Global Economics

PetroChina Investors Shrug Off Buffett Sale


The investing wizard sells 28 million shares of the Chinese oil company criticized for links to Sudan, but his remaining 9% stake rakes it in

Warren Buffett , long celebrated for his investing skill, more recently has won renown for his philanthropy, especially his gift of billions of dollars to the Bill and Melinda Gates Foundation. That hasn't stopped critics from denouncing him for being a major shareholder in PetroChina (PTR), the Chinese state-owned oil company that is a big investor in Sudan, where millions have died or become refugees because of the conflict that has wracked the Darfur region.

Critics have been calling for Buffett to sell his PetroChina stake in order to protest the company's support for the Sudanese regime. And on Sept. 20, Buffett's Berkshire Hathaway (BRK) sold 28 million shares in PetroChina. The sale was Buffett's third in the last two months.

Activists say that their message is finally getting through to investors. "This steady series of sales of PetroChina… is an increasingly clear demonstration of divestment by Berkshire Hathaway," Investors Against Genocide, a Boston-based group, said in a statement. " We hope that these sales by the largest single shareholder of PetroChina send a clear signal to PetroChina, the government of China, and the government of Sudan that large investors like Mr. Buffett, and hundreds of thousands of small investors, do not want their money to be complicit in genocide."

Shares Hit Record High

Nevertheless, most analysts in Hong Kong agree that Buffett's sell-off was motivated by profit-taking, not humanitarian concern. Even after the three sales, Berkshire still owns nearly 9% of China's largest oil company, making it the second-largest shareholder behind the government-backed China National Petroleum, which owns 88%.

And from an investor's standpoint, the shares have been rewarding. Despite the news of Buffett's latest sale, the company's Hong Kong-listed shares hit a record high Sept. 21, thanks largely to rising crude oil prices. PetroChina's ADRs have advanced more than 200% in New York Stock Exchange (NYX) trading over the past three years, well outpacing other major international energy players such as Exxon Mobil (XOM) (a 90% advance), Chevron (CVX) (80%), and BP (BP) (25%).

Like the international majors, the big three China oil companies—PetroChina, Sinopec (SNP), and CNOOC (CEO)—are making enormous profits, given persistently high energy prices. In 2006, PetroChina posted net income of nearly $20 billion on revenues of about $92 billion, and its market cap runs currently at about $283 billion, behind Exxon Mobil, but ahead of nearly everyone else.

In terms of strategy, what distinguishes the Chinese companies most from the majors is that they are plowing much larger sums, relatively speaking, back into actually finding and producing more oil and gas.

Keeping Expenses Down

In the U.S., the bigs, such as Exxon Mobil and Chevron, have faced criticism for what's viewed as an overly conservative posture given their earnings bonanza. For example, in the first half of 2007, Exxon Mobil spent $9.3 billion on capital expenditures (much of which went to exploration), representing about 34% of its cash flow. For the same period, the company spent $16 billion on share buybacks. Meanwhile, overall production declined 2% in the first half.

By contrast, in the first half of the year, PetroChina reported about $6.8 billion in capital spending. That's a rate of 46% of cash flow. The company's production advanced 3.7%. "PetroChina's spending is closer to that of a small [or] midcap energy company," Beijing BNP Paribas (BNPP.PA) analyst Bradley Way wrote in a recent research note. As a result, PetroChina and CNOOC are adding new reserves faster than they are producing from existing stocks.

A Major Argument

And rather than buy back shares, PetroChina will in fact offer more; pending regulatory approval, the company plans to offer as many as 4 billion Class A shares on the Shanghai exchange. The company has indicated it will use the proceeds to boost output and build a pipeline.

The majors have argued that by not chasing marginal or uneconomic fields, they are simply being disciplined stewards of shareholder capital. And they rightly point out that exploration projects large enough to make a big difference to these behemoths' bottom lines are rare, technologically intensive, and very costly to drill.

There are a few reasons for the Chinese companies' more aggressive posture and results. The most important—and obvious—is that the China oil giants have a national mandate to achieve energy security for China. The increased rate of investment is "the result of a government directive," says David Johnson, a Macquarie Bank (MBL.AX) energy analyst in Hong Kong.

Cheap Loans from the Government

Given such a nudge, their hurdle rates for new projects are significantly lower than international competitors. For drilling projects, the majors generally demand a return on capital of 15%, say experts. In Way's research note, he indicates that PetroChina may lower its standard to as low as 10% in some instances.

The Chinese companies can live with lower rates of return, however, since their largest stakeholder—the government—guarantees they have a lower cost of capital than their private-enterprise rivals. Gordon Kwan, an analyst at CLSA Asia-Pacific Markets in Hong Kong, estimates PetroChina's cost of capital to be 6%, for example, vs. about 8% for the supermajors. "If the Chinese companies need money, the Chinese government will give them cheap loans," Kwan says. PetroChina did not respond to a request for comment for this article.

Of course there's the issue of access, highlighted dramatically by the furor over PetroChina's investment in Sudan. Thus far, Chinese companies have not been fettered by geopolitical concerns, going headlong into oil-rich hotspots such as Iran, Nigeria, Venezuela, and Sudan. Analysts don't expect PetroChina, for example, to be particularly fazed by the Berkshire sales. "But the pressure was there," says Johnson. "It's a risk [the Chinese companies] have to consider."

Remembering the Unocal Fight

The glare from such controversies will only become more intense as they become more aggressive acquirers of energy assets around the globe. Right now, PetroChina gets 95% of its production from fields on the mainland or in shallow waters offshore. Indeed, the company's biggest asset is still the mammoth Daqing field in northeastern China, which was discovered in the 1950s. Sinopec, which has more of a refining presence than the other two companies, has virtually all of its reserves in China. Even CNOOC, a pure-play exploration company and the most outward-facing of China's big three, gets just 10% of its reserves from overseas.

Late last year, PetroChina bought a 67% interest in PetroKazakhstan for $2.7 billion. And shares of Oil Search, a Papua New Guinea oil and gas producer, spiked Sept. 17 after a report of a $5 billion PetroChina bid. Analysts anticipate even more activity in the coming years, but don't necessarily expect any big trophy acquisitions. Recalling the political fight kicked up after CNOOC tried to buy U.S.-based Unocal, the China big three "prefer going after individual assets rather than corporations," says David Hurd, a Deutsche Bank (DB) analyst in Beijing.


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