of segment revenue from CNOOC Group as of 2019, we down-cycle forecast well services segmental revenue to only decline by a mild 2% YoY for 2020E, with a 2% YoY increase in revenue from CNOOC offsetting a 50% decline in revenue from other parties (mainly overseas projects) in 2020E. However, we forecast segmental EBIT to decline to CNY1,775m for 2021E from CNY2,938m for 2019 and CNY2,946m for 2020E due to difficulty in bargaining for higher services fees during contract renewal negotiations.

COSL: well services segmental forecasts 2015 2016 2017 2018 2019 2020E 2021E 2022E Total Revenue (CNYm) 6,913 5,568 6,996 9,793 15,030 14,732 14,788 20,583 Revenue (CNOOC) (CNYm) 6,317 5,382 6,498 9,025 13,902 14,168 14,450 19,737 Revenue (Others) (CNYm) 596 186 497 768 1,128 564 338 846 EBIT (CNYm) 394 (422) 1,370 1,636 2,938 2,946 1,775 3,087 EBIT margin 6% -8% 20% 17% 20% 20% 12% 15%

Source: Bloomberg, Daiwa forecasts

COSL: well services segmental revenue COSL: well services segmental EBIT (CNYm) (CNYm) (USD/bbl) 22,500 60% 3,500 25% 50% 20,000 3,000 20% 17,500 40% 2,500 15% 15,000 30% 20% 2,000 12,500 10% 10% 1,500 10,000 5% 0% 1,000 7,500 -10% 500 0% 5,000 -20% 0 -5% 2,500 -30% 0 -40% (500) -10% 2015 2016 2017 2018 2019 2020E 2021E 2022E 2015 2016 2017 2018 2019 2020E 2021E 2022E CNOOC Other YoY (RHS) CNOOC EBIT Margin (RHS)

Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

Stable income thanks Low correlation with oil prices underpins the stability of well services. low correlation with oil The well services segment is the least cyclical among all of COSL’s segments. The prices segmental revenue generated by well services saw a weak -0.15 correlation with Brent crude over 2012-19 (vs. a 0.70-0.96 correlation for COSL’s other 3 segments). Besides, segmental EBIT of well services also has the lowest positive correlation of 0.04 (vs. 0.70- 0.89 correlation of other segments). We believe this low correlation can be partly attributed to the large revenue contribution from CNOOC, which maintains relatively stable production while other segments are more closely related to exploration activities which fluctuate more with oil prices. Numerically, this low correlation suggests that the well services segment should be able to withstand the challenges from the tumble in oil prices.

COSL: correlation between revenue and Brent historical price COSL: correlation between EBIT and Brent historical price 0.96 1.0 1.0 0.89 0.78 0.9 0.79 0.70 0.8 0.8 0.70 0.6 0.7 0.6 0.4 0.5 0.2 0.4 0.0 0.3 0.2 -0.2 0.04 -0.15 0.1 -0.4 0.0 Well Services Drilling Services Marine Support Geophysical Well Services Drilling Services Marine Support Geophysical Services acquisition & Services acquisition & surveying services surveying services Source: Daiwa Source: Daiwa

China Oilfield Services (2883 HK): 22 April 2020

CNOOC’s contribution to CNOOC’s policy-driven capex supports the stability of well services segmental inject even more stability earnings. With 92% of revenue coming from CNOOC, total segmental revenue hinges on CNOOC’s domestic capex with a strong correlation of 0.90. As stated above, we believe CNOOC’s capex will be largely unaffected in 2020-22 as national energy security remains one of the Central Government’s top priorities. Unlike some of its peers, such as Anton (3337 HK, HKD0.48, Hold [3]), COSL discloses few details, like contract backlog, about this segment. We therefore peg COSL’s segmental revenue from CNOOC to our forecast for CNOOC’s domestic capex. We look for a slight 2% YoY increase in COSL’s 2020E well segmental revenue as CNOOC will likely spend a higher proportion of its domestic capex on production rather than exploration in order to fulfil its 2020E production target, thus leading to high demand for COSL’s well services.

Yet, we forecast COSL’s segmental EBIT margin to contract from 20% for 2019 to 12% for 2021E, as we expect CNOOC to bargain for lower well services fees to minimise costs in order to break even; but this margin contraction should be manageable given the services fees for projects in 2020E are already locked in by contracts, and COSL’s management suggested during the post-2019 analysts’ briefing in late March that it has not thus far been required by CNOOC to revisit any existing contracts. We expect the margin contraction to become prominent only in 2021E when contract renewal takes place, but a likely oil price recovery by then should limit the downside for services fees.

COSL: well services segmental revenue from CNOOC vs COSL: well services segmental forecasts CNOOC’s domestic capex (CNYm) (CNYm) 25% 25,000 80,000 20% 70,000 20,000 60,000 15% 50,000 15,000 10% 40,000 10,000 30,000 5% 20,000 5,000 0% 10,000 0 0 -5% 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E Wells services segmental revenue from CNOOC -10% 2016 2017 2018 2019 2020E 2021E 2022E CNOOC's domestic capex (RHS) Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts Note: Correlation between COSL‘s well services segmental revenue and CNOOC’s domestic capex is 0.90.

Non-CNOOC revenue will likely be severely affected by global capex cut. The fate of the COSL’s non-China revenue segment will be very different from that of CNOOC’s revenue, as non-CNOOC segmental revenue is mainly from overseas projects with lower margins, which are prone to downturns in global oil prices. We forecast a 50% decline in COSL’s non-CNOOC revenue for 2020E followed by a further 40% decline for 2021E upon the renewal of contracts. Due to a predicted sharp fall in non-CNOOC revenue, we look for the segmental revenue contribution from CNOOC to rise from 92% for 2019 to 96% for 2020E and 98% for 2021E.

COSL: well services segmental non-CNOOC revenue COSL: well services segmental revenue breakdown (CNYm) 100% 2,100 200% 80% 1,600 150%

1,100 100% 60%

600 50% 97% 93% 92% 92% 96% 98% 96% 40% 100 0%

(400) (50%) 20%

(900) (100%) 0% 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E 2016 2017 2018 2019 2020E 2021E 2022E Other YoY (RHS) CNOOC Other

Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts 15

China Oilfield Services (2883 HK): 22 April 2020

Drilling services: stable workload but day rates under pressure Utilisation rates of rigs The drilling services segment provides traditional drilling rigs, module rigs, land drilling rigs remain resilient but day and rig management services. COSL has the second-largest offshore drilling rig fleet in the rates will likely come world with 52 drilling rigs (38 jack-ups and 14 semi-subs) in 2019 with 2 more jack-ups under pressure expected to come on line in 2020E. COSL has gradually shifted more resources back to China following CNOOC’s shift of development focus back to the domestic segment since 2018. We believe this domestic focus will provide solid support for usage of COSL’s rigs (with above 70% overall utilisation in 2020-22E). However, we believe rig day rates (particularly for semi-sub rigs that are used for more costly deep-water operations) will likely be under pressure due to the oil price war. We forecast COSL’s drilling services segmental revenue to decline by 7% YoY in 2020E and 12% YoY in 2021E while segmental EBIT declines by 9% YoY in 2020E and 34% YoY in 2021E due to margin squeeze.

COSL: drilling services segment forecast 2015 2016 2017 2018 2019 2020E 2021E 2022E No. of drilling jack-up rigs 32 33 32 36 38 40 40 40 Utilization rate of jack-up rigs (%) 74% 56% 61% 67% 81% 85% 80% 80% Day rate of jack-up (CNY'000/day) 610 472 464 446 481 435 426 469 Revenue (Jack-up) (CNYm) 5,373 3,182 3,342 3,690 5,360 5,395 4,976 5,473 No. of drilling semi-sub rigs 11 11 11 12 14 14 14 14 Utilisation rate of semi-sub rigs (%) 62% 40% 45% 68% 71% 65% 55% 70% Day rate of semi-sub (CNY'000/day) 1,922 1,283 1,333 1,187 1,200 1,144 1,121 1,233 Revenue (Semi-sub) (CNYm) 4,563 2,085 2,391 3,404 4,322 3,799 3,150 4,410 Revenue (Other) (CNYm) 2,104 1,231 608 656 1,143 919 813 988 Total Revenue (CNYm) 12,040 6,499 6,341 7,750 10,825 10,113 8,939 10,872 EBIT (CNYm) 973 (10,076) (112) (1,255) 443 405 268 413 EBIT margin 8% -155% -2% -16% 4% 4% 3% 4%

Source: Bloomberg, Daiwa forecasts

COSL: drilling rig fleet

Source: Company

China Oilfield Services (2883 HK): 22 April 2020

CNOOC’s domestic Reduced cyclicality of drilling services segment thanks to CNOOC’s domestic focus. focus to support high rig According to our calculations, we find a strong 0.96 correlation between COSL’s drilling utilisation rates for services segmental revenue from CNOOC and CNOOC’s domestic capex in 2012-19. In COSL the last oil crisis in 2015-17, COSL’s drilling rig utilisation plunged from 92% in 2014 to 71% in 2015, then to 52% in 2016 as CNOOC switched its focus towards its overseas segment in order to save all-in costs. Consequently, COSL’s drilling services segmental revenue from CNOOC plunged by 37% YoY in 2015 and 51% YoY in 2016. Yet, the backdrop is completely different this year as CNOOC has to focus on domestic E&P under the Central Government’s requirement. CNOOC’s domestic focus was directly reflected in COSL’s well services segmental revenue with contribution from CNOOC rising from the trough of 42% in 2016 to 59% in 2019. We expect CNOOC’s ongoing development in the Bohai Sea (water depth of 10-30m) and South China Sea (water depth of 900-1500m) to support the workload for COSL’s jack-up rigs and semi-sub rigs, respectively.

COSL: drilling services segmental revenue from CNOOC vs COSL: well services segmental revenue breakdown CNOOC’s domestic capex (CNYm) (CNYm) 100% 10,000 80,000 70,000 80% 8,000 60,000 60% 6,000 50,000 40,000 40%

4,000 30,000

68%

65% 65%

59% 58%

20,000 55%

54%

52% 49% 2,000 20% 47% 10,000 42% 0 0 0% 2012 2013 2014 2015 2016 2017 2018 2019 2020E2021E 2022E 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E Drilling services segmental revenue from CNOOC CNOOC Other CNOOC's domestic capex (RHS) Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts Note: Correlation between COSL‘s drilling services segmental revenue and CNOOC’s domestic capex is 0.96.

Jack-up utilisation Utilisation rate of COSL’s jack-up rigs will continue to remain high, supported by supported by CNOOC’s CNOOC’s development of the shallow-water area in Bohai. One of the main focuses of development in Bohai CNOOC’s domestic production plan is heavy oil thermal recovery projects in Bohai, with 6 out of 10 new projects-to-come in 2020E being located in Bohai. On 16 March 2020, CNOOC announced a large-sized discovery at the Kenli 6-1 site in Bohai Bay, which is expected to be the first large-sized oilfield in Laibei Lower Uplift with production capacity of 1,178bpd. Given the operational area for CNOOC’s projects in Bohai are mainly in shallow water with a depth of 10-30m, this geographical structure provides solid demand for COSL’s jack-ups rigs. In fact, due to the strong demand for offshore rigs in China, COSL has chartered 9 rigs in 2019 to meet CNOOC’s needs. With this captive demand, we expect COSL will continue to see a peer-leading jack-up rig utilisation rate of c.80%, yet the day rate will likely come under pressure (as we expect CNOOC to ask for lower leasing fees to maintain commercial viability of its oil fields) and stay at c.USD61-62k/day over 2020-21E. We also forecast total operating days to increase from 11,135 in 2019 to 12,410 in 2020E due to the addition of 2 more jack-up rigs.

COSL: jack-up revenue and operating days COSL: jack-up rigs day rate and utilisation rate (CNYm) (USDk/day) 9,050 14,000 140 100% 8067 127 8,050 130 6887 12,000 117 7,050 6275 120 90% 10,000 108 6,050 5373 5360 5395 5473 110 4976 80% 5,050 8,000 100 94 3690 4,050 3182 3342 90 6,000 70% 3,050 80 71 69 4,000 68 65 67 2,050 70 62 61 60% 1,050 2,000 60 50 0 50 50% 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E Revenue Operating Days (RHS) Day rate Utilization rate (RHS)

Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts 17

China Oilfield Services (2883 HK): 22 April 2020

Global jack-up rigs day rate Global jack-up rigs utilisation rate (USD/d) (%) 190,000 100 170,000 90 150,000 80 130,000 70 110,000 60 90,000 50 70,000 40 50,000 30 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Feb-19 Feb-20 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Feb-19 Feb-20 Jackup IC 250 WD Day Rate Jackup IC 300 WD Day Rate Jackup IC 250 WD Utilization Rate Jackup IC 300 WD Utilization Rate Jackup IC 350+ WD Day Rate Jackup IC 300+ WD Utilization Rate Jackup IC 350+ WD Utilization Rate Source: Bloomberg Source: Bloomberg

Semi-sub utilisation will We see a gloomier picture for COSL’s semi-sub rigs due to the high cost of deep- likely see larger water operations in the East China Sea and South China Sea. As part of its plan to downsizing given the increase reserve life and to sustain long-term production growth, CNOOC has turned its high-cost nature of eye to deep-water projects in the South China Sea. As CNOOC stepped up exploration deep-water operations activities in deep-water areas, COSL’s semi-sub rigs utilisation rate rebounded from 40% in 2016 to 71% in 2019. With two Liuhua projects in the Eastern South China Sea scheduled to commence operation in 2H20E, we believe COSL’s semi-sub rigs utilisation rate will likely be supported by domestic production demand. Nonetheless, we believe demand for semi-sub rigs for deep water exploration will likely be delayed due to the high costs involved. We forecast COSL to see a marked 16pp contraction of semi-sub utilisation rate in 2019-21E together with a 3.5% drop per annum in day rate during that period. As a result, we expect revenue from semi-sub drilling services to decline gradually from CNY4,322m in 2019 to CNY3,150m in 2021E.

COSL: semi-sub revenue and operating days COSL: semi-sub rigs day rate and utilisation rate (CNYm) (USDk/day) 8,050 4,000 350 323 322 100% 6930 298 7,050 3,500 296 5973 300 90% 6,050 3,000 4563 250 80% 5,050 4322 4410 2,500 204 3799 185 4,050 3404 2,000 200 173 172 176 70% 3207 3150 163 160 3,050 2391 1,500 2085 150 60% 2,050 1,000 100 50% 1,050 500 50 0 50 40% 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E Revenue Operating Days (RHS) Day rate Utilization rate (RHS)

Source: Bloomberg, Daiwa forecast Source: Bloomberg, Daiwa forecast

Global semi-sub rigs day rate Global semi-sub rigs utilization rate (USD/d) (%) 500,000 100 90 400,000 80 70 300,000 60 50 200,000 40 30 100,000 20 10 0 0 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Feb-19 Feb-20 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Feb-19 Feb-20 Semisub < 1500 WD Day Rate Semisub 1500-5000 WD Day Rate Semisub < 1500 WD Utilization Rate Semisub 1500-5000 WD Utilization Rate Semisub 5000-8000 WD Day Rate Semisub 8000+ WD Day Rate Semisub 5000-8000 WD Utilization Rate Semisub 8000+ WD Utilization Rate Source: Bloomberg Source: Bloomberg

Impairment losses will likely be much less serious in 2020 after booking of impairment losses in 2016. As an asset-heavy asset, the drilling services segment, which accounts for 45% of COSL’s total assets while contributing 35% of revenue and 15% of

China Oilfield Services (2883 HK): 22 April 2020

EBIT as of 2019, saw negative EBIT of CNY10,076bn in 2016 during the previous oil price downturn, in which CNY8,261m was actually impairment losses per our calculation. We believe after the booking of impairment losses in 2016, another large booking of impairment losses is unlikely to be seen in 2020 as COSL should have already taken prudent accounting practice given it had not booked any significant impairment reversal since 2016.

COSL: total asset by segment COSL: drilling services segmental D&A cost and impairment losses 100,000 (CNYm) 0 (1,000) (2,000) 50,000 (3,000) (4,000) (5,000) (6,000) 0 (7,000) 2012 2013 2014 2015 2016 2017 2018 2019 (8,000) Geophysical acquisition & surveying services (9,000) Marine Support Services 2012 2013 2014 2015 2016 2017 2018 2019 Drilling Services D&A Cost Total impairment losses Well Services Source: Company, Daiwa Source: Company, Daiwa

Re-deployment flexibility “Back to domestic” will continue to be the focus of COSL’s drilling services provides further support segment. We believe COSL will temporarily shelve part of its “Double-50%” strategy of to utilisation of rigs deriving 50% of revenue from China and 50% of revenue from the rest of the world. Alongside China’s back-to-domestic strategy, COSL has recalled 10 rigs from overseas back to China since mid-2018 and 3 more in 2019 to support domestic production growth, resulting in a rise in domestic rig ratio to 74% in 2019 from 61% in 1H18. In 2020E, COSL guided a further increase in the domestic rig ratio to 75% (ie, 41 domestic rigs and 14 overseas rigs). In view of the global overcapacity of offshore drilling rigs, which further deteriorated due to the global oil price downturn, we believe COSL will likely deploy more rigs back to the domestic market given the dim outlook overseas amid the low oil-price environment coupled with OPEC+ output cuts. Aside from self-owned rigs, COSL leased 9 drilling rigs in 2019 (mainly for deep-water projects in the South China Sea), but COSL’s management said during its post-2019 results briefing that there will be no extra penalty incurred for termination of leasing contracts. Besides, we see no cancellation of overseas projects thus far according to the rig operation status as of 29 February 2020 released by COSL. COSL’s management also confirmed in mid-April that there was no cancellation of orders.

Global offshore drilling rigs oversupply situation Stacking Under construction Warm Cold Number Contracted Rate Jack -up 83 50 56 5 9% Semi-sub 26 22 8 0 0% Drillship 15 16 18 1 6% Total 124 88 82 6 7%

Source: Company, IHS Report as of December 2019

China Oilfield Services (2883 HK): 22 April 2020

COSL: rig operation status as of 29 February 2020

Source: Company

COSL: rig operation status as of 31 December 2019

Source: Company

China Oilfield Services (2883 HK): 22 April 2020

Marine support services: a cutback in charted fleet is unavoidable Utilisation of vessels COSL owns and operates the largest and most diverse marine support and transportation likely to remain high but fleet in offshore China with 90 self-owned vessels and 45 chartered vessels as of 2019. day rates under pressure We believe operating days for self-owned vessels will be stable in 2020 with the addition of just like the drilling 2 vessels in 2020E and as COSL will likely trim the size of its chartered fleet, which offers services segment lower margin given the extra cost of leasing incurred, as witnessed in previous years. Nonetheless, we expect 2020E revenue to decline by 22% YoY on the back of: 1) a c.10% YoY decline in day rates of self-owned vessels, and 2) c.30% decline in operating days of its chartered fleet. Meanwhile, segmental EBIT will decrease by 25% YoY in 2020E, with the adverse impact from a decline in revenue partly offset by margin expansion due to reduced contribution from chartered vessels.

COSL: marine support services segment forecast 2015 2016 2017 2018 2019 2020E 2021E 2022E Total operating days (self-owned) 23,974 23,912 28,424 30,249 30,986 31,199 31,793 33,620 Overall Day rate (self-owned) 74 64 69 71 69 62 59 76 Revenue (self-owned) (CNYm) 1,765 1,527 1,965 2,151 2,123 1,924 1,863 2,561 Total operating days (chartered) 13,289 7,809 8,094 9,894 15,266 10,686 8,549 9,404 Overall Day rate (chartered) 71 54 58 55 61 43 42 54 Revenue (chartered) (CNYm) 939 422 473 547 930 455 357 511 Total Revenue (CNYm) 2,703 1,949 2,438 2,698 3,053 2,380 2,220 3,071 EBIT (CNYm) 317 (327) 314 226 256 192 186 218 EBIT margin 12% -17% 13% 8% 8% 8% 8% 7%

Source: Company, Daiwa forecasts

COSL: total operating days by type of vessels COSL: number of self-owned vessels and utilisation rate (days) (No.) 40,000 100 100% 35,000 95 95% 30,000 90 25,000 85 90% 20,000 80 15,000 94 75 90 92 90 92 92 85% 10,000 70 83 5,000 75 80% 65 72 70 70 0 2015 2016 2017 2018 2019 2020E 2021E 2022E 60 75% Standby vessels AHTS vesselsvessels Platform supply vessels 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E No. of self-owned vessels Utilization rate (RHS) Multi-purpose vessels Workover support barges Source: Company, Daiwa forecast Source: Company, Daiwa forecast

Geophysical acquisition and surveying services: victim of exploration capex cuts CNOOC’s exploration COSL provides a wide range of integrated geophysical and surveying services, such as capex will likely decline broadband, high-density seismic acquisition services, submarine cable and submarine temporarily, driving node multi-component seismic acquisition services as well as integrated offshore surveying down COSL’s revenue services. On top of this, COSL has also established a multi-client data library with Spectrum Geo to provide SaaS services. In our view, CNOOC will likely scale back its exploratory capex in 2020E to reserve resources for production ramp-up, and COSL Canada will likely see a setback in business development as overseas oil majors are also cutting E&P capex. As such, we hold a rather dim outlook for this segment with a 29% YoY decline in revenue in 2020E with a 33% YoY drop of EBIT to CNY173m.

COSL: geophysical acquisition and surveying services segment forecast 2015 2016 2017 2018 2019 2020E 2021E 2022E CNOOC Domestic Exploration Capex 9,515 6,205 7,978 9,995 15,120 11,132 14,000 21,300 Revenue (CNYm) 1,526 1,527 1,965 2,151 2,123 1,497 1,495 2,055 EBIT (CNYm) (52) (542) (104) 37 258 173 125 225 EBIT margin -3% -51% -6% 2% 12% 10% 8% 12%

Source: Company, Daiwa forecasts

China Oilfield Services (2883 HK): 22 April 2020

COSL: operating volume of geophysical services fleet CNOOC: domestic exploration capex

(km/km2) (CNYm) 80,000 24,000 70,000 21,000 60,000 18,000 50,000 15,000 40,000 12,000 30,000 9,000 20,000 6,000 10,000 3,000 0 2012 2013 2014 2015 2016 2017 2018 2019 0 2D acquisition (km) 3D acquisition (km2) Submarine cable (km2) 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E

Source: Company Source: Company, Daiwa forecast

China Oilfield Services (2883 HK): 22 April 2020

Financials

A revenue decline due to We expect COSL to see an 8% YoY decline in revenue in 2020E followed by another 6% global oil price YoY decline in revenue in 2021E, due to a drop in services fees during contract renewal. downturns will be The revenue contraction is particularly prominent for COSL’s drilling services and prominent in 2H20E and geophysical acquisition and surveying services segments, which are more closely related 2021E to the exploratory capex of CNOOC, which will likely be slashed in 2020-21E. Meanwhile, we believe revenue from its largest segment, well services, will be roughly flat YoY given its asset-light nature and close ties with CNOOC’s domestic development capex, which will be largely stable in our view. We expect COSL to see a strong comeback with 32% YoY revenue growth in 2022E as global oil prices gradually recover.

COSL: revenue Revenue (CNYm) 2015 2016 2017 2018 2019 2020E 2021E 2022E Well Services 6,913 5,568 6,996 9,793 15,030 14,732 14,338 20,016 Drilling Services 12,040 6,499 6,341 7,750 10,825 10,113 8,939 10,872 Marine Support Services 2,703 1,949 2,438 2,698 3,053 1,924 1,863 2,561 Geophysical acquisition & surveying services 1,518 1,070 1,684 1,646 2,168 1,734 1,561 1,873 Total 23,174 15,086 17,459 21,887 31,076 28,504 26,701 35,322 YoY -35% 16% 25% 42% -8% -6% 32%

Source: Company, Daiwa forecasts

In terms of profitability of underlying segments, we expect COSL to see a marked decline in profits beginning in 2H20E. We expect total EBIT to decline by 5% YoY in 2020E followed by another 38% YoY decline in 2021E. Excluding the USD188m proceeding from Equinor, we forecast COSL’s recurring net profit at CNY1,866m in 2020E, down 14% YoY. Recurring net profit will see a further decline in 2021E to CNY1,202m before recovering to pre-crisis levels of CNY2,250m in 2022E.

COSL: financial snapshot (CNYm) 2015 2016 2017 2018 2019 2020E 2021E 2022E Revenue 23,174 15,086 17,459 21,887 31,076 28,504 26,701 35,322 YoY -35% 16% 25% 42% -8% -6% 32%

EBIT 1,632 (11,368) 1,468 644 3,895 3,717 2,300 3,858 YoY -797% -113% -56% 505% -5% -38% 68%

Net Profit (recurring) 831 (11,609) (251) (543) 2,172 1,866 1,202 2,250 YoY -1496% -98% 117% -500% -14% -36% 87%

Source: Company, Daiwa forecasts

COSL: EBIT by segment COSL: recurring net profit (CNYm) (CNYm) 5,000 4,000 500% 2,000 0 0 0% (5,000) (2,000) (4,000) -500% (10,000) (6,000)

(15,000) (8,000) -1000% 2015 2016 2017 2018 2019 2020E 2021E 2022E (10,000) Geophysical acquisition & surveying services (12,000) -1500% Marine Support Services 2015 2016 2017 2018 2019 2020E 2021E 2022E Drilling Services Recurring net profit attributable to shareholders YoY (RHS) Well Services Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

USD188m from Equinor As for 2020E, we believe COSL’s reported earnings will be boosted by the USD188m to be booked as 2020E proceeds from Equinor of Norway. On 8 January 2020, COSL announced the latest earnings update on civil action that its wholly-owned, COSL Offshore Management AS (COM), had taken against Equinor Energy AS (Equinor) in Norway before the Oslo District Court. COM was appealing against Equinor’s premature termination of COSL’s drilling rig – COSL Innovator. COM and Equinor eventually signed a settlement agreement in 2020 in which Equinor would pay COM USD188m and both sides agreed to put aside differences and strengthen cooperation. According to COSL’s management, the company had already received payment from Equinor and the USD188m will be recorded as earnings in 2020E.

China Oilfield Services (2883 HK): 22 April 2020

Yet, we are also doubtful about business opportunities for both sides in the near future given Norway is weighing supply cuts alongside OPEC+ due to low global oil prices.

Our base-case scenario As for dividend payout, we believe COSL will likely trim the payout ratio to 20% for assumes a 20% payout 2020E before returning to a 30% payout ratio on reported earnings in 2021-22E. ratio for 2020E and 30% COSL has maintained its dividend payout throughout the years. Even in 2016 when COSL for 2021-22E registered a net loss of CNY11,456m (ie, a reported EPS of negative CNY2.40), the company still declared a DPS of CNY0.05. For 2020-22E, we believe COSL will adhere to this tradition but COSL will likely trim its payout ratio to 20%, which is the minimum payout ratio that COSL pledges to give during years with positive net profit, in 2020E given: 1) oil price uncertainty casts a cloud over the long-term profitability of COSL, and 2) reported net profit will be boosted by USD188m from Equinor. We expect COSL will return to a payout ratio of 30% on reported earnings in 2021E and 2022E given more clear oil price outlook by then.

COSL: EPS COSL: DPS and payout ratio (CNY) (CNY) 2 0.6 800% 700% 0.5 1 600% 0.4 500% 0 400% 0.3 300% (1) 0.2 200% 100% (2) 0.1 0% (3) 0.0 -100% 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E EPS (Reported) EPS (Recurring) DPS Payout ratio on reported EPS (RHS)

Source: Company, Daiwa forecast Source: Company, Daiwa forecast

Healthy gearing with aggressive capex plan By end-2019, COSL’s net debt-to-equity was 52%, which is lower than 2018’s 69% but higher than 2017’s 51%. COSL has been purchasing short-term wealth management products since 2018 for better use of its idle capital. After adding back CNY1,750m and CNY4,511m of wealth management products for 2018 and 2019, respectively, we calculate the adjusted net debt-to-equity of COSL to be only 40%. Yet, it is also noteworthy that 2020-22 will be the peak refinancing period for COSL. Based on our calculation, COSL has CNY4,430m, CNY3,537m and CNY3,019m of debt to be repaid in 2020E, 2021E and 2022E, respectively. Given COSL’s higher credit rating as shown in the table below, we expect COSL to see limited difficulties in refinancing. Management also suggested that COSL has a USD refinancing plan and we also expect COSL to convert the wealth management products back into cash to settle the repayment of debts.

COSL: credit rating comparable Ratings Company BBG Code Moody's S&P Fitch COSL 2883 HK A3 (Stable) BBB+ (Stable) A (Stable)

Schlumberger SLB US A1 (Stable) A+ (Neg.) -

Baker Hughes BKR US A3 (Stable) A- (Stable) -

Top 4 Top Halliburton HAL US Baa1 (Stable) A- (Neg.) - Global Weatherford WFTLF US - B- (Neg.) -

Transocean RIG US B3 (Neg.) CCC+ (Neg.) -

Diamond DO US B2 (Neg.) CCC+ (Stable) -

Seadrill SDRL US Caa2 (Stable) CCC (Neg.) - Peers

Offshore Valaris VAL US Caa2 (Neg.) CCC+ (Neg.) - Noble NBL US - BBB (Stable) BBB (Stable)

Source: Company

COSL also guided for a CNY4.5bn capex plan for 2020E but we doubt whether it will actually spend that much. During its post-2019 results analysts’ briefing, COSL’s management insisted that they will keep their CNY4.5bn capex plan for 2020E unchanged. Yet, we believe it is more reasonable that COSL will spend less than its guidance as: 1) it

China Oilfield Services (2883 HK): 22 April 2020

may have to reserve more cash for debt repayment given refinancing difficulty for oil companies amid low oil prices, and 2) some parts of its capex are for non-urgent areas, eg, upgrading vessels to LNG-power for environmental reasons, which can be delayed until cash flow prospects of the company become more visible.

COSL: net debt-to-equity COSL: capex 80% (CNYm) 70% 10,000

60% 8,000 50% 6,000 40% 30% 4,000 20% 2,000 10% 0% 0 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E 2012 2013 2014 2015 2016 2017 2018 2019 2020E 2021E 2022E Net debt-to-equity Adjusted Net debt-to-equity capex capex guidance

Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

China Oilfield Services (2883 HK): 22 April 2020

Valuation Initiating with an Outperform (2) rating and TP of HKD6.3 We initiate with a We initiate coverage of COSL with an Outperform (2) rating and PBR-based 12-month TP Outperform (2) rating of HKD6.3. The stock is currently trading at 0.62x 2020E PER, which is 1.46SD below its and PBR-based 12- historical average since 2008. We set our TP of HKD6.3 on a target 0.68x 2020E PER, or month TP of HKD6.3 1.34SD below its average since 2008. The lower-than-historical-average is due mainly to weak oil price sentiment under the current global COVID-19 pandemic and oil price war.

COSL-A dual listed on the Shanghai Stock Exchange in September 2007, which is currently trading at 1.5x 2020E PER (vs. COSL-H: 0.62x 2020E PER). The 228% A-H premium for the same company’s PBR valuation suggests that COSL-H is undervalued vis- a-vis different markets. We see COSL as a deep-value play for investors looking for over- corrected oil names after the outbreak of the oil price war in March 2020.

COSL-A-H: valuation premium

400%

300%

200%

100%

0% Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 A-H Premium Average

Source: Factset

COSL: valuation comparison Mkt cap Turnover PER (x) PBR (x) Company name BBG code Rating Share price Target price (USDm) (USDm) 2020E 2021E 2022E 2020E 2021E 2022E COSL-H 2883 HK Outperform 5.83 6.30 3,589 19.9 13.6 21.2 11.3 0.6 0.6 0.6 H-Share companies (HKD) Anton 3337 HK Hold 0.48 0.53 184 2.6 10.8 4.2 4.1 0.4 0.4 0.4 Honghua 196 HK Hold 0.22 0.26 149 0.3 18.6 14.6 7.5 0.2 0.2 0.2 Sinopec SSC 1033 HK NR 0.57 n.a. 4,133 0.7 12.4 7.7 6.9 1.2 0.9 0.7 SPT Energy 1251 HK NR 0.31 n.a. 74 0.4 2.8 2.1 28.3 0.3 0.3 0.4 Simple average 11.1 7.1 11.7 0.5 0.5 0.4 Weighted average 12.4 7.7 7.2 1.1 0.9 0.7 A-Share Companies (CNY) COSL-A 601808 CH NR 12.33 n.a. 8,058 38.0 17.8 16.3 13.0 1.5 1.4 1.3 Yantai Jereh 002353 CH - 25.64 n.a. 3,417 87.1 16.4 19.7 14.6 2.2 2.0 1.8 Offshore Oil Engineering 600583 CH NR 5.26 n.a. 3,102 22.9 25.1 18.0 13.3 0.9 0.8 0.7 Simple average 19.8 18.0 13.6 1.5 1.4 1.3 Weighted average 19.1 17.5 13.4 1.5 1.4 1.3 Global leading OFS Companies (USD) Schlumberger SLB US NR 15.21 n.a. 20,390 427.2 61.7 206.9 20.5 1.3 1.3 1.3 Baker Hughes BKR US NR 12.98 n.a. 13,147 127.9 39.2 34.4 18.8 0.7 0.7 0.7 Halliburton HAL US NR 7.63 n.a. 6,515 285.5 128.7 1750.0 17.7 0.9 1.0 1.1 Simple average 76.5 663.8 19.0 1.0 1.0 1.0 Weighted average 65.2 401.3 19.5 1.0 1.1 1.1

Source: Bloomberg, FactSet, Daiwa forecasts. Prices as of close on 22 April 2020

China Oilfield Services (2883 HK): 22 April 2020

Investment risks Larger-than-expected decline in CNOOC’s capex The key downside risk to Our call mainly relies on a smaller-than-expected cut in CNOOC’s capex given COSL our call is weaker-than- derives c.80% of its revenue from CNOOC. If CNOOC announces a lower-than-expected expected capex due to capex plan in late April 2020, COSL’s profitability will likely be undermined in the future in declining oil prices terms of a lower workload or lower day rates, and COSL’s share price sentiment will likely be severely impacted. This is the primary risk to our call.

COSL share price vs. CNOOC capex

25 120 110 20 100

15 90 80 10 70 60 5 50 0 40 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul-19 Share price of COSL Capex of CNOOC

Source: Company, Factset Note: Correlation between share price of COSL and capex of CNOOC is 0.80

Larger-than-expected decline in oil prices Our call suggests that CNOOC’s domestic capex will be largely unaffected by the oil price slump. Nonetheless, if global oil prices go further south, it is possible that CNOOC will have to achieve the national energy security initiative by importing more low-cost oil from international markets to replenish strategic reserves, rather than ramping up domestic production. This will pose downward pressure on the profitability of all of COSL’s segments.

China Oilfield Services (2883 HK): 22 April 2020

ESG activity Environmental COSL has stepped up its efforts in environmental conservation by promoting technological advancement. Overall, the company is on a downtrend in terms of environmental emissions. In 2019, COSL achieved a 20% YoY decline in CO2 emission per revenue on the back of 9% YoY increase of investment in energy conversion and emissions reduction. Also, COSL has continued to switch its focus from the asset-heavy polluting drilling segment to the environmentally-friendly well services segment.

As for the well services segment, COSL has been conducting research to promote green development of offshore oilfields. For instance, it has developed a biodegradable and environmentally-harmless water-based drilling fluid system to replace the traditional use of mud. Also, in 2019, it has reduced the use of drilling fluid by 60% by raising the recycling rate of filtered waste drilling fluid to over 80%. COSL is also providing environmental protection services like solids control services and drilling waste management services for offshore E&P oil companies.

As for other segments, COSL is building environmentally-friendly LNG power guard vessels to lower environmental emissions of its marine support services segment. COSL is also leveraging on its expertise in geophysical acquisition to expand into wind power surveying.

Employees COSL adheres to the Quality, Health, Safety and Environment (QHSE) policy to ensure operation safety. It has established an emergency group composed of experts from various fields to enhance its response to emergency situations. Furthermore, the company has built and ran detailed simulations of the most high-risk operational emergency scenarios. In 2019, the company carried out a total of 18,085 ship-shore joint exercises and on-site exercises involving rigs, ships and shore facilities. The efforts are also reflected by improvement in operation safety metrics, COSL saw a decline in accumulated lost working days ratio from 1.6 in 2018 to 1.24 in 2019.

Shareholding structure State-owned CNOOC owns a 50.53% stake in COSL. Some investors may be worried about the Chinese government’s influence over COSL that sometimes may jeopardise the interests of ordinary shareholders. Yet, we see COSL as being in a sweet spot precisely because of such influence. Under the national energy security initiative since 2019, the offshore oil O&P workload has been boosted significantly, thus serving as a major positive to COSL’s revenue and profits.

China Oilfield Services (2883 HK): 22 April 2020

Appendix I: company background

A dual-listed offshore China Oilfield Services Limited (COSL) is one of the leading integrated oilfield services OFS company under providers in the world. It was listed on the main board of the Hong Kong Exchange in 2002 CNOOC and dual-listed on the Shanghai Stock Exchange in 2007. COSL’s controlling shareholder is CNOOC, which owns a 50.53% stake in the company. COSL has close ties with other companies within CNOOC, in particular the listed E&P arm, CNOOC (883 HK), as COSL is the major OFS provider for CNOOC.

CNOOC Group: shareholding structure

50.53% China Oilfield Services (2833 HK / 601808 CH)

55.01% Offshore Oil Engineering SASAC (600538 CH) 100% CNOOC 37.90% 11.57% Group 81.65% CNOOC Energy Tech & Services (600968 CH)

64.44% CNOOC H-share A-share (883 HK)

Source: Company

COSL currently provides 4 types of OFS services, namely 1) Well services; 2) Drilling services; 3) Marine support services; 4) Geophysical acquisition and surveying services.

The company has formulated a “Double-50%” strategy with two main focuses: 1) Technology/Equipment: 50% of revenue from its technology segment (well services) and 50% of revenue from its equipment segment (drilling services, marine transportation services and geophysical and surveying segments); 2) Domestic/Overseas: 50% of revenue from China and 50% of revenue from the rest of the world.

As of 2019, technology/equipment revenue ratio is 48%/52% while domestic/overseas revenue ratio is 78%/22%.

COSL: revenue breakdown by segment CNOOC: revenue breakdown by geography

100% 100%

80%

50% 60%

45% 48% 40% 78% 37% 40% 75% 74% 29% 30% 69% 67% 68% 0% 20% 2014 2015 2016 2017 2018 2019 Geophysical acquisition & surveying services 0% Marine Support Services 2014 2015 2016 2017 2018 2019 Drilling Services Domestic Overseas Well Services Source: Company Source: Company, Daiwa forecast

China Oilfield Services (2883 HK): 22 April 2020

COSL: business scope

Source: Company

COSL: business presence

Source: Company

China Oilfield Services (2883 HK): 22 April 2020

Daiwa’s Asia Pacific Research Directory

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China Oilfield Services (2883 HK): 22 April 2020

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China Oilfield Services (2883 HK): 22 April 2020

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China Oilfield Services (2883 HK): 22 April 2020

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The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months.

Disclosure of investment ratings Rating Percentage of total Buy* 70.04% Hold** 24.21% Sell*** 5.75% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 31 March 2020. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings.

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