Playing China's Hunger for Oil

03/02/2010 12:00 pm EST


Yiannis Mostrous

Editor, The Capitalist Times

Yiannis G. Mostrous, editor of the Silk Road Investor, says exposure to China's Oil Patch is crucial, and this ADR provides the best access.

Economies such as China and India are much more energy intensive than more developed ones like the United States and Germany. Accordingly, it’s the rate of growth that counts when trying to evaluate stocks, not the absolute demand and supply numbers. 

Coal is China’s primary energy source, and coal-fired power plants should be increase in number and capacity in the future. Oil represents just 20% of the country’s energy consumption—half that of the US.

Transportation accounts for the majority of oil use, [and] it’s one of the economy’s fastest growing sectors. As households’ income increases, so do aspirations; taking the family out for a weekend drive in the country has become a pastime for a lot of Chinese.

The number of cars in China has doubled over the past three years to 42 million and is expected to hit around 200 million in the next ten years. Investors should expect China to import more oil and aggressively drill new oil fields.

CNOOC (NYSE: CEO) is the best way to gain exposure to China’s oil exploration and production efforts. Via its parent, [the China National Offshore Oil Company, which holds a 66% interest], CNOOC has exclusive rights to negotiate for offshore production-sharing contracts with the government and foreign companies. The bulk of its operations are off the coast of China, though the company also has assets in Indonesia, Australia, and Nigeria.

CNOOC will increase production roughly 25% this year to the equivalent of 280 million barrels of oil. This strong production growth will be driven by nine new projects, most of which are targeted to start up in the first half of the year. CNOOC expects to drill 98 exploration wells this year, compared to 87 in 2009.

The company’s shares have suffered along with most resource stocks in the recent correction. But investors are also worried about increasing finding and development costs, a trend that began in mid-2009 and should continue.

The 2010 budget includes capital expenditures of (US) $7.9 billion, 30% higher than last year, a key to delivering higher growth. Such an outcome will also improve the company’s earnings, making the stock less affected by the price of oil. This does not mean that if oil prices collapse CNOOC will do well; it does mean that the company is in the early stages of creating a smoother business cycle for itself. 

The stock trades at 8.7x expected 2010 earnings, and the company has set reserve replacement targets above 100%. CNOOC also has a strong balance sheet with (US) $3.5 billion in cash, which should prove handy as the company continues to evaluate potential acquisition targets. Buy CNOOC up to (US) $165. (This American Depositary Receipt, which represents 100 Class H Shares of CNOOC, closed Monday around $157—Editor.)

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