The Wall Street Journal: Investors May Have Overreacted To PetroChina’s Big Oil-Field Find

EXTRACT: Royal Dutch Shell, in a famous example, had to revise its oil reserves downward to comply with SEC guidelines.

THE ARTICLE

By SHAI OSTER
May 10, 2007

BEIJING — Investors in PetroChina got a big lift Friday. An announcement of the company’s discovery of a vast oil field caused the shares to spurt 14% in Hong Kong that day.

But there is reason for caution about how much of a long-term boost the find will give.

Late last Thursday, the listed unit of state-owned China National Petroleum Corp. said it had discovered 1.02 billion metric tons, or about 7.33 billion barrels of oil equivalent, of crude oil and natural-gas reserves in northeastern China’s Bohai Bay.

On Friday, PetroChina stock rose to HK$10.16 (US$1.30), a gain of HK$1.25, and was the most actively traded issue in Hong Kong. A total of HK$1.18 billion of shares — 16 times the turnover a day earlier — changed hands.

After Friday’s surge, the share price has cooled a bit as investors seem to feel the market got a little overexcited by the find. Yesterday, the stock fell three Hong Kong cents to HK$9.94.

At first blush, the new find points to a significant shift in PetroChina’s and China’s fortunes. A big field close to home could mean less dependence on costly imports, less of a need to buy overpriced foreign fields, and a fatter bottom line for the company.

“This is a very significant discovery at a critical juncture,” says Gordon Kwan, director of China oil and gas research at CLSA Asia-Pacific Markets. The headline on his report about it was “The Mother of All Oil Discoveries in Asia,” and he says it would equal the entire current reserves of Cnooc, China’s third-biggest oil company in terms of output.

But other analysts say there are some questions about how costly the field will be to develop and how big it really is when held up to much tougher U.S. standards, which take into account how much oil in a field can actually be produced. PetroChina, which has American depositary receipts traded on the New York Stock Exchange, hasn’t yet booked its reserves with the U.S. Securities and Exchange Commission on this new find.

“With meaningful volumes of oil not coming online for several years, reserve estimates at this phase not being official, and stock-price estimates having near and midterm reserve replacement built in, we believe the reaction in markets was somewhat overdone,” says Bradley Way, a Beijing-based analyst with BNP Paribas. He maintains a hold rating on the stock with a 12-month target of HK$10.50.

Goldman Sachs also remains cautious, raising worries about the potential costs of developing the field. It maintains a neutral rating and has a 12-month target price of HK$9.30.

Depending on how it’s measured, PetroChina’s new field could be the biggest find in China in 30 years, and the company’s second-biggest oil discovery. It could hold as much as 3.3 billion barrels of recoverable oil, according to the more optimistic estimates. China’s flagship oil field, Daqing, in the northeast had some 4.4 billion barrels at the end of 2005, according to Citigroup.

The share price of PetroChina, the country’s largest integrated oil producer, rallied nearly 75% in 2006, with a peak close of HK$11.12 on Dec. 28. It then fell as low as HK$8.57 on March 21. Driving the selloff were disappointing 2006 financial results. These highlighted unexpectedly hefty production costs, which meant that company profit rose 6% even as world oil prices surged 25%.

PetroChina defended its rising costs, saying the company went after tougher-to-develop fields to take full advantage of the high price of crude. It also pointed out that, in absolute terms, its earnings were a record-high US$18.5 billion.

The company told Hong Kong’s stock exchange that the new field, called Jidong Nanpu Oilfield, is near the city of Tangshan in coastal Hebei Province. It is close to Caofeidian Harbor, which will be a major new industrial hub not far from Beijing. The state-run Xinhua news agency said the field was partly onshore and offshore, covering around 1,500 square kilometers and producing light oil, which is cheaper to refine into profitable products such as gasoline or jet fuel.

In a research note, Citigroup called this discovery “game changing.” In a note the day after the announcement, the bank said the find “could transform PetroChina from a company struggling to hold oil production flat to a company with strong crude growth in the coming years.” Still, Citigroup didn’t change its 12-month target price for PetroChina of HK$10.80, while reiterating its buy recommendation.

Mr. Kwan of CLSA has a 12-month target price of HK$11.80 and thinks there could be more upside for PetroChina from its recently announced gas field in Sichuan. The company hasn’t released any data on that find.

For listed oil companies to have reserves booked by U.S. standards with the SEC, several months of independent testing are required to see just how much of the oil underground is actually recoverable. While recovery rates can vary according to what types of technology are used, some analysts say that based on PetroChina’s track record, they expect it might eventually produce less than half of the oil in the field.

The SEC guidelines matter because investors use them as the global benchmark for assessing how much oil a company will be able to pump. Royal Dutch Shell, in a famous example, had to revise its oil reserves downward to comply with SEC guidelines. Some analysts suggest that PetroChina’s find, while still important, will add much less value than Friday’s jump in the share price implied.

CLSA’s Mr. Kwan thinks the field will come in at what PetroChina said. “Estimating reserves is an art, not a science. The Chinese art may differ from SEC art,” he says.

Other analysts note that until oil is actually produced, perhaps as early as 2010, the new field will cost — not make — money. And even when production begins, they add, there will be another two to three years before it reaches its peak.

Just after PetroChina announced the Bohai Bay discovery, it got another piece of good news, from the U.S., where activists have been urging PetroChina’s biggest shareholder, Warren Buffett’s Berkshire Hathaway Inc., to divest its stock.

They wanted Berkshire Hathaway out to protest the development of oil by PetroChina’s parent company in Sudan, where ethnic fighting has displaced millions in the Darfur region. But a motion to sell the U.S. investor’s US$3.31 billion stake was soundly defeated at a shareholders meeting Saturday.

Write to Shai Oster at [email protected]

 

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