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Oil, Gas & Chemicals
Urbanisation and wage increases in China will continue to drive
demand for oil products and plastics
Key themes for 2011 will be unique value proposition from
favourable product mix, pricing regime, LT strategy
Preference for Asian refining and chemicals over policy-ridden
Chinese energy names. Top picks CNOOC, S-Oil and SK Energy
2011 outlook
Crude oil
The Brent crude price has risen from USD76/bbl
in January to USD86/bbl in November, above
HSBC’s house view. From an Asian standpoint,
we believe a number of factors may continue to
support oil prices in 2011-12.
First, China is running out of oil. In 2010, China
produced 4.7% of the world’s crude but consumed
10.5% of it. The nation’s aggregate reserve life of
10.7 years is less than a quarter of the world
average. This will continue to drive Chinese oil
majors into global markets to secure oil assets at
potentially aggressive valuations and boost the oil
price outlook in both the short and long term.
Second, there is a demand/supply mismatch for
crude types. This year, China’s oil demand growth
was driven by diesel. According to IEA’s 2010
medium-term forecast, non-OPEC supply will
significantly decline from 2012 and dependence
on OPEC is expected to increase. However, a
significant portion of OPEC crude is natural gas
liquids (NGLs), which yield less middle-distillate
products. The potential diesel shortage could
prompt an oil price rally as witnessed in 2007-08.
Natural gas
China’s gas economics look set to continue to
deteriorate due to insufficient price increases in
spite of China’s ambitious expansion in gas
infrastructure and unconventional gas
development drives.
According to the National Development and
Reform Commission (NDRC), China’s gas
market should increase from 90bcm in 2009 to
250-300bcm in 2020. By 2020, about 45% of
demand should be supplied by imported gas and
unconventionals. China’s current wellhead selling
price for gas is RMB0.76/cm. On the other hand,
gas production costs vary from RMB0.38/cm for
existing onshore production to RMB0.70/cm for
new onshore, RMB0.7-1.0/cm for unconventional
gas (shale, CBM), RMB2.0/cm for pipe gas at the
border and RMB3.0-3.5/cm for LNG at the
receiving terminal, according to PetroChina.
Using a typical gas economics model, without
imports, China’s gas EBITDAX margin is 40%.
With 10% supply assumed to come from pipe gas
and unconventional, the EBITDAX margin
plunges to 17%. For China’s gas economics to be
restored to a 40% EBITDAX margin, China
would have to increase domestic gas prices by
30% pa till 2015.
Refining
Declining supply addition in China in 2011-12,
coupled with robust domestic demand growth, is
likely to turn China into a net importer of refined
products. While China’s refining capacity growth
could accelerate in 2013, new regulations in Japan
could cut the country’s refining capacity by c1.2m
b/d (c4% of Asian capacity), offsetting potential
exports from China. We expect Singapore
complex margins to recover from USD4/b to
USD7/b by 2014.
Chemicals
After peaking at 18% in 2010, Asia/Middle East
combined petrochemical capacity growth will
sharply decline to 4.4% pa in 2011-14. Assuming
Chinese demand growth is sustained at 1.0x GDP
based on continuing urbanisation in the central
and western parts of the country, China’s demand
will likely absorb 80-85% of that incremental
capacity from Asia/Middle East till 2014. Given
the usual ramp-up delays of new projects, it
essentially predicts a market in which both Asian
and Middle Eastern producers can co-exist.
2011 high conviction idea
S-Oil (010950 KS, OW, KRW80,200,
TP KRW100,000)
As Korea’s only pure refiner, S-Oil is the most
leveraged to improving refining margins. The
refining segment will contribute 45% of 2011
EBIT with the balance from associated refinery
products, lube base oil and aromatics. Thus, we
believe the company is best positioned to benefit
from the refining margin uptrend in 2011-12.
S-Oil is also the best poised in Asia to benefit
from a sustained increase in PX operating margins
which are even higher than refining’s (15% vs.
5%). Responding to the UN’s gasoline embargo,
Iran has reduced production of petrochemicals to
maximise gasoline production, thus decreasing the
supply of PX and driving margins up 50% in
4Q10. The embargo appears unlikely to end soon,
and S-Oil is the best positioned in Asia to benefit
from robust PX margins as it will double its PX/
benzene capacity in 2Q11.
Valuation
We value S-Oil at KRW100,000 based on 2011-
12e PB of 2.4x, based on a historical PB model.
Due to recent earnings revision and ROE
improvement from robust PX margins, FX effects,
YTD oil prices and other factors, our RV-based
PB came out at 2.8x, much higher than the
historical peak of 2.3-2.4x. However, we will use
historical multiple until we see signs of dividend
payout improvement. At the current stock price,
our TP implies a potential return of 26% including
dividend yield.
Risks
We believe our forecasts could be materially
affected by the following: 1) PX margin collapse,
2) disappointing refining margin recovery, 3) new
aromatics unit ramp-up delay, 4) major production
disruptions at existing facilities, 5) massive nonoperating losses, and 6) regulatory fines.
Winners from Chinese growth
CNOOC (883 HK, OW, HKD16.84,
TP HKD19.5)
CNOOC is the most leveraged to Chinese growth
within our China universe based on its exceptional
earnings growth potential without downstream
dilution. As pure oil play (80% of sales, 60% of
reserves), its earnings stand to benefit most from
any oil price surprise. If we were to use the
current spot oil price vs our current forecast of
USD76/bbl, 2011 EPS would increase by 15%
and DCF by 18%. Future production growth
prospects are bright given China’s strong
underlying demand for oil products and plastics
and stockpiling needs to fill new reserve and
pipeline systems. It also boasts a competitive cost
structure, strong returns and ample excess cash
with a lack of debt.
We had been worried that CNOOC would
overpay for assets but the company made the last
two acquisitions at lower-than-expected
valuations (ie, Eagle Ford shale project at a 20%
discount, Pan American at 25% below the
speculated price). Also, the company made a
strategic acquisition to keep the oil:gas ratio in its
reserves at the current 60:40. This should shield
the company from policy objectives in China.
Valuation
We value CNOOC at HKD19.5 based on a DCF
methodology with a WACC of 10% and a longterm oil price of USD84/b. At the current share
price, our TP implies a potential return of 18%,
including a dividend yield of 2.5% for FY10.
Risks
Our forecasts could be materially affected by: 1)
oil and gas prices higher/lower than our base case,
2) production disruption/project delays, 3) valueeroding, aggressive M&As, 4) uneconomical
investments under government pressure.
Techtonic shift
SK Energy (096770 KS, OW(V),
KRW165,500, KRW177,000)
SK Energy is set to evolve from a low-margin
refinery/chemical producer (2-3%/7-8% EBIT
margin) to an integrated energy company with
E&P earnings contribution (40-60% EBIT
margin) rising to roughly half of total EBIT.
Until 1Q10, SKE hadn’t aggressively addressed
its key upstream assets, such as Brazil deepwater
blocks (20% and 27% stakes in Brazil BMC-30
and BMC-32) and Vietnam shallow-water assets,
largely due to its long-standing company culture
as a downstream giant in Korea. However, the
market sentiment is rapidly catching up. Using
spot market data, the sum-of-the-parts value of
SKE comes out at KRW190,000. From 0.5x SoTP
value by mid-2010, the current share price stands
at 0.9x.
We expect the next catalyst to come from the
corporate de-merger effective from 1 January
2011, which will enhance divisional autonomy in
business strategy and asset sales. Also, SoTP
value itself will rise from any upside risk to our
current oil price forecast of USD76/b for 2010
and LT USD84/b, timely ramp-ups of new E&P
projects and continued management commitment
to raise market awareness on E&P value.
Valuation
We value SKE at 1.6x target PB on normal ROE
of 17.8%, cost of equity 12.9% and a long-term
growth rate of 4.5% (vs sector average 3.0%).
Normal ROE of 17.8% is the return when SKE’s
E&P EBIT represents 45% of total at HSBC’s
base-case oil price assumption of USD76/b.
Based on a sum-of-the-parts method, SKE’s
intrinsic value comes out at KRW190,000/share.
We choose the PB method (or the residual value
model) over SoTP in order to establish a common
valuation methodology for the Asian refining and
petrochemical sector.
Risks
Our forecasts could be materially affected by: 1)
Failure to prove reserve potential at Brazil blocks,
2) major production disruptions, 3) lower oil
prices or refining and chemicals margins below
our base case/consensus, 4) massive nonoperating losses, 5) regulatory fines.
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