CNPC (HK) expected to justify premium in price
Nothing worries economic planners quite like oil dependency. China is a big producer but remains dependent on imported supplies. More worrying, much of its dwindling reserves are inaccessible without dramatic industry modernisation.
China National Petroleum Corp (CNPC) faces the dilemma of securing capital and knowhow without ceding strategic control to foreign companies.
Investors are convinced the answer lies in red chip CNPC (Hong Kong). Formerly Paragon Holdings, the 54 per cent owned subsidiary of the mainland giant has a mandate to receive lucrative production contracts.
Not quite asset injections in the usual sense, CNPC (Hong Kong) has already secured deals on terms out of the reach of foreign firms. Betting that more will follow the stock soared from 80 cents in late April to a high of $4.80 yesterday.
Like much of the red-chip boom, the price reflects huge confidence in a future stream of juicy contracts. Deutsche Morgan Grenfell (DMG) puts fair value at 52 cents per share - on a net present value basis - assuming an as yet unsigned deal is secured.
CNPC is highly influential, reporting directly to the State Council. Controlling 91 per cent of China's total oil and gas reserves it can offer its listed off-shoot guaranteed fields to exploit far into the future. Few big oil companies could hope for such a boon.
For now the hype remains just that. The company has just two significant assets in a Thai project inherited from Paragon and a production sharing contract to retrieve inaccessible reserves on the mainland Karamay field.
The kicker lies in the details. The company is being paid for oil already being pumped before its committed US$66 billion is spent. Effectively money for nothing, the project is forecast by consultants Gaffney & Cline to generate an internal rate of return of 38 per cent.
Foreign firms would never win such terms where immediate charges of flogging national assets too cheap would erupt. The idea is to grow CNPC (Hong Kong) into a viable vehicle for raising capital and becoming a stand-alone exploration-production company.
There is ample precedent for doing so with Japanese and Taiwanese firms engaged in exploration joint ventures worldwide. The idea is to secure guaranteed oil supplies in event of a crisis. China, remember, sees national interest rather more acutely than most.
CNPC's problem lies in the long-term decline of existing reserves with poor equipment and past mistakes making many fields uneconomic. Enter CNPC (Hong Kong). Unencumbered by the foreign stigma it can secure contracts that justify using modern, and expensive, extraction techniques.
The next move is to grow the firm. DMG reckons that any oil company needs annual cash flows of at least US$100 million to achieve critical mass. That demands producing assets of at least $1.5 billion, about four times its present size.
In the pipeline is the Liaohe project in Liaoning province. The field is low quality with a recovery rate estimated at only 25 per cent of the total 125 million tonne reserves. A production sharing contract has proved elusive, but resolution is expected before the end of the year.
More must follow to justify the present share price premium. China clearly has a long-term need for oil, whatever the changing policy towards red-chip asset injections. The bet is those contracts are secured on nothing less than spectacular terms, and sooner rather than later.