Is China's Big Oil Bet Going Bust?

By Markets Fool.com

No pain, no gain, they say, but after betting big on Canada's energy industry, Chinese oil companies have suffered plenty of pain without any commensurate gain.

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Their wager is going bust, and PetroChina (NYSE: PTR), the Chinese government-owned oil giant, is angling to exit Canada's oil sands market by swapping assets with international industry players. Rivals China Petroleum & Chemical (NYSE: SNP), also known as Sinopec, and CNOOC (NYSE: CEO)have also taken it on the chin because of oil's depressed value with the latter reported to be taking an $842 million impairment related to properties in North America and the North Sea.

Alberta's oil sands region hit a gusher of activity, but could become a dry hole as prices crater. Photo: Howl Arts Collective via Flickr.

A gusher of investment
There is no bigger trading partner in Canada's energy industry than China, which has invested tens of billions of dollars in oil and gas assets over the last six years. The nation's investment in the industry might have been higher, but restrictions placed on foreign ownership of Canadianassets in 2012 brought that to a halt such that last year saw virtually no activity in the energy industry.

Coupled with long timelines for project development and high costs in Canada, China paid top dollar for many of its assets as the energy sector boomed.

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CNOOC, for example, in 2013 paid $15.1 billion for Nexen, which valued the oil company's assets at $17 per barrel, compared with the $11 per barrel it paid when it bought OPTI Canada for $2.1 billion the year before. But with oil prices cut in half over the past year, CNOOC might have to write off as much as a third of the investment, or $5 billion. CNOOC has also acquired a 7% interest in Syncrude and has a 12% interest in MEG Energy, an oil sands company in the southern Athabasca region of Alberta.

Sinopec paid $4.6 billion for a 9% interest in Syncrude-- a price some analysts believe was $1 billion too much-- which valued the assets at $23 per barrel.China National Petroleum also paid over $5 billion for a joint venture in Encana's Canadian shale gas properties.

PetroChina was originally scheduled to buy Athabasca Oil's Dover oil sands project last year for $1.3 billion, but ended up paying less than $1.2 billionand will stretch the payments out over several years. Athabasca recently posted a $129 million fourth-quarter loss and announced it would delay completion of its Duvernay formation project, where PetroChina paid Encana $2.2 billion for a 50% stake in 2012.

Gorging on energy
Despite an energy market that often seemed uncertain, the Chinese oil majors remained keenly focused on securing long-term supplies of petroleum to feed their country's seemingly insatiable appetite for energy resources.

In 2010, Chinese oil and gas companies alone represented about 20% of global merger and acquisition activity in the sector, and both PetroChina and Sinopec planned on spending upward of $36 billion that year on exploration and production investments. CNOOC said at the time it planned on topping the $10 billion it had spent the year before.

But five years later, it's a different story. PetroChina is cutting its capital expenditures budget 9% this year from $47 billion to $43 billion, three-quarters of which will be maintenance capex only. Sinopec is cutting its capex budget to $22 billion, a 12% decline from last year, and in February CNOOC said it would reduce capex spending some 26% to 35% this year, the first time in five years that it has reduced this budget item. China National Petroleum declared it is undertaking "revolutionary measures" to cut costs.

To escape the morass they find themselves in, the Chinese oil majors are looking to restructure their Canadian businesses to minimize further pain.

A mad dash for the exits
PetroChina said it wants to engage in asset swaps with major international oil companies, acknowledging that depressed oil prices will make it difficult to find a buyer for its Canadian oil sands assets. CNOOC, in addition to its multi-million dollar asset impairment, is eliminating 400 jobs, or 13% of its global workforce, with 340 of the lost positions occurring in North America. It is also closing the Nexen oil trading operation, at a cost of an additional 100 jobs.

The Chinese government is even considering consolidating its government-owned oil companies to make them more efficient and competitive. Two ideas floated include merging China National Petroleum and Sinopec, or CNOOC and Sinochem Group.

Oil sands are a higher-cost resource to extract that require oil prices be closer to $100a barrel to just break-even rather than $50, where the commodity currently trades. While older projects can still be profitable below that level -- a recent Financial Post review of Citibank data revealed breakeven points can run as low as $28 a barrel on some projects -- it's the large, newer assets that need oil at just $70, $80, or $90 or more to not induce losses.

China remains a massive consumer of energy resources, and oil, which accounts for 20% of China's energyusage, remains key. That helps explain why China made the big bet it did on oil, but Canada ended up enacting tough restrictions on foreign ownership of domestic assets, and the western pipeline capacity expansions that were supposed to bring crude from the oil sands to China have not yet materialized.

While intuitively it would seem China's oil giants would rue having gone all-in on one bet, their country's insatiable energy appetite may yet see them make the same wager elsewhere such as in Mexico or Venezuela. If prices rebound that could give them a bigger payoff down the road, but given market expectations that oil prices will remain flat for the foreseeable future even as operating costs rise, their currentlower valuations won't seem like such a bargain and another bet will have gone bust.


The article Is China's Big Oil Bet Going Bust? originally appeared on Fool.com.

Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.