We have maintained our Neutral recommendation for China Petroleum and Chemical Corporation (SNP), or Sinopec. The company’s robust exploration and production (E&P) agenda for the year has been somewhat mitigated by its downstream weighted asset structure.
Following the strong first half 2011 results of Sinopec, backed by higher capacity, domestic economic growth and increased prices for petroleum and related products, it remains proactive to build a better position in the E&P space. The company expects 2011 to be a profitable year owing to the greater contribution from upstream activities.
Sinopec plans to accelerate the exploration of Tazhong and Bachu areas in western China. Overall, appraisal activity will remain high in the northern and western margin of the Junggar Basin and the southern areas of Ordos. During the first half, Sinopec made new discoveries in blocks at the matured fields in eastern China, the Tuofutai area of the Tahe oil field in western China, and the northern margin of the Junggar Basin.
Natural gas business also happens to be the company’s another potentially lucrative growth area. Sinopec expects the segment to witness strong growth in the coming years as China moves from coal to natural gas.
For the balance of the year, Sinopec intends to invest in natural gas exploration and development in northeastern Sichuan and the Shandong LNG project. Natural gas blocks, such as Yuanba, southeast Sichuan and Xinchang, will also see enhanced development activities.
For the second half of 2011, Sinopec anticipates production to average 165 million barrels of oil and process 114 million tons of oil, besides generating 247.2 billion cubic feet of natural gas. The company also expects the total domestic sales volume of refined oil products in the second half of the year to be 74.9 million tons and looks to manufacture 4.84 million tons of ethylene.
However, our apprehensions remain around the area of its portfolio structure. In the E&P space, although Sinopec is an integrated oil company, it is fairly different from western oil majors, particularly in its capital allocation. The asset structure that balances the risk-return trade off for the average western integrated major is two-thirds upstream/one-third downstream. Sinopec, on the other hand, is significantly downstream weighted.
Again, we also remain concerned about the company’s overseas upstream volume, which experienced a downfall in the first half due to the overhaul of offshore production machinery.
The quantitative Zacks #3 Rank (short-term Hold rating) for the company, which competes with CNOOC Ltd (CEO) and Petroleo Brasileiro (PBR) aka Petrobras, indicates no clear directional pressure on the shares over the near term. For the long term, we maintain our Neutral recommendation on the stock.
