2. April 7, 2011 Global Strategy
Investment Recommendation 2
S&P Equity Research has a positive view on the global energy sector and as
of Apr. 1, 2011, we are Overweight the sector in all three regions (US, Europe
and Asia).
Within the sub-industries, we have a preference for the integrated oil & gas
and exploration & production companies. We see underlying strength in oil
prices underpinned by improving global demand as conducive for the
sector’s income performance over the near to mid term.
For Greater China, our preference lies with PetroChina, given the company’s
upstream leverage, balanced integrated operations, and its status as a
potential beneficiary of a long-touted gas price reform. We also like E&P
player CNOOC Ltd, but given its strong outperformance YTD, we would
recommend investors to buy on dips.
A quick resolution to MENA conflicts could send near term oil prices down
and lead to a pullback in energy sector share prices but the improving
demand outlook should provide support.
An increasingly pertinent issue for Greater China O&G stocks is rising cost
pressures; given the regulated nature of China’s refined product market,
pricing adjustments tend to lag increases in crude prices. This explains our
cautious view on Sinopec, which we see will incur refining losses over the
short-term as crude prices remain elevated.
While the US gas market remains soft, we see a more stable gas market
globally, particularly with the potential interest in natural gas and LNG for
thermal power generation. This follows recent worries over radiation
contamination in the aftermath of the Great Tohoku earthquake’s impact on
Japan’s Fukushima Daiichi nuclear power plant. Greater concern on the
safety of nuclear power will also boost demand for natural gas in China, in
our view, further pushing the agenda for pricing reform.
Our global views on the drilling and fabrication segments are more cautious.
While the higher prices should boost confidence, capacity pressure remains
on rig day rates. Still, we expect continuing strength in offshore China
activity, signified by CNOOC Ltd’s +55% YoY increase in planned capex in
2011, to result in an increase in dayrates for 2011, potentially benefiting
offshore services player COSL.
Risks to our recommendations and risks would come from slowdown in US
economic growth that dampens the outlook for global demand. Higher than
expected cost pressures that cannot be passed on will also dampen our
earnings expectations. The sector is also subject to government regulatory
risk particularly in the form of increased windfall taxes and heightened
environmental charges.
Standard & Poor’s Equity Research
3. April 7, 2011 Global Strategy
Outlook: Oil Market 3
Fundamentals
USD115/bbl level (Brent), indicates to us a world uncertain of itself. On the one
hand, worries over a potential supply disruption from MENA remain; on the
Rising prices tempered by inflation
other, a prolonged and significant rise in crude oil prices could ultimately push
impact worries
back the global economy into a recession and result in lower energy demand.
S&P Economics thinks a USD10/bbl rise in oil prices would lower US real GDP by
0.5% after a two-year period.
Oil markets tightened significantly in 4Q10… …and OECD inventories are approaching five-year average
mbpd USD/bbl mbpd
5 160 2,900
4 140 2,800
3 2,700
120
2 2,600
100
1 2,500
80
0 2,400
Jan-01
Jan-03
Jan-05
Jan-07
Jan-09
Jan-11
60
-1 2,300
40 2,200
-2
-3 20 2,100
Jan-01
Jan-04
Jan-07
Jan-10
-4 0
Implied stock draws WTI (RHS) OECD commercial inventories Five-year average
Source: EIA, S&P Equity Research estimates Source: EIA, S&P Equity Research estimates
To a certain extent, we believe there is a fundamental basis for the current crude
Market began to tighten in Sept 2010 run-up. Oil fundamentals had begun to shift as early as September 2010. As the
global economy rebounded, there was a significant increase in demand for oil,
especially in 2H10, but the supply response from OPEC lagged, hence pushing up
crude oil prices (excluding WTI, which is plagued by high Cushing inventories).
Implied stock draw for September 2010, according to data from the International
Energy Agency (IEA), was the largest since November 2007, indicating a
significant tightening of the global crude demand & supply. Events in MENA
further aggravated the tightening market, as market participants began pricing in
a risk premium on a potential MENA supply disruption.
Standard & Poor’s Equity Research
4. April 7, 2011 Global Strategy
OPEC spare capacity off its seven-year high… … leading to potentially the highest stock draw since 4Q07 4
mbpd USD/bbl Net stock draw, mbpd
8 160 3.0
7 140 2.5
2.0
6 120
1.5
5 100
1.0
4 80
0.5
Five-year average
3 60
0.0
1Q06
4Q06
3Q07
2Q08
1Q09
4Q09
3Q10
2Q11F
1Q12F
4Q12F
2 40
-0.5
1 20
-1.0
0 0 -1.5
Jan-94
Jan-97
Jan-00
Jan-03
Jan-06
Jan-09
-2.0
OPEC Spare Capacity WTI (RHS) US Other OECD Non-OECD
Source: EIA, S&P Equity Research estimates Source: EIA, Bloomberg S&P Equity Research estimates
S&P Global Crude Oil Price Outlook
Based on a combination of data from EIA, IHS Global Insight and S&P Equity
Research estimates, we expect 2011 oil consumption growth to average about
1.51 mbpd (+1.7% YoY), while 2012 oil consumption is expected to increase by
1.69 mbpd (+1.9% YoY). In 2010, much of the growth was accounted for by non-
OECD countries, while the US was the only OECD country that saw significant
growth.
We expect this trend to continue into 2011-12, as non-OECD countries, including
China, Brazil and countries in the Middle East region, are expected to lead world
Growth to be led by non-OECD
economic growth, albeit at a slower pace vs. 2010. Asia Pacific ex-Japan countries
countries, in particular China, Brazil and
are likely to record GDP growth rates double that of the US and Eurozone, which
Mid-East countries
will remain hampered by slow consumption growth and high unemployment.
OECD countries are not expected to show any significant growth in oil demand
between now and 2012.
Oil supply is expected to increase 0.97 mbpd (+1.1% YoY) in 2011, vs. a 2.12
mbpd growth in 2010. The slower growth is due a decline in OECD production, on
2011 oil supply growth crimped by
declines in Canadian and North Sea production. US production is expected to see
OECD production declines…
a slight YoY contraction due to the lingering effects of the GoM drilling
moratorium, while Mexico is expected to see a sharp 7.3% YoY decline in
production due its ageing oilfields and infrastructure. Non-OECD production is
expected to pick up the slack, with OPEC incremental production driving much of
the YoY growth.
OPEC production is expected to grow by 0.8 mbpd in 2011 (mainly from
unregulated non-crude production such as NGL), with much of Libya’s lost oil
…and aggravated by lost Libyan capacity
production capacity (total production capacity of 1.8 mbpd) to be offset by
Standard & Poor’s Equity Research
5. April 7, 2011 Global Strategy
inventory drawdown and higher production from other OPEC members. 2012
5
production is expected to increase by a bumper 2.19 mbpd, mainly on higher
OPEC production as lost production capacity in Libya come back online.
World YoY demand and supply balance
A tighter energy market in 2011 on
mbp
rebounding demand and supply shocks
3.0
2.5
2.0
1.5
1.0
0.5
0.0
2006 2007 2008 2009 2010 2011F 2012F
-0.5
-1.0
-1.5
-2.0
Incremental supply Incremental demand
Source: EIA, S&P Equity Research estimates
Overall, we see a relatively tight year for crude oil demand & supply in 2011, and
Overall, a tight year ahead, before supply
inventory drawdowns should be fairly high during the year, on Libyan production
eases in 2012
cuts and higher demand from quake-afflicted Japan. OPEC spare capacity is
expected to decline to about 4 mbpd by end-2011, the lowest level since July
2009, indicating a significantly tighter market. Barring any further geopolitical
disruptions, the situation should ease in 2012 as lost Libyan production comes
back online and/or other OPEC countries boost supply. Our 2011 crude price
assumption for WTI currently stands at USD99/bbl for 2011 and USD96/bbl for
2012.
Standard & Poor’s Equity Research
6. April 7, 2011 Global Strategy
Potentially Tighter Supply – Heightened MENA Risks
6
Political flare ups in the Middle East that impact supply send global oil prices up
Oil prices reflect supply risks and stock markets down are not new. There have been around five such major
events since 1967. In fact, the big 1973/1974 stock market crash and recession was
triggered in part by the Yom Kippur War that led to a mass embargo in oil exports
to then Arab unfriendly states by Arab members of OPEC. For the most part,
however, the shortfall in supplies is offset by other producing countries, albeit
not without a significant oil price rise in the short term.
We see the latest events to have a similar path in terms of impact to the market to
the more recent oil supply shocks of 1990 and 2000. These had more subdued
impact relative to the 1973 and 1979 supply shocks, according to economists,
because of reduced US dependency on oil and the availability of stock piles. We
also don’t expect political upheavals to spread to key oil producers – namely Iran,
Saudi Arabia and the United Arab Emirates. Ongoing Yemeni and Syrian protest
should have little fundamental impact while Bahrain is a small, albeit high
quality, producer.
According to a Mar. 15 report from the IEA, OPEC spare capacity was estimated at
around 4.28 mbpd. Platts quotes sources as saying that Libyan production has
Current OPEC spare capacity may be
trickled to 100,000-120,000 bpd. Libya normally produces 1.6 mbpd of
below 3 mbpd, lowest level since 2008
predominantly light, sweet crude or around 2% of global production. This would
mean that OPEC’s EIA estimated spare capacity should now be reduced to around
2.8 mbpd from over 4 mln bpd in February, the lowest level since 2008. At the
peak oil price of USD147/bbl, it was estimated that spare capacity at the time was
around 1.5 mbpd. Current spare capacity, therefore, remains relatively
comfortable above 2003-2008 levels.
We believe current oil prices therefore reflect heightened risk of further supply
shortfalls, more so than actual supply:demand fundamentals. But it should be
Oil prices are therefore reflecting lesser
noted that OPEC excess capacity tends to be in heavy, sour crude which is not a
supply flexibility, raising risk, implying
direct substitute for light, sweet crude and not all refineries can adapt to take
upside to our oil price forecast
sour crude. Also, oil prices are also reacting to economic data showing a stronger
US demand recovery. We note that as current OPEC capacity is below our base
case scenario of 4 mbpd, if Libyan production remains compromised, there may
be upside to our oil price assumptions.
Japan’s Great Tohoku earthquake is also likely to add demand factors in the
short-mid term as the country relies more heavily on thermal power plants to
Demand may also rise more than
make up for the closures at some of its nuclear power plants. Platts’ sources
expected – Japan to import more crude
indicate that they expect utility company Tokyo Electric Power Corp. (TEPCo)
and fuel oil for power generation
crude and fuel oil consumption to jump 60% in April from March levels. This has
sent the prices of Asian burning oils – namely Minas – soaring.
Standard & Poor’s Equity Research
7. April 7, 2011 Global Strategy
Higher Crude Prices & the Impact on China Energy Players
7
Stronger YoY crude oil prices benefit upstream-heavy players like PetroChina and
Upstream-heavy operators to benefit, but CNOOC Ltd. Despite the latter’s pure upstream exposure, and hence greater
CNOOC Ltd may see ASP dilution on leverage to oil prices, we see the impact of higher oil prices on CNOOC Ltd to be
increased Bridas contribution somewhat diluted by its Argentinian arm, 50%-owned Bridas, especially upon the
consolidation of the additional 60% stake in Pan American Energy (Bridas’ main
asset) purchased from BP plc in Nov 2010. We estimate Argentinian crude pricing
(nett of sales tax and Petroleo Plus tax credits) to be some USD12-15/bbl below
WTI prices, and this will dilute CNOOC Ltd’s ASPs from 2011 onwards, in our
view.
With Asian gas prices generally moving in line with crude oil (vs. depressed
Henry Hub natural gas prices which are more linked to local US demand/supply
Higher international gas prices to spur
conditions), and a tightening in the Asian spot LNG market as Japan deals with
domestic gas price reform?
the impact of the Tohoku earthquake, we expect increasing pressure on the
Chinese government to revise its pricing formula on natural gas, which at this
point is fixed by government decree. Other push factors include the setting up of
at least another 37.6 bl cu m annual LNG importing capacity till 2014,
PetroChina’s ramp-up of gas imports via the WEP2 pipeline (the company targets
to increase natural gas production to 50% of total oil equivalent production by
2015, from 30% currently) and increasing demand for the fuel (we estimate China
consumed some 110 bln cu m in 2010, and this should increase to 135-140 bln cu
m in 2011).
Still, increasing inflationary concern is likely to be a weighty counterbalance to
any potential pricing reform, which will push gas costs higher and eventually hit
Or will inflationary pressures hold sway?
the population via higher power, heating, fertiliser and food costs. Hence, in
place of a general increase in wellhead gas price, we see the potential for a one-
off subsidy by the government in 2011 to compensate PetroChina’s gas pipeline
business (similar to that granted to refiners in 2008), before a long-term solution
is put in place. Over the longer term, reform of the gas pricing mechanism
(potentially set at the end-user level via a reference basket of alternative fuels,
with a net-back formula used to calculate wholesale and wellhead gas prices,
according to industry sources) will benefit PetroChina, given its dominance in gas
production, and will also increase the monetisation of its unrivalled gas
distribution network.
The combination of higher input costs and price controls on the end product will
also hit China’s refiners, although the impact will be lessened by the refined
Refining losses likely in 2011
product price mechanism currently in place. The mechanism allows for price
adjustments to be made by the government based on a specified formula, but as
can be seen in the two adjustments already made since the beginning of the year
(including the 4.9%-5.6% increase for diesel and gasoline respectively, announced
yesterday), in practice the adjustments can lag crude prices and hence depressing
short-term margins. We expect both PetroChina and Sinopec’s refining arm to
suffer losses this year, although we do not expect the quantum to match 2008’s
losses.
We expect marketing profits for China’s integrated oils to perform in line China’s
economic growth, which we expect to reach 9.4% in 2011 (vs. 10.3% in 2010).
Marketing and chemical profits should
Chemical demand should also grow in line with the economy, although margins
grow in line with economy
may be under some pressure, due to increasing feedstock costs.
Standard & Poor’s Equity Research
8. April 7, 2011 Global Strategy
Higher crude prices will also boost confidence in oilfield services companies,
8
although we believe the key driver for companies such as COSL remains the
Higher crude prices to boost confidence
bullish prospects for offshore China. This will be driven by higher capex
in oilfield services companies
spending, mainly from parent CNOOC Ltd, and focusing on higher exploration
work (+45% YoY increase in exploration budgets) and deepwater development.
Strong M&A Environment to Continue Despite Volatility
Global upstream transacted value for 2010 rose to USD228.2 bln, breaching the
Global upstream M&A value reached a previous all time high of USD200.7 bln set in 1998, with much of the transactions
new record of USD228.2 bln in 2010 being done at the asset level and led by national oil companies (NOCs), and
mainly from China. Cross-border NOC & sovereign wealth fund (SWF)
transactions reached close to USD44.2 bln in our estimates, or 19% of total global
M&A transaction in 2010, while Chinese NOC’s were involved in USD24.6 bln
worth of M&A deals, or 11% of the total global transaction in 2010.
Given the strength in crude prices in 2010 vs. 2009, worldwide deal pricing for P2
(proved + probable) increased substantially, up 18% YoY to USD6.55/boe, based
Implied values increased in line with
on data from IHS Herold. North American pricing dipped from USD16.45/boe in
crude price strength
2009 to USD10.50/boe in 2010, but this was skewed by opportunistic purchases of
conventional gas assets in Canada.
NOC/SWF purchases driving worldwide M&A… … as implied values climb on higher crude prices
USD/boe
Chinese
NOC 18
11%
16
Other
NOC/SW Fs 14
9%
12
10
8
6
4
2
0
Other 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
buyers
World US
80%
Source: IHS Herold, S&P Equity Research estimates Source: IHS Herold, S&P Equity Research estimates. Values are based on 2P reserves.
Despite increasing crude price and geopolitical volatility, we expect global M&A
Expect continuing strength in global activity to continue to remain strong, driven by ample liquidity and cashed-up
M&A in 2011 balance sheets at oil majors and NOCs, especially those with large oil exposures
worldwide and/or gas exposure outside North America. Further, slow organic
reserve growth and, especially for NOCs, increasing energy security concerns
amidst greater resource nationalism and restricted access to acreage will
continue to spur the global search for available assets.
Standard & Poor’s Equity Research
9. April 7, 2011 Global Strategy
9
Global upstream M&A breaches previous record on ample liquidity
USD mln
250,000
200,000
150,000
100,000
50,000
0
2011 YTD
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Source: IHS Herold, S&P Equity Research estimates
Top 10 M&A deals by transaction value in 2010
Transaction Reserve Reserve Implied
value (USD Value size value
Date Buyer Seller Deal level Region bln) (USD bln) (mmboe) % gas R/P ratio (USD/boe)
Sep-10 Petrobras Brazil Government Asset LatAm 42.5 42.5 5,000 0% N/A 8.50 ^
Aug-10 Vedanta Cairn Energy Corporate Asia Pacific 9.9 8.0 204 1% 12.5 39.03 *
Nov-10 Bridas, CNOOC Ltd BP plc Asset LatAm 7.1 7.1 858 33% 17.3 8.23
Mar-10 AFK Sistema Sberbank Rossii Corporate FSU 6.1 4.6 1,300 0% 6.6 3.53
May-10 Royal Dutch Shell East Res, KKR Corporate United States 4.7 4.3 2,000 100% N/A 2.16 #
Apr-10 Apache Corp Mariner Energy Corporate United States 4.7 3.4 181 53% 9.6 18.76
Apr-10 Sinopec Group ConocoPhillips Asset Canada 4.7 3.5 248 0% 29.5 14.02
Nov-10 Chevron Corp Atlas Energy Corporate United States 4.3 1.5 141 99% 27.9 10.33
Oct-10 Sinopec Group Repsol YPF Asset LatAm 4.3 4.0 480 25% N/A 8.24 ^
Mar-10 PetroChina, Shell Arrow Energy Corporate Asia Pacific 3.9 1.9 590 100% 183.1 3.24 *
Source: IHS Herold, S&P Equity Research estimates. Reserve size and metrics based on 1P reserves, unless otherwise noted. *based on 2P reserves. ^based on contingent resources.
#based on total recoverable reserves.
Standard & Poor’s Equity Research
10. April 7, 2011 Global Strategy
10
Notable deals so far in 2011
Transaction Reserve Reserve Implied
value (USD Value size value
Date Buyer Seller Deal level Region bln) (USD bln) (mmboe) % gas R/P ratio (USD/boe)
Jan-11 Rosneft BP plc Corporate Diversified 11.8 5.9 619 54.3% 9.1 9.57 @
Jan-11 BP plc Rosneft Corporate FSU 9.0 5.6 1,325 0.0% 15.3 4.26 @
Feb-11 BP plc Reliance Industries Asset South Asia 7.2 5.3 582 96.0% 17.7 9.02 *
Feb-11 PetroChina Encana Asset Canada 5.5 4.4 217 92.5% 10.7 20.25 *
Feb-11 BHP Billiton Group Chesapeake Energy Asset United States 4.8 4.0 400 100.0% 15.8 9.98
Mar-11 Total SA Novatek OAO Corporate FSU 4.1 4.1 1,512 91.5% 29.7 2.70 *
Mar-11 KNOC Anadarko Asset United States 1.6 1.6 150 27.0% N/A 10.33 #
Mar-11 CNOOC Limited Tullow Oil plc Asset Africa 1.5 1.5 333 0.0% N/A 4.41 #
Mar-11 Total SA Tullow Oil plc Asset Africa 1.5 1.5 333 0.0% N/A 4.41 #
Source: IHS Herold, S&P Equity Research estimates. Reserve size and metrics based on 1P reserves, unless otherwise noted. *based on 2P reserves. ^based on contingent resources.
#based on total recoverable reserves. @ Transaction blocked by Russian arbitration body. Excludes CNOOC acquisition of 33.3% stake in Chesapeake’s 800,000 acre Niobrara Shale acreage
for USD1.27 bln due to lack of reserve value and information.
The M&A focus for 2011, in our view, will be in onshore North America, due to a
number of reasons:
North American onshore assets to be in
prime focus
Continuing strife in the MENA region will move investments by risk-averse
majors and independents away from the area. NOCs with deeper pockets and
potentially higher risk tolerance (especially given energy security concerns)
may see expansionary opportunities in MENA, albeit at a higher risk level
and potential overall cost than previous excursions.
Similarly, ongoing regulatory concerns on the Gulf of Mexico operations will
push oil majors and independents into onshore US.
Depressed North American gas prices provide an opportunity for oil majors
and NOCs to snap up weaker prey in the onshore US gas market. This is a
particularly attractive proposition for gas-hungry NOCs e.g. those from
China, given their deep pockets, access to cheap funding, the potential to
secure cheap gas for their LNG imports and their long-run bullish view on
gas.
Development of unconventional plays such as tight oil/gas and oil sands are
streets ahead in the US and Canada compared to the rest of the world. With
increasing risk aversion on MENA plays, we believe the virtually zero
exploratory risks and large resources in place for tight oil/gas and oil sands
will make it an attractive proposition for asset buyers, especially at current
crude prices.
Given these attractions and looking into 2011, we expect deal pricing for onshore
North America acreage to remain at a premium to worldwide pricing. We expect
the Chinese companies to continue to cautiously inch their way into North
America via joint-ventures and equity stakes, to avoid potential political backlash
(e.g. Unocal).
Standard & Poor’s Equity Research
11. April 7, 2011 Global Strategy
Stock Recommendations 11
S&P Hong Kong / China Oil & Gas Recommendations and Key Ratios
EPS
Bloomberg Share Price YTD perf PER x
Company Name Recommend Growth Div Yield 3-Yr EPS P/BV ROE Net Gearing
Ticker LCY 2011 2011
2011 2011 CAGR% 2011 2011 2011
2883 HK
China Oilfield Services Ltd 18.00 Buy 6.2% 14.9 11% 1.3% 17% 2.3 17% 86%
883 HK
CNOOC Ltd 20.85 Hold 12.3% 12.5 15% 2.4% 18% 3.0 26% Net Cash
857 HK
PetroChina 12.04 Strong Buy 17.7% 10.9 22% 4.1% 3% 1.8 17% 26%
386 HK
Sinopec 7.89 Hold 5.4% 8.4 -4% 3.0% 5% 1.2 15% 51%
Source: S&P Equity Research estimates
COSL (HKD18.00, 4-STARS, 12-mo TP: HKD18)
Despite lower revenue recorded in 2010 (primarily due to a one-off reversal of
deferred revenue booked in 2009 for the cancellation of the drilling contract for
COSL Pioneer), greater integration synergies with Awilco and lower asset
impairment charges vs. 2009 meant margins and net profit improved
significantly. We expect 2011 will see more strength on a significant increase in
parent CNOOC Ltd's capex investments (+55.5% YoY), stronger dayrates on
increased offshore activities, new capacity deliveries (2 jackups and 1 semi), and
a new management contract for the ultra-deepwater HYSY981 (owned by CNOOC
Ltd). Risks to our recommendation and target price may arise from a fall in crude
prices and financial difficulties at clients that may hurt returns. In addition,
COSL’s acquisition of Awilco in 2008 has raised the group’s net gearing to close
to 100%, reducing flexibility on future investment. An issuance of new A-shares
remains pending, but the impact should already be discounted by the market. /
Ahmad Halim, CFA
CNOOC Ltd (HKD20.85, 3-STARS, 12-mo TP: HKD19)
2010 was a record year for CNOOC Ltd, both in terms of profits and production
growth. We expect 2011 production growth to moderate from +45% YoY in 2010
to about 11% YoY. While this remains strong vs other E&P players, other
headwinds should limit outperformance for the year: costs are expected to
increase on greater deepwater activities, higher DDA charges as newer, more
costly fields commence operations and crude ASPs should see some dilution
effect from greater Bridas contribution. Recent acquisition of a 33.3% stake in
Tullow’s Uganda blocks is positive for reserve replacement but production impact
during the forecast period is negligible. Funding remains ample, with CNOOC Ltd
carrying a net cash balance. Risks to our target price and recommendation come
from potentially lower U.S. product consumption that would send oil prices
lower. Further, higher-than-expected lifting costs will eat into CNOOC Ltd's
Standard & Poor’s Equity Research
12. April 7, 2011 Global Strategy
margins. In addition, with its oil primarily sold to Sinopec, pricing power may be
12
more limited. / Ahmad Halim, CFA
PetroChina (HKD12.04, 5-STARS, 12-mo TP: HKD14)
2010 results indicate some pressure on margins for both its refining and chemical
(R&C) unit and its pipeline unit. For 2011, we expect its R&C unit will book losses
in 2011, if product prices are not adjusted more aggressively vs. current levels.
Pipeline profits could continue to be pressured in 2011, before a rebound in 2012,
as we do not expect city gate prices to respond quickly enough to cover higher
input costs. Still, we think that PetroChina should benefit from higher oil prices
given its substantial upstream leverage, while a possible wellhead gas price hike
could also boost E&P profits. Risks to our recommendation and earnings
forecasts include prolonged reluctance by the PRC government to address pricing
inefficiencies. Policy uncertainty may also diminish earnings quality, and at
worst, destroy value for PetroChina. The company’s share price may also be
subject to swings in the oil price, despite the greater balance in its downstream
earnings. / Ahmad Halim, CFA
Sinopec (HKD7.89, 3-STARS, 12-mo TP: HKD8)
Slow product price adjustments hit Sinopec’s earnings hard in 2010; despite a
significant 97% EBIT growth from the E&P division on new Puguang gas
production, overall net profit only grew by 13.7% YoY due to substantially lower
refining margins. We expect Sinopec will book in refining losses in 2011, as short-
term concerns on inflation will cap aggressive price adjustments, in our view,
although over the longer term we expect Sinopec’s refining arm to return to
profitability as China slowly moves more toward a market-based price
mechanism. Risks to our target price and recommendation would come from
national interests that may supersede shareholder interests. The potential for
higher marketing competition may also eat into profitability, while Sinopec's
status as a net buyer of oil means a higher risk premium is warranted. / Ahmad
Halim, CFA
Standard & Poor’s Equity Research
13. April 7, 2011 Global Strategy
FFO- Funds From Operations
Glossary FY- Fiscal Year
P/E- Price/Earnings
13
PEG Ratio- P/E-to-Growth Ratio
S&P STARS - Since January 1, 1987, Standard & Poor’s Equity Research Services PV- Present Value
has ranked a universe of U.S. common stocks, ADRs (American Depositary Receipts), R&D- Research & Development
and ADSs (American Depositary Shares) based on a given equity’s potential for ROE- Return on Equity
future performance. Similarly, Standard & Poor’s Equity Research Services has used ROI- Return on Investment
STARS® methodology to rank Asian and European equities since June 30, 2002. ROIC- Return on Invested Capital
Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts ROA- Return on Assets
rank equities according to their individual forecast of an equity’s future total return SG&A- Selling, General & Administrative Expenses
potential versus the expected total return of a relevant benchmark (e.g., a regional WACC- Weighted Average Cost of Capital
index (S&P Asia 50 Index, S&P Europe 350® Index or S&P 500® Index)), based on a
12-month time horizon. STARS was designed to meet the needs of investors looking Dividends on American Depository Receipts (ADRs) and American Depository
to put their investment decisions in perspective. Shares (ADSs) are net of taxes (paid in the country of origin).
S&P Quality Rankings (also known as S&P Earnings & Dividend Rankings)-
Growth and stability of earnings and dividends are deemed key elements in
establishing S&P’s earnings and dividend rankings for common stocks, which are
Disclosures/Disclaimers
designed to capsulize the nature of this record in a single symbol. It should be noted,
Required Disclosures
however, that the process also takes into consideration certain adjustments and
modifications deemed desirable in establishing such rankings. The final score for
each stock is measured against a scoring matrix determined by analysis of the scores
In contrast to the qualitative STARS recommendations covered in this report, which
of a large and representative sample of stocks. The range of scores in the array of
are determined and assigned by S&P equity analysts, S&P’s quantitative
this sample has been aligned with the following ladder of rankings:
evaluations are derived from S&P’s proprietary Fair Value quantitative model. In
A+ Highest B+ Average C Lowest particular, the Fair Value Ranking methodology is a relative ranking methodology,
A High B Below Average D In Reorganization whereas the STARS methodology is not. Because the Fair Value model and the
A- Above Average B- Lower NR Not Ranked STARS methodology reflect different criteria, assumptions and analytical methods,
quantitative evaluations may at times differ from (or even contradict) an equity
S&P Issuer Credit Rating - A Standard & Poor’s Issuer Credit Rating is a current analyst’s STARS recommendations. As a quantitative model, Fair Value relies on
opinion of an obligor’s overall financial capacity (its creditworthiness) to pay its history and consensus estimates and does not introduce an element of subjectivity
financial obligations. This opinion focuses on the obligor’s capacity and willingness as can be the case with equity analysts in assigning STARS recommendations.
to meet its financial commitments as they come due. It does not apply to any specific
financial obligation, as it does not take into account the nature of and provisions of
the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the
S&P Global STARS Distribution
legality and enforceability of the obligation. In addition, it does not take into account In North America
the creditworthiness of the guarantors, insurers, or other forms of credit As of March 31, 2011, research analysts at Standard & Poor’s Equity Research
enhancement on the obligation. Services U.S. recommended 37.5% of issuers with buy recommendations, 54.9%
with hold recommendations and 7.6% with sell recommendations.
S&P Core Earnings - Standard & Poor's Core Earnings is a uniform methodology for
adjusting operating earnings by focusing on a company's after-tax earnings In Europe
generated from its principal businesses. Included in the Standard & Poor's definition As of March 31, 2011, research analysts at Standard & Poor’s Equity Research
are employee stock option grant expenses, pension costs, restructuring charges from Services Europe recommended 35.6% of issuers with buy recommendations, 47.0%
ongoing operations, write-downs of depreciable or amortizable operating assets, with hold recommendations and 17.4% with sell recommendations.
purchased research and development, M&A related expenses and unrealized
In Asia
gains/losses from hedging activities. Excluded from the definition are pension gains,
As of March 31, 2011, research analysts at Standard & Poor’s Equity Research
impairment of goodwill charges, gains or losses from asset sales, reversal of prior-
Services Asia recommended 46.7% of issuers with buy recommendations, 46.7%
year charges and provision from litigation or insurance settlements.
with hold recommendations and 6.6% with sell recommendations.
S&P 12 Month Target Price – The S&P equity analyst’s projection of the market
Globally
price a given security will command 12 months hence, based on a combination of
As of March 31, 2011, research analysts at Standard & Poor’s Equity Research
intrinsic, relative, and private market valuation metrics.
Services globally recommended 38.0% of issuers with buy recommendations,
Standard & Poor’s Equity Research Services – Standard & Poor’s Equity Research 52.9% with hold recommendations and 9.1% with sell recommendations.
Services U.S. includes Standard & Poor’s Investment Advisory Services LLC;
5-STARS (Strong Buy): Total return is expected to outperform the total return of a
Standard & Poor’s Equity Research Services Europe includes Standard & Poor’s LLC-
relevant benchmark, by a wide margin over the coming 12 months, with shares
London; Standard & Poor’s Equity Research Services Asia includes Standard &
rising in price on an absolute basis.
Poor’s LLC’s offices in Singapore, Standard & Poor’s Investment Advisory Services
4-STARS (Buy): Total return is expected to outperform the total return of a relevant
(HK) Limited in Hong Kong, Standard & Poor’s Malaysia Sdn Bhd, and Standard &
benchmark over the coming 12 months, with shares rising in price on an absolute
Poor’s Information Services (Australia) Pty Ltd.
basis.
Abbreviations Used in S&P Equity Research Reports 3-STARS (Hold): Total return is expected to closely approximate the total return of
CAGR- Compound Annual Growth Rate a relevant benchmark over the coming 12 months, with shares generally rising in
CAPEX- Capital Expenditures price on an absolute basis.
CY- Calendar Year 2-STARS (Sell): Total return is expected to underperform the total return of a
DCF- Discounted Cash Flow relevant benchmark over the coming 12 months, and the share price is not
EBIT- Earnings Before Interest and Taxes anticipated to show a gain.
EBITDA- Earnings Before Interest, Taxes, Depreciation and Amortization 1-STARS (Strong Sell): Total return is expected to underperform the total return of
EPS- Earnings Per Share a relevant benchmark by a wide margin over the coming 12 months, with shares
EV- Enterprise Value falling in price on an absolute basis.
FCF- Free Cash Flow
Standard & Poor’s Equity Research
14. April 7, 2011 Global Strategy
Relevant benchmarks: In North America the relevant benchmark is the S&P 500 organizations, including organizations whose securities or services they may
Index, in Europe and in Asia, the relevant benchmarks are generally the S&P Europe recommend, rate, include in model portfolios, evaluate or otherwise address. 14
350 Index and the S&P Asia 50 Index.
S&P and/or one of its affiliates has performed services for and received
For All Regions: compensation from this company during the past twelve months.
All of the views expressed in this research report accurately reflect the research
analyst's personal views regarding any and all of the subject securities or issuers. No S&P has received compensation from one or more institutions, each in the range of
part of analyst compensation was, is, or will be, directly or indirectly, related to the HKD 78,000 to HKD 390,000, for the right to distribute and co-brand S&P’s research
specific recommendations or views expressed in this research report. on this company.
S&P Global Quantitative Disclaimers
Recommendations Distribution With respect to reports issued to clients in Japan and in the case of inconsistencies
between the English and Japanese version of a report, the English version prevails.
In Europe
With respect to reports issued to clients in German and in the case of
As of March 31, 2011, Standard & Poor’s Quantitative Services Europe recommended
inconsistencies between the English and German version of a report, the English
46.2% of issuers with buy recommendations, 21.4% with hold recommendations and version prevails. Neither S&P nor its affiliates guarantee the accuracy of the
32.4% with sell recommendations.
translation. Assumptions, opinions and estimates constitute our judgment as of the
In Asia date of this material and are subject to change without notice. Past performance is
not necessarily indicative of future results.
As of March 31, 2011, Standard & Poor’s Quantitative Services Asia recommended
47.0% of issuers with buy recommendations, 18.0% with hold recommendations and
Standard & Poor’s, its affiliates, and any third-party providers, as well as their
35.0% with sell recommendations.
directors, officers, shareholders, employees or agents (collectively S&P Parties) do
not guarantee the accuracy, completeness or adequacy of this material, and S&P
Globally
As of March 31, 2011, Standard & Poor’s Quantitative Services globally Parties shall have no liability for any errors, omissions, or interruptions therein,
recommended 46.7% of issuers with buy recommendations, 19.3% with hold regardless of the cause, or for the results obtained from the use of the information
provided by the S&P Parties. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR
recommendations and 34.0% with sell recommendations.
IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF
MERCHANTABILITY, SUITABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR
Additional information is available upon request.
USE. In no event shall S&P Parties be liable to any party for any direct, indirect,
Other Disclosures incidental, exemplary, compensatory, punitive, special or consequential damages,
costs, expenses, legal fees, or losses (including, without limitation, lost income or
This report has been prepared and issued by Standard & Poor’s and/or one of its lost profits and opportunity costs) in connection with any use of the information
affiliates. In the United States, research reports are prepared by Standard & Poor’s contained in this document even if advised of the possibility of such damages.
Investment Advisory Services LLC (“SPIAS”). In the United States, research reports
Ratings from Standard & Poor’s Ratings Services are statements of opinion as of
are issued by Standard & Poor’s (“S&P”); in the United Kingdom by Standard &
the date they are expressed and not statements of fact or recommendations to
Poor’s LLC (“S&P LLC”), which is authorized and regulated by the Financial Services
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Authority; in Hong Kong by Standard & Poor’s Investment Advisory Services (HK)
Standard & Poor’s assumes no obligation to update its opinions following
Limited, which is regulated by the Hong Kong Securities Futures Commission; in
publication in any form or format. Standard & Poor’s ratings should not be relied
Singapore by Standard & Poor’s LLC, which is regulated by the Monetary Authority
on and are not substitutes for the skill, judgment and experience of the user, its
of Singapore; in Malaysia by Standard & Poor’s Malaysia Sdn Bhd (“S&PM”), which
management, employees, advisors and/or clients when making investment and
is regulated by the Securities Commission; in Australia by Standard & Poor’s
other business decisions. Standard & Poor’s rating opinions do not address the
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suitability of any security. Standard & Poor’s does not act as a fiduciary. While
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Standard & Poor’s has obtained information from sources it believes to be reliable,
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Standard & Poor’s does not perform an audit and undertakes no duty of due
The research and analytical services performed by SPIAS, S&P LLC, S&PM, and SPIS diligence or independent verification of any information it receives.
are each conducted separately from any other analytical activity of Standard &
Standard & Poor’s keeps certain activities of its business units separate from each
Poor’s.
other in order to preserve the independence and objectivity of their respective
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securities, including exchange-traded investments whose investment objective is to Standard & Poor’s has established policies and procedures to maintain the
substantially replicate the returns of a proprietary Standard & Poor's index, such as confidentiality of certain non-public information received in connection with each
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to the amount of assets that are invested in the fund or the volume of trading activity
Standard & Poor’s Ratings Services did not participate in the development of this
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affiliate earning compensation in addition to the subscription fees or other
credit-related analyses, normally from issuers or underwriters of securities or from
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investment or security by Standard & Poor’s and/or one of its affiliates is not a
analyses. Standard & Poor’s public ratings and analyses are made available on its
recommendation to buy, sell, or hold such investment or security, nor is it considered
Web sites, www.standardandpoors.com (free of charge), and
to be investment advice.
www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may
Indexes are unmanaged, statistical composites and their returns do not include be distributed through other means, including via Standard & Poor’s publications
payment of any sales charges or fees an investor would pay to purchase the and third-party redistributors. Additional information about our ratings fees is
securities they represent. Such costs would lower performance. It is not possible to available at www.standardandpoors.com/usratingsfees.
invest directly in an index.
This material is not intended as an offer or solicitation for the purchase or sale of
Standard & Poor's and its affiliates provide a wide range of services to, or relating to, any security or other financial instrument. Securities, financial instruments or
many organizations, including issuers of securities, investment advisers, broker- strategies mentioned herein may not be suitable for all investors. Any opinions
dealers, investment banks, other financial institutions and financial intermediaries, expressed herein are given in good faith, are subject to change without notice, and
and accordingly may receive fees or other economic benefits from those are only current as of the stated date of their issue. Prices, values, or income from
Standard & Poor’s Equity Research
15. April 7, 2011 Global Strategy
any securities or investments mentioned in this report may fall against the interests
of the investor and the investor may get back less than the amount invested. Where 15
an investment is described as being likely to yield income, please note that the
amount of income that the investor will receive from such an investment may
fluctuate. Where an investment or security is denominated in a different currency to
the investor’s currency of reference, changes in rates of exchange may have an
adverse effect on the value, price or income of or from that investment to the
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tax consequences of making any particular investment decision. This material is not
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investment objectives, financial situations or needs and is not intended as a
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Before acting on any recommendation in this material, you should consider whether
it is suitable for your particular circumstances and, if necessary, seek professional
advice.
This document does not constitute an offer of services in jurisdictions where
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For residents of the U.K. –this report is only directed at and should only be relied on
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respectively.
For residents of Singapore - Anything herein that may be construed as a
recommendation is intended for general circulation and does not take into account
the specific investment objectives, financial situation or particular needs of any
particular person. Advice should be sought from a financial adviser regarding the
suitability of an investment, taking into account the specific investment objectives,
financial situation or particular needs of any person in receipt of the
recommendation, before the person makes a commitment to purchase the
investment product.
For residents of Malaysia - All queries in relation to this report should be referred to
Ching Wah Tam.
For residents of Indonesia - This research report does not constitute an offering
document and it should not be construed as an offer of securities in Indonesia, and
that any such securities will only be offered or sold through a financial institution.
For residents of the Philippines - The securities being offered or sold have not been
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Standard & Poor’s Equity Research
16. April 7, 2011 Global Strategy
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Standard & Poor’s Equity Research
