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Napoleon Of China's Oil Patch


Chinese oil company CNOOC Ltd. (CEO) may be coming back for more. After months of on-again, off-again talk about buying Unocal Corp. (UCL), CNOOC on June 7 said that it is still interested in a deal, potentially derailing Chevron Corp.'s (CVX) $16.4 billion bid for the U.S. oil producer. If successful, such a deal would be the biggest overseas acquisition ever by a Chinese company -- and would further establish CNOOC as the most ambitious Chinese player in the oil patch. CNOOC is "ahead of the curve in China," says Scott Roberts, director of Cambridge Energy Research Associates in Beijing. "And they are willing to think big."

A Napoleon syndrome may be at work here. CNOOC is dwarfed by China's two biggest petroplayers, PetroChina Co. (PTR) and Sinopec Corp. (SNP), but it's proving to be the toughest kid on the block. Its name stands for China National Offshore Oil Corp., which is the parent company of CNOOC Ltd., the publicly traded arm of the business floated in 2001 in Hong Kong and New York. CNOOC was created in 1982 to cooperate with foreign companies in exploration and drilling both overseas and at home. Any Unocal deal is a long shot -- and the company isn't even saying it will definitely make a bid -- but CNOOC still takes its overseas mandate very seriously. "We will go wherever there are opportunities," says Yang Hua, chief financial officer of CNOOC Ltd. "We are looking at every possibility."

Lately, CNOOC has certainly been seizing lots of opportunities. Since May, 2004, the company has completed three big transactions giving it access to oil and gas from the waters off Australia and Indonesia to the dry oil sands of Alberta, Canada. Such deals helped boost revenues by 30% last year, to $6.7 billion, while net profits jumped 40%, to $1.95 billion. In the first quarter of 2005, sales continued their growth, surging 47.6%. Over the past 10 years, CNOOC's reserves and production have grown by some 15% annually. Plans for the next five years call for production to keep increasing by as much as 11%, says CFO Yang. The company's stock is already up 30% over the past year, and CLSA Asia-Pacific Markets is predicting that it will climb another 30% within 12 months.

There's good reason to believe that bullish prediction. China is sucking up energy faster than any country on earth, and that's not likely to change anytime soon as foreign investment continues to pour in and Chinese consumers boost their spending by 10% or more annually. Beijing expects energy consumption to double by 2020, which gives CNOOC "a very good outlook," says Hernan Ladeuix, head of oil and gas research at CLSA Asia-Pacific Markets. "The Chinese companies will all benefit."

WESTERN SENSIBILITIES

CNOOC, though, is likely to make out better than its hometown competitors. Its long experience working overseas has made it more attuned to Western commercial sensibilities, and four of the eight members of CNOOC Ltd.'s board are independents with international experience, including Kenneth S. Courtis, managing director of Goldman Sachs Asia. Several top officials are U.S.-educated, including CEO Fu Chengyu. He has a master's degree in petroleum engineering from the University of Southern California and once worked in China for Phillips Petroleum Co. -- unusual in Chinese state-owned companies, where managers are typically drawn from the ranks of career bureaucrats. And the company is far more forthcoming with data on its financial performance than most Chinese state-owned enterprises are.

CNOOC is also positioning itself as China's leading player in natural gas. As Beijing seeks to wean itself from Mideast oil and limit the use of dirty coal, gas use could rise to as much as 10% of total energy consumed in China by 2020, more than triple the level today. The parent company is building liquefied-natural-gas terminals in Shanghai and in Guangdong and Fujian provinces and has signed deals for several more across China. To keep the gas flowing into those facilities, CNOOC Ltd. in December expanded its stake in Australia's rich North West Shelf gas project to just over 5%. And it's negotiating to buy into the Gorgon LNG project off Australia, which is owned by Chevron (CVX), Shell, and ExxonMobil (XOM). Meanwhile, CNOOC has become one of the biggest players in Indonesia's offshore gas fields, and in April it purchased a 17% stake in Calgary-based MEG Energy Corp., giving it access to an estimated 2 billion barrels of reserves in the oil sands of western Canada.

PILES OF DEBT

Where would Unocal fit into this strategy? Unocal's rich gas reserves in Thailand and Indonesia would give CNOOC a big boost. At the end of last year, CNOOC's proven reserves totaled 2.2 billion barrels of oil equivalents, compared with Unocal's 1.8 billion, but Unocal's production would more than double CNOOC's output.

There's no guarantee, though, that CNOOC will successfully outbid Chevron. CNOOC's market capitalization stands at $22 billion, compared with Chevron's $115 billion. And since issuing new shares would dilute the Chinese government's 70% stake in CNOOC and could anger smaller shareholders, any deal would likely have to be financed with piles of debt, which could wreak havoc on the company's sound balance sheet. Even if CNOOC does prevail, it will have to pay Chevron a $500 million breakup fee to bow out. "It's a pretty big bite they would have to take," says one investment banker familiar with the company.

CNOOC is facing obstacles in other areas, too. Its two bigger Chinese competitors are moving to lock up oil and gas supplies at home and abroad. Sinopec has bought into gas in Saudi Arabia. PetroChina has invested in gas fields in Indonesia and Kazakhstan and is building a 4,000-kilometer West-East Gas Pipeline to ship gas from the deserts of Xinjiang to energy-hungry Shanghai. And both companies are planning their own LNG terminals across China. The grabs for acreage are playing out even as gas prices are rising -- a challenge for all three Chinese petromajors. "They will be accessing supplies in a tightening market" as India and the U.S. both increase their reliance on gas, says Peter de Wit, executive vice-president for Asia at Shell Gas & Power. "They really have a lot of competition coming."

Beijing is doing its bit to help. The government has waived import duties on LNG and lowered taxes on the Guangdong LNG pilot project operated by CNOOC. Further down the road, all the Chinese companies will see soaring profits as gas and oil prices are freed from controls that today keep them about 25% below world prices, CLSA figures. More profits mean more deals. CNOOC is just getting started.

By Dexter Roberts in Beijing


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