In late May 2018, China’s National Development and Reform Commission (NDRC) announced that the natural gas pricing system for residential and non-residential city-gate will be unifying to reflect the rising demand and costs. As a result, the residential city-gate prices will increase by 25 percent from 10 June and fixed for the next 12 months. Subsequently, the balance of the price differential may be reflected with an increase of up to 20 percent a year later.
The unification of the two pricing systems will push natural gas prices towards market-oriented pricing. Previously, natural gas prices did not reflect the actual gas cost fluctuations due to the two-tier pricing system. This change will allow for more frequent adjustments in city-gate pricing and improve the situation of losses incurred from imported gases.
China National Offshore Oil Corporation (CNOOC)
The forecast for oil prices has been raised to US$70-US$75 per barrel in 2018 and US$65-US$70 per barrel from 2019 onwards. As an upstream oil and gas company, CNOOC is a direct proxy to gain from the higher oil prices as it engages in exploration and production (E&P) of crude oil and natural gas with exclusive rights for exploration in offshore China.
Previously, market pressure was mounting on CNOOC due to its declining reserves life. However, in 4Q17, CNOOC announced an increase in reserve life from 8.1 years to 10.3 years. This was attributed to the booking of reserves from its projects in South America and re-booking of reserves in Canada.
Analysts from DBS felt that the market has over-penalised CNOOC, with the effect of higher oil prices and longer reserve life has yet to be factored into the current share price. In addition, CNOOC has an attractive dividend yield of 4.8 percent. Given the above reasons, they reiterated a Buy call for CNOOC with a target price of HK$16.00.
PetroChina is China’s largest integrated oil and gas company with operations from upstream to downstream, making it one of the biggest potential winners among China’s oil and gas companies to gain from higher oil prices and the unifying of natural gas pricing systems.
The company’s operating profit has historically been driven by its E&P segment which accounted for 60 percent to 100 percent of its profit depending on oil prices. Given that the estimated breakeven cost for crude oil is approximately US$50 per barrel, the forecasted long-term price of US$65 to US$70 will allow a gradual rebound in PetroChina’s operating profit.
Currently, PetroChina’s non-E&P segments are valued at close to zero. This might be a potential catalyst for the company as the country is undergoing pipeline reforms which might unlock the value. In addition, PetroChina is the largest importer of natural gas in China and policy reforms pertaining to natural gas will definitely benefit the company.
Analysts from DBS reiterated their Buy call for PetroChina with a target price of HK$7.60.
China Petroleum & Chem (Sinopec)
Similar to PetroChina, Sinopec is an integrated oil and gas company in China. The key difference between the two companies is that Sinopec is the largest refiner in China and refining oil is the company’s main revenue source. Sinopec tends to do well when oil prices are low which is in contrary to its peers. Given that long-term price of crude oil is projected to be in the range of US$65 to US$70 per barrel, it will still be low enough for the company to sustain its margins and remain within a “sweet spot”.
As its main revenue driver, income from its refining segment accounts for an approximate 50 percent of its operating profit. Low oil prices and domestic capacity and output will be the key factors that investors need to watch out for. In its retail segment, the company and PetroChina have been facing strong competition from smaller refineries. As a result, the two companies have been slashing their retail prices to keep up with the competition and is one of the key risks for Sinopec.
The unification of natural gas pricing systems is expected to bode well for Sinopec’s downstream business as it will have more flexibility in changing prices that are reflective to existing market rates. In addition, a potential catalyst for Sinopec will be the proposed overseas listing of its marketing segment which might unlock value for investors. Given the above reasons, analysts from DBS reiterated their Buy call for Sinopec and gave a target price of HK$9.00.