In the words of Xiang Yu, a 19th-century Chinese poet, the emerging majors have "strength to lift mountains and spirit to take on the world." And they will. It's only a matter of time. The three newly public Chinese oil and gas companies appear ready to play a significant role in the global oil and gas industry, considering their potentials are enormous. PetroChina has the second-largest oil reserves of any company in the global oil and gas industry, as well as the third-largest net present value (NPV) of any oil company, behind only ExxonMobil and BP, and the fourth-highest net income in the industry. CNOOC Ltd., China's offshore giant, has the largest reserves of the international upstream majors. This is coupled with the lowest proportion of developed reserves, the highest net income and the highest return on adjusted capital employed (ROACE) of its peers. Sinopec, on the other hand, has both the highest historic and forecast net-income growth of the industry, and has the fourth-largest refining and marketing capacity of any petroleum company. Meanwhile, Petrobras has unmistakable potential, with sizeable oil and gas assets, the highest production growth seen in the industry during the last few years, a tight grip on Brazil's refining industry and a growing gas and power presence. Furthermore, it has exploration and production assets in 11 countries outside of Brazil. These are some of the key conclusions reached by a new report published by Evaluate Energy of London, which analyzed PetroChina, Sinopec, CNOOC and Petrobras in terms of financial and operating performance, asset base, strategic vision, strengths and weaknesses. The study benchmarks these firms against their international competitors in a wide-ranging selection of financial, operating and segment data. PetroChina The rapid growth of China's economy in recent years has generated significant growth in consumption of primary energy. In 2000, China was the world's second-largest consumer of primary energy and the third-largest consumer of petroleum products. It was expected that China will replace Japan as the second-largest consumer of petroleum products by the end of 2001. This has led to a large supply-demand imbalance in the country, with China now being a net importer of crude oil. China's crude-oil production grew at a compounded annual growth rate (CAGR) of only 1.7% from 1990-99-but consumption grew at a CAGR of 6.4%. The rising volume of imports reflects China's failure to boost production in line with rising domestic demands, due to a lack of innovative exploration ideas, outdated technology and shortage of investment funds to bring new fields into operation. In 2000, China imported 70.3 million tonnes of crude. Oil production stabilized at approximately 160 million tonnes, supplying only 73% of national requirements. If oil production stayed at current levels, the country's import dependence would reach 50% in 2020. One solution proposed by the Chinese government is the development of the country's natural gas market, especially in the high-growth coastal areas. With a heightened interest in efficiency and the environment-not to mention the increased fuel load that will be needed for the 2008 Olympics-gas production and usage is set to take off in a substantial manner. Beijing is actively promoting the use of gas as an alternative to coal, traditionally China's main primary energy source, with royalty-tax benefits for offshore gas production, and it is encouraging the building of gas-transmission lines and gas-fired power plants. Based on gross domestic product (GDP) and primary energy-driven growth models, the U.S. Energy Information Administration (EIA) projects Chinese gas consumption will grow at a CAGR of 14.4% during the next 10 years to 3.9 trillion cubic feet (Tcf) in 2010. The State Development Planning Commission projects a slightly lower CAGR of approximately 13.19% during the next five years. The government is encouraging foreigners to invest, but who is the domestic winner of this change in fuelstock? Another Chinese major, Sinopec, has little presence in gas, concentrating on refining, marketing and chemicals. Another, CNOOC, has substantial gas production offshore, but no access to the huge inland reserves and it has a minor presence in the midstream sector. PetroChina, on the other hand, has staked its future on gas, controlling the enormous Tarim and Sichuan gas regions, and coordinating the monumental West-East pipeline project. Pipe dreams PetroChina has staked a large percentage of its future on the 4,200-kilometer West-East pipeline, funneling gas from the giant Tarim Basin through the Yangtze Delta regions to Shanghai. And despite recent setbacks, such as the withdrawal of BP from the project, the vision might just pay off. Note that PetroChina's gas reserves place it behind only RD/Shell, ExxonMobil and BP. There is a mismatch, however, between PetroChina's huge resources and its relatively small gas production. This imbalance should be ironed out by the new pipeline, which will provide PetroChina's "missing link"-a means of transporting stranded gas reserves from the western portion of the country to the highly populated east. Furthermore, it may act as a catalyst to opening new exploration frontiers along the route, and also opportunities for existing Russian and landlocked Caspian fields in pursuit of a market-with China providing one of the fastest-growing energy markets in the world. Completion of the first section, linking Jianbian and Shanghai, is expected in fourth-quarter 2003, and completion of the whole network is anticipated by 2005. The total downstream demand is expected to be 11.3 billion cubic meters per year. The carrot to lure the international majors into the project is the opportunity to gain a stake in the giant Kela-2 gas discovery, the crown jewel of the Tarim Basin. This should counteract the majors' need for a 15% internal rate of return, which is unlikely from the pipeline alone. To ensure long-term energy security in the region, China has been holding talks to build several transnational gas pipelines from Russia, Kazakhstan and Turkmenistan. With many having doubts over PetroChina's Tarim discoveries reliably producing more than 12 billion cubic meters of gas annually, importing gas from Turkmenistan and neighboring Central Asian countries is a long-term possibility. Vast volumes of gas are stranded in Russia and the Caspian region. Opportunities that could be opened by the completion of the West-East pipeline include importing gas from Sakhalin, West Siberia, East Siberia and the Caspian region. These are big opportunities-BG and ChevronTexaco estimate the gas reserves they are drilling in Kazakhstan are larger than those of Kuwait. Deposits beneath Turkmenistan may hold more gas than the U.S. and Mexico combined. Opening these reserves to the huge Asian markets is the long-term growth option PetroChina alone can boast. CNOOC While PetroChina and Sinopec control the republic's onshore energy resources, CNOOC reigns supreme in offshore production, in a development area twice the size of the Gulf of Mexico. Born as the showpiece of Chinese E&P, CNOOC commands more than 1.8 billion barrels equivalent of proven oil and gas reserves, with 66% undeveloped, ensuring production growth of around 15% during the next five years. The company has adopted a Western-style, return-focused management philosophy and a long history of interaction with the international scene. CNOOC is highly competitive by all international measures. Project feasibility studies are based on US$15 oil price, and a minimum internal-rate-of-return (IRR) hurdle of 14%. Unlike Sinopec and PetroChina, CNOOC is already a world-class company with the respectability and valuation premium. However, this also means there is diminishing scope for future cost-cutting. Some investors may dismiss CNOOC because of its small size relative to PetroChina and Sinopec. This would be foolish. While CNOOC is small, it has the best E&P business model of the three companies. Furthermore, it has a whole series of advantages over its larger competitors. • It has an exceptional Western-style human-resource management. CNOOC president Liucheng Wei has worked closely with BP in offshore oil exploration, and the company has been sending employees abroad to MBA schools for several years. By 2003, CNOOC will have at least 200 foreign MBA-trained executives, aged 40 or younger, in a workforce that will not equ al much more than 1,200. • It commands the country's best geologists and petroleum engineers. • It has exclusive access to the offshore region of China, and is the only company allowed to work with foreign oil companies offshore. Furthermore, it has the right to acquire an up to 51% participating interest in any successful discovery made by a foreign partner, at no cost. • The Chinese State Council has recently revised the regulations on exploitation of offshore petroleum resources, prompted by a comprehensive review of all business laws and regulations by the Chinese government to ensure compliance with the World Trade Organization. The removal of restrictions governing technology transfers and domestic component requirements in procurement now provides a level playing ground for all oilfield-service contractors-domestic or international. This revision not only confirms CNOOC's exclusive right to the offshore realm, but also is expected to benefit CNOOC's E&P business and further increase production-sharing activities offshore China. • The company has a long tradition of working with international companies, and has signed some 150 PSCs with 70 such companies, including BP, Agip, ChevronTexaco, Phillips, Husky and Burlington Resources. • Given more business flexibility historically by the Chinese government, CNOOC now has superior corporate governance, operational procedures and cost structures. All the Chinese companies have expressed a desire to expand internationally, though only CNOOC has disclosed definite plans. It already owns a 39.71% interest in an operation in the Malacca Strait, and has signed a memorandum of understanding with Chevron Australia to explore the feasibility of acquiring interests in the Gorgon area offshore Australia, and in working to develop the gas market in coastal China. CNOOC also has a continuing interest in bringing more PSC partners into offshore China. The liquefied natural gas (LNG) market in China is set to follow that of natural gas. Since 1990, worldwide LNG trade has enjoyed a 7% CAGR, as production costs have almost halved. China's major LNG project is in Guangdong and is led by CNOOC. It includes the construction of a receiving terminal with a capacity of 3 million tons per year. Phase 1 is due onstream in 2006. BP has already won the terminal and trunkline bid, bringing operating experience into the project, as well as LNG sources. Sinopec China's downstream industry has developed via a combination of two separate dynamics-the discovery of significant oil deposits in the northeast, and the high level of rivalry and competition between various provinces that occurred when China was a closed economy. This led to an industry that is fragmented, undersized and inefficient. The lack of a good transportation and distribution system in the country, coupled with the bureaucracy involved in effecting interprovincial business meant oil was often refined locally in small plants, an inefficient and costly process. Sinopec's main challenge is to upgrade its refining network to internationally competitive standards. China has lightened its demand profile for more than a decade, leading to increasing demand for gasoline and diesel. However, this trend was not immediately matched by the refineries' product slates. China is now experiencing pressure to improve its refining system to match its evolving demand pattern by installing more upgrading units. The process is being led by a need to maximize the output of diesel at the expense of gasoline, which is currently in oversupply. A further change needed is consolidation. Refining is a business in which economies of scale are significant, and the trend within the global refining industry is towards fewer, but larger, plants. Sinopec needs to close down its numerous smaller refineries, and focus attention onto its world-scale ones. Luckily for Sinopec, marketing is expected to be the key to its overall success. Its principal market encompasses China's eastern and southern regions where the largest and fastest-growing cities are located. It has the largest refined petroleum products marketing and distribution operations in China, with competition only possible from a relatively weak PetroChina. Sinopec's marketing is fairly self-sufficient, with 83% of refined products supplied by the refinery division. The company controls 62.4% of the gasoline-sales market, 61.4% of the diesel-sales market and 52.0% of the jet fuel and kerosene market. Sinopec's other star division is chemicals-it is China's largest chemical producer, holding about half the market share for major chemical products such as synthetic resins, intermediate petrochemicals, synthetic fibers, synthetic rubbers and chemical fertilizers. Supply-demand dynamics indicate a positive outlook. China has a huge ethylene shortfall, with demand currently growing at GDP levels. The market can still absorb a considerable amount of plant expansions without hurting margins and Sinopec plans to take advantage of this by increasing capacity and yields. Expansion is expected to take two routes: the expansion of existing facilities and joint ventures with Western parties. Four joint ventures are currently planned, with major benefits being the integration of advanced Western technology into the Chinese petrochemical industry, and reduced financing needs. It is expected that these projects will be project-financed off balance sheet, so with only a 25% equity contribution, the risk to Sinopec will be relatively small. Sinopec's one chemical-sector problem is its numerous listed subsidiaries, including Yizheng Petrochemicals, Beijing Yanhua and Shanghai Petrochemicals. All of these show weakness in product pricing, falling share prices and analyst disappointment. For Sinopec's impeccable credentials in refining and chemicals, it constantly disappoints the market. First-half 2001 results were lower than analysts' estimates, in the face of very poor market conditions in the chemicals and refining businesses, and a weak performance in the marketing division. There is excessive supply and weaker-than-expected demand in Asian markets. With it's A-share debut being priced at the top of expectations, the stock subsequently performed worse than expected. With the company's continued high debt burden, there is little foreseeable positive news to drive the share price until its inclusion into the MSCI China Free Index at the end of 2001. Petrobras This Brazilian giant is spreading its wings, aiming to become an internationally competitive energy company by focusing on E&P, product supply and electricity supply to Latin America. Its strong fundamentals and exceptional growth profile among its international peers help offset the problems it faces domestically. Petrobras has had a spate of operational issues, including the dramatic sinking of Platform P-36 and a number of major and minor oil spills. While these have not significantly changed its production targets, they have had a damaging effect on international opinion At press time, Petrobras' CEO resigned, but the company's growth profile should not be affected during the transition. While Petrobras is now floated on the international market, the government still has a great deal of control, including pricing regulation, funding requirements for the National Petroleum Agency, and fuel transportation subsidies. The stock has historically been driven more by the market than by fundamentals. In addition, the country's currency-the real-has weakened, creating a negative impact on the company's free cash flow, although EBITDA would benefit, due to the company's cost structure (around 90% of revenue being levered to the dollar, but only 55% of costs). The government's debt to Petrobras is not as high as expected, implying that the company will lose a substantial cash amount in 2001. Brazil's overall economic environment remains risky. Still, Petrobras' fundamental strengths cannot, and should not, be denied. The company has a focused, quality E&P operation in the Campos Basin with unmatched insight into sedimentary basins in Brazil. This is coupled with exceptional deepwater and ultradeepwater experience, which could be transferred to other areas such as the Gulf of Mexico. Oil production is expected to grow 8%. This is more than twice the growth of most other international oil companies. Finally, the company dominates Brazilian energy across the value chain, from oil and gas to electricity and power. After years of restructuring since privatization, Petrobras is focused on cutting E&P costs, including participation with international companies to reduce the need for capital investment and E&P risks. It also is disposing of marginal and noncore assets, and is focused on larger offshore fields with high well productivity near existing infrastructure, to reduce financial and operating costs. It also focuses on sustaining the company's superior growth. This includes the strengthening of its global deep and ultradeepwater positions, the continued development of large proved and undeveloped reserves, and the expansion of its offshore gas production. Its production target is 2.2 million barrels of oil equivalent per day in 2005, comprised of 1.9 million BOE from Brazil, and 300,000 BOE internationally. Oil is expected to account for 85% of the total. The strategy in refining, marketing and chemicals also focuses on cutting costs, increase profitability and increasing product quality. However, it is in corporate and environmental strategies that Petrobras may make the biggest headway. The company aims to increase the transparency of its relationships with the government, the community and shareholders, integrate subsidiaries, incorporate rate-of-return hurdles for business segments and reduce financial costs by more frequent access of the international capital markets, thus reducing the cost of capital. Petrobras aims to reach international standards of environmental excellence by 2003, investing US$1 billion in health, safety and the environment during the next three to five years on revising contingency plans and risk assessments, increased supervision, reduced waste, treated effluent, controlled emissions and the use of alternative energy. Petrobras already has an international footprint, though only a small proportion of production comes from this area. It has development activities in Argentina, Bolivia, Colombia, Nigeria, the U.S. and Cuba, and exploration activities in Trinidad and Tobago, Angola, Equatorial Guinea and Kazakhstan. The company intends to pursue opportunities in Latin America, the Gulf of Mexico and West Africa, aiming to produce 30 million barrels a day internationally by 2005. The common theme to any acquisitions or joint ventures will be the exploitation and transfer of its deepwater expertise from the Campos Basin. Downstream, the company aims to further develop international refining capacity to process the heavy-oil surpluses produced by Brazil, and to increase its retail presence in the Americas. M Rebecca Hitchin is an oil and gas analyst for Evaluate Energy (evaluategroup.com) in London, which specializes in forecasting, benchmarking, competitor analysis and M&A analysis for the global oil and gas industry. Lars Alveberg, an analyst as well, contributed to the article.