BARRON'S

Why Investors Are Wrong About China’s Oil Demand

 

Jefferies says oil should be viewed as a consumption, not industrial, product. Upgrades CNOOC and Sinopec.


By Jefferies / Sept. 30, 2015 1:27 a.m. ET

 

CNOOC Ltd ( 883.HK ) (HKD7.72, Sep.30, 2015)
Sinopec H-shares ( 386.HK ) (HKD4.58, Sep.30, 2015)
Sinopec A-shares (600028.CN) (CNY4.73, sep.2015)
Jefferies upgrades integrated oil companies CNOOC (price target HKD9.75 a share), Sinopec-H
(HKD4.48) and Sinopec-A (CNY5.40) to Buy.


Key Takeaway
The latest China data point to hit markets was an 8.8% August drop in industrial company profits.
China’s oil companies certainly did not help profits with Brent down 54% YoY. We believe,
however, that industrial profits says next to nothing about oil demand, which has been accelerating,
and that, while considered industrial companies, China’s oil companies will be driven by
consumption-led growth. We upgrade CNOOC, Sinopec-H and Sinopec-A to Buy.


China’s oil demand head fake. We believe China is pulling a “head fake”, which, in our view,
could whiplash prices. Catching the market off guard, China’s oil demand weakened 2012-2014 with
economic rebalancing as, for the time being, oil was an industrial product (i.e., diesel, fuel oil, LPG,
lubricants, asphalts etc.). Ultimately, with increasing wealth, oil becomes a consumption product. We
believe the market missed the weak patch in China’s oil demand in 2012-14 and is now missing oil
demand strength as consumption demand accelerates (see here).


Misunderstanding China oil demand. We believe many commentators do not understand that oil is
a consumption commodity, are following irrelevant data and misunderstand how auto-sales affect oil
demand. These errors, we believe, have become embedded in oil prices. We believe the press latches
onto erroneous data when commenting on China’s oil demand because China’s actual oil demand is
difficult to calculate. We believe the most accurate accounting of final demand is Refiner Throughput
(China NBS) + Net Product Imports (customs) + Change in Inventories (China OGP). All of these
metrics are reported by different sources and net imports need to cobble together data for gasoline,
diesel, kerosene, fuel oil, base oil, naphtha, lubricants, LPG, bitumen, petroleum coke, paraffin and
other petroleum products. Because it gets messy, we believe the press latches onto misleading data
like crude imports (too volatile), product exports (too small), car sales and industrial data (irrelevant).


Nothing changed, except share prices. The most boring — or, in sell-side parlance, “noncommercial”
— rating change is one based entirely on valuations. Well, this series of upgrades is
exactly one of those. We did not change our oil price forecast. We did not change any estimates. We
did not change target prices. We only changed our ratings because we believe the market has 1)
erroneously assumed that China’s industrial weakness signals weak oil demand and 2) China’s oil
companies are driven by the industrial cycle.


Cheap, cheap, cheap. Followers of our research should know that we are not great fans of CNOOC
and Sinopec’s upstream assets. We believe they have been depleted and, in CNOOC’s case, are being
over-stretched for growth. But at these valuations, we don’t care.


CNOOC is trading at 2016/17 EV/DACF multiple of 2.8x/2.5x while Sinopec, with largely
downstream exposure, trades at 4.5x/3.9x. We believe mid-cycle multiple for an average E&P is ~6x.
While we do not like CNOOC and Sinopec’s upstream assets, we do not believe they are that bad.
We still prefer PetroChina ( 857.HK, Buy, TP HK$9.50).

The companies mentioned in Hot Research are subjects of research reports issued recently by
investment firms. Their opinions in no way represent those of Barrons.com or Dow Jones & Company,
Inc. Share prices at the time the report was issued and the date of the report are in parentheses.


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