What it means for China's big oil companies

Deutsche Bank Markets Research Asia Hong Kong Energy Oil & Gas Industry China's RMB devaluation Date 20 August 2015 Special Report What it means for China's big oil companies Bottom line ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015. David Hurd, CFA Research Analyst (+852) 2203 6242 david.hurd@db.com Top picks Sinopec (0386.HK),HKD5.43 Buy PetroChina (0857.HK),HKD6.80 Hold CNOOC Ltd (0883.HK),HKD9.11 Hold China Oilfield Services (2883.HK),HKD9.10 Hold Source: Deutsche Bank Companies Featured Sinopec (0386.HK),HKD5.43 Buy 2014A 2015E 2016E P/E (x) 13.6 12.8 11.6 EV/EBITDA (x) 6.0 4.8 4.4 Price/book (x) 1.0 0.8 0.8 PetroChina (0857.HK),HKD6.80 Hold 2014A 2015E 2016E P/E (x) 12.4 17.2 11.3 EV/EBITDA (x) 5.3 5.6 4.7 Price/book (x) 1.1 0.8 0.8 CNOOC Ltd (0883.HK),HKD9.11 Hold 2014A 2015E 2016E P/E (x) 7.6 14.3 8.5 EV/EBITDA (x) 3.6 3.8 2.9 Price/book (x) 1.0 0.9 0.8 China Oilfield Services (2883.HK),HKD9.10 Hold 2014A 2015E 2016E P/E (x) 9.6 12.3 8.0 EV/EBITDA (x) 6.9 6.2 4.9 Price/book (x) 1.1 0.7 0.7 Source: Deutsche Bank We write this report because we suspect that over the coming 6 to 12 months we may need to refer to it again. We would not recommend buying or selling any of the Chinese oil companies strictly based on an engineered 3% devaluation of the RMB. We believe the devaluation supports reported earnings at Sinopec (SNP) and to a lesser degree PetroChina (PTR), yet reduces reported earnings at CNOOC and COSL. Foreign exchange translation gains / (losses) are non-cash and non-taxable events. How do we look at this issue? The impact of translation gains / losses from USD denominated debt held by the Chinese O&G Companies is straightforward. CNOOC Ltd (100%) and COSL (94%) hold USD debt to the exclusion of RMB debt, seemingly as (CNOOC Group) policy. We were surprised to see that PetroChina holds as high a percentage of USD debt, as disclosed in its 20F filings: as of 2013 year-end, 23.3% of PTR’s total debt was USD denominated; as of 2014 year-end, 24.8% of PTR’s debt was USD denominated. The rest of PTR’s debt is in RMB. Sinopec likewise discloses its USD debt holdings in its 20F report. As at 2013 year-end, 11.6% of SNP’s total debt was in USD or HKD (linked to USD); whereas at 2014 year-end, 15.8% of SNP’s debt was in USD and the rest in RMB. CNOOC has a lot of USD debt (US$ 22bn), even more so than PTR (US$ 21.5bn), Sinopec (US$ 8.3bn) and COSL (US$ 4.1bn), as of year-end 2014. Operations and inflation: These two issues are more complicated. We assume: 1) all revenues (100%) for our Chinese O&G companies are in USD; COSL is NOT an O&G company; it is an Oil Service company; 2) international operations generate USD operating costs; 3) domestic operations generate RMB operating costs, except for the cost of importing oil, which is a USD cost. CNOOC Ltd publishes operating costs for its foreign operations; COSL does not and neither do PTR and / or SNP. For PTR and SNP we assume operating costs in USD proportionate to foreign-to-total production; for COSL we assume foreign operating costs proportionate to its foreign-to-total revenues. We were surprised: 37.7% of CNOOC’s total 2014 BOE production came from its international operations, while 39.2% of its operating costs came from foreign operations - close. We adjust USD revenues and operating costs to the devaluation of RMB to USD. We adjust domestic operating costs by DB forecasted inflation for China. Valuation and risks: We value our Chinese oil companies from DCF models. A DB strategy group sets our China Risk Free Rate (3.9%) and Equity Risk Premium (5.60%); we use Bbrg adjusted Betas, either 2-year or 3-year to produce an estimated cost of equity for each individual company. Estimating a Terminal Growth rate is tricky. We tend to use an estimated long term oil production growth rate (1% to 3%) for our oil producing companies and for COSL we use an estimated (2.5%) volume growth number – this would be volume growth in terms of vessels, rigs, streamers, etc. The principal risks to our Chinese oil companies are: 1) higher / lower than anticipated oil and / or natural gas prices; 2) unanticipated changes to China’s O&G fisc