12 January 2017 Asia Pacific/Hong Kong Equity Research Energy China Oil & Gas Sector Research Analysts SECTOR FORECAST Horace Tse 852 2101 7379 [email protected] 2017: A year of second-phase recovery Jessie Xu 852 2101 7650 [email protected] Figure 1: Chinese Oils typically see expansion of multiples during upcycle (Rebased to 100) EV/EBITDA (x) 300 6.5 6.0 250 Oil price trend - 2016-17 vs 2009-11 5.5 +1STD: 5.3x 5.0 200 4.5 Avg: 4.2x 4.0 150 3.5 3.0 -1STD: 3.2x 100 2.5 CNOOC 2.0 50 1.5 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-16 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jul-16 Jan-17 Jul-17 Source: the BLOOMBERG PROFESSIONAL™ service, company data, Credit Suisse estimates ■ Accelerated oil market rebalancing post OPEC deal. We believe the OPEC cut effective from January, coupled with robust 1.5mb/d global oil demand growth, should induce 400mbs of inventory drawdown in 2017 and accelerate the global oil market rebalance. CS forecasts US$56/bbl Brent in 2017, with upside risk if OPEC adheres to the 32.5mb/d low-end output cut. Since the announcement of the OPEC deal, oil prices were up 22% and global peers have rallied 12%, but Chinese Oils, particularly CNOOC, have lagged. We expect a reversal of the underperformance trend. ■ Multiple catalysts ahead. (1) We think the market is too bearish on CNOOC’s production/reserves and its upcoming 2017 Strategy Preview could surprise on the upside. (2) Sinopec’s marketing business divestment could be the biggest catalyst this year; latest comps and recent transactions suggest 20x P/E valuation for the marketing business. We raise the marketing business valuation to 18x P/E (from 14x) in our Sinopec model. ■ Valuation rerating during an oil price upcycle. The Big 3 Oils are pricing in 4.5x 2017E EV/EBITDA at our US$56/bbl assumption, >1 SD below the historical average. During the 2009-11 upcycle, the Big 3 Oils’ EV/EBITDA multiples rerated from 3x to 6x on average. In terms of implied oil prices, Sinopec is one of the lowest within the region at US$55/bbl long-term oil price, vs Asia Oils’ average of US$60 and CS’s long-term oil price assumption of US$65. ■ Pecking order: CNOOC > Sinopec > PetroChina. CNOOC (upgrade to Outperform, TP HK$12.8) is the most leveraged to oil price recovery, cheap and has significantly underperformed global peers, with the 2017 Strategy Preview as a near-term catalyst. Sinopec (upgrade to Outperform, TP HK$7.3) should see valuation/earnings upside from its marketing business, plus tailwinds from a prolonged chemical upcycle. PetroChina (Neutral, TP HK$7.0) has priced in a lot of expectations on the gas pipeline revaluation potential so upside is limited. Please see the company pages at the back for the other ratings, TP and EPS changes made. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 12 January 2017 Focus table and charts Figure 2: Credit Suisse oil price forecasts—base case and bull case (US$/bbl) 2014 2015 2016 1Q17E 2Q17E 3Q17E 4Q17E 2017E 2018E 2019E LT Base case Brent 98.9 52.4 44.0 46.0 56.0 61.0 62.0 56.3 65.0 65.0 65.0 WTI 93.1 48.8 43.2 45.0 55.0 60.0 60.0 55.0 62.5 62.5 62.5 Bull case Brent 98.9 52.4 44.0 61.0 66.0 71.0 72.0 67.5 65.0 65.0 65.0 WTI 93.1 48.8 43.2 60.0 65.0 70.0 70.0 66.3 62.5 62.5 62.5 Source: Credit Suisse Global Energy Team estimates Figure 3: Oil supply and demand (3 mma, mb/d) Figure 4: Global oil inventory stock change (mbs) Source: IEA, JODI, EIA, Petrologistics, BP, Country data, Credit Suisse Global Energy Team Source: IEA, JODI, EIA, Petrologistics, BP, Country data, Wood Mackenzie, Credit Suisse Global Energy Team estimates Figure 5: Chinese Oils have significantly Figure 6: CNOOC has witnessed a massive rerating underperformed oil price and global peers during the last oil upcycle 25% EV/EBITDA (x) Performance since 30 Nov 2016 6.5 20% (OPEC deal announcement) 6.0 15% 5.5 +1STD: 5.3x 10% 5.0 5% 4.5 Avg: 4.2x 0% 4.0 -5% 3.5 BP 3.0 -1STD: 3.2x ENI PTT Total Hess Brent Japex Statoil Repsol PTTEP 2.5 Sinopec CNOOC Chevron Reliance Anadarko CNOOC Oil Search Oil PetroChina 2.0 ConocoPhillips 1.5 Royal Dutch Shell Dutch Royal Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse research Source: Company data, Credit Suisse research Figure 7: Latest comps and recent transactions suggests higher valuation for Sinopec’s Marketing Figure 8: Asia Oils—implied LT oil price comparison P/E (x) (US$/bbl) 25 80 22 Sinopec $70 20 70 $65 20 18 $60 $62 16 60 $55 $57 14 $50 15 50 10 40 30 5 20 - 10 US C-Store Caltex Australia BP-Woolworths 2014 sell-down CS current peers transaction implied assumed - valuation valuation PTTEP Sinopec OGDC CNOOC PetroChina ONGC Oil India Source: I/B/E/S, company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates China Oil & Gas Sector 2 12 January 2017 2017: A year of second-phase recovery Accelerated oil market rebalancing post OPEC deal $56/bbl CS base case In our view, the OPEC cut effective from 1 January 2017, coupled with robust 1.5mb/d 2017 forecast (Brent) global oil demand growth, should induce 400mbs of inventory drawdown in 2017 and accelerate the rebalance of the global oil market. CS' Global Energy Team forecasts US$56/bbl Brent for 2017, but acknowledges that there could be upside risk to oil prices should OPEC adhere to the 32.5mb/d low-end of the agreed cut. Despite oil prices going up 22% since OPEC struck the deal in November 2016, the Big 3 Oils’ underperformance is significant, particularly CNOOC. CNOOC is down 1% since then, having hugely underperformed global peers and consistent with our Underperform stance; Sinopec and PetroChina are up 9% and 17%, respectively. We expect a reversal of the underperformance trend, with multiple catalysts in sight. Multiple catalysts ahead We expect fundamental We expect company-specific catalysts to drive share prices, on top of an oil price share price drivers over recovery: (1) The market is concerned about CNOOC’s deteriorating production and low the course of 2017 on reserve life, and expectations are low heading into the 2017 Strategy Preview, but we top of an oil price believe it should bring positive surprises. Its 2017 production decline should be limited to uptick low single digits vs market expectations of a 5-8% decline. Two mega-size discoveries recently announced by its partner, ExxonMobil, suggests successful exploration effort under a low capex environment and will address concerns on its low reserve life. (2) Sinopec's marketing business divestment, which is coherent with the SOE reform that China is re-emphasising, would be a big catalyst for this year. Latest comps and recent transactions suggest 20x P/E valuation for the marketing business; hence, we raise the marketing business valuation to 18x P/E (from 14x) in our Sinopec model. Over the next 6- 9 months, we expect Sinopec to see further development and collaboration on its non-fuel business. Valuation rerating during an oil price upcycle EV/EBITDA multiples Under our US$56/bbl base-case oil price assumption, the Big 3 Oils are currently pricing in expanded from 3x to 6x 4.5x 2017E EV/EBITDA, which is more than 1 SD below the historical average. Our during the 2009-11 analysis of the past oil cycles suggests that during the 2009-11 recovery, the Big 3 Oils’ upcycle EV/EBITDA multiples have rerated from 3x to 6x on average. In terms of implied oil prices, Sinopec is one of the lowest within the region at US$55/bbl long-term oil price, vs Asia Oils’ average of US$60/bbl and CS’s long-term oil price assumption of US$65/bbl. Pecking order: CNOOC > Sinopec > PetroChina ■ CNOOC (0883.HK, OUTPERFORM, TP HK$12.8): We upgrade CNOOC to an OUTPERFORM (from Underperform) and raise our TP to HK$12.8 (from HK$7.0). CNOOC is the highest leveraged to an oil price recovery given its lowest all-in cost (US$38/boe). At 4x 2017E EV/EBITDA, the stock is cheap relative to its own history and global E&P peers. The 2017 Strategy Preview would be a near-term catalyst. ■ Sinopec (0386.HK, OUTPERFORM, TP HK$7.3): We upgrade Sinopec to OUTPERFORM (from Neutral) and raise our TP to HK$7.3 (from HK$6.1). Its marketing business sell-down targeted for 2H17 would be a market focus throughout the year, and we expect plentiful newsflow on further non-fuel business collaborations.