China's Kazakh prize: The expert opinion
By Jeff Moore
Success is not yet assured for the Chinese National Petroleum Corporation's bid
for the Canadian oil company PetroKazakhstan (PK). That will require a
two-thirds vote by shareholders at a meeting to be held in October, and
probably the approval of the Kazakh government, which has had tense relations
with PK in the past. India's OME consortium is still said to be in the hunt,
and Russia lurks in the background. But oil industry experts interviewed by
ATol say that PK will be a good acquisition for CNPC: it has good assets,
including a relatively new refinery and some top-quality fields; it produces
high-quality light, sweet crude; and it's strategically located near the
Chinese border.
China's energy giant The Chinese National Petroleum Corporation (CNPC), responsible for
more than two-thirds of China's oil production, is China's largest energy
company. It is a state-owned enterprise, but like other Chinese energy majors
such as Sinopec and CNOOC, it offers limited stock to the public in order to
raise cash and modernize. In April 2000, CNPC had an initial public offering
(IPO) on both the Hong Kong and New York stock exchanges through one of its
subsidiaries, PetroChina.
In 2001, Petroleum Intelligence Weekly said CNPC ranked 10th among the world's
top petroleum companies. Fortune Global 500 increased it in rank from 52 in
2004 to 46 in 2005 in terms of assets and revenues. Its total assets are worth
over US$90 billion. According to CNPC, the company has 14 oil and gas projects
and 14 refineries and petrochemical facilities, supported by scores of
marketing companies and research and development entities.
As a result of China's growing energy needs, CNPC in the late 1990s began to
transform into a multinational company. According to a paper by Bernard D Cole
at the US Institute for National Strategic Studies, its goal is to emulate the
ExxonMobil model, with overseas production accounting for 60-70% of profits.
Its international subsidiary flagships are CNPC International (CNPCI) and China
National Oil and Gas Exploration Development Corporation (CNODC), both active
globally.
Moreover, being a state-owned enterprise, CNPC was a key factor in Beijing's
national ninth and tenth five-year plans. The ninth plan, which spanned the
1995-2000 period, called for, among other things, improving energy efficiency
by 5% annually, in part by acquiring modern technology. The tenth plan, which
runs from 2001 from 2005, continued the previous efficiency goals but also
called on enterprises to seek international sources of oil and gas. CNPC
responded to this goal energetically, and now has projects in over 11
countries, including Indonesia, Sudan, Azerbaijan, Syria, Algeria, Ecuador,
Peru, Niger, Chad, Russia, and Kazakhstan. The latter two have been the main
focus of China's international oil hunt in recent years.
Before CNPC International made a bid for PetroKazakhstan, it already had
several projects in the country. It owns 85.42% of Aktobemunaigas Corporation
(now CNPC Aktobe), 100% of the Bars exploration and development block formerly
owned by Nimir Petroleum Bars Holding BV of Great Britain, and 50% of the North
Buzachi oil and gas field located in northwest Kazakhstan, also
formerly of Nimir and Chevron Texaco.
Additionally, CNPC is a joint, 50% investor in the Atasu-Alashankou pipeline
with KazMunaiGaz, Kazakhstan's state oil company. At 980 kilometers, this
pipeline runs from a production facility in Atasu, in central Kazakhstan, to a
railroad station in Alashankou in China. It will have an immediate 200,000
barrels-a-day capacity, and a peak capacity of 400,000 barrels a day.
Completion is scheduled for December 2005 with commissioning in 2006. CNPC is
augmenting the Atasu-Alashankou with a wholly domestic pipeline, a 246-km line
that runs from Alashankou to a refinery in Dushanzi.
The prize: PetroKazakhstan's assets
CNPC's interest in PetroKazakhstan will help solidify its position in
Kazakhstan, primarily because the target company is one of the top operators in
the country. PK has been operating there for eight years, and is Kazakhstan's
second biggest foreign-owned energy venture. Says William Magee of Credifinance
Securities Ltd in Canada, "PetroKazakhstan is sitting on a lot of oil in the
South Turgai Basin of central Kazakhstan. All of their 10 fields are relatively
close to the large Kumkol field processing facility."
Regarding reserves, Magee says, "As of the end December 2004, PetroKazakhstan
had about 357 million barrels proven, and 146 million barrels probable, which
is a total of 503 million barrels, of oil." He noted that the company also owns
the Shymkent refinery. "[This] refinery in particular is the most recently
built refinery in the former Soviet Union, built in about 1986." Shymkent's
recent construction makes it a fairly modern facility by industry standards. It
is also Kazakhstan's biggest refinery, reportedly processing 3.5 million tons
of oil in 2004. In recent years, it has been the main refinery providing
gasoline to Kazakhstan.
He continues, "Right now, PetroKazakhstan is producing about 100,000 barrels a
day. It would have been 150,000 barrels a day if they [had not had] to recently
cut back on production. The government threatened to take away their license if
they did not stop gas flaring, which is burning [off] gas associated with [oil
production], and it's not good for the environment. So the government went
after them right now, not later, even though the company had a plan to have it
all cleaned up ... by mid-2006."
As for buying PetroKazakhstan, according to Martin Molyneaux, managing director
of Institutional Research for FirstEnergy Capital Corp, "For China, this deal
is about resources. It's material. But it's not a solution to China's growing
oil demand. PetroKazakhstan represents maybe 30% of one year's demand growth in
China if it keeps growing [at its current rate]. So the Chinese would need one
PetroKazakhstan every four months to satisfy demand [growth]. Still, it's a
good and a fairly large purchase for them."
Magee specifies, "They have a very good refinery - it's pretty modern - as well
as production and reserves. They produce high quality oil, too. It's light
sweet crude. So taken as a whole - the reserves, the production facilities, the
refinery, and pipelines - it's a nice package. And it's strategically located
near the Chinese border, close to its ultimate markets."
Steven Knell adds, "At $4.18 billion, it's a good price. With this offer, CNPC
is looking at obtaining PetroKazakhstan's proven oil and gas reserves for about
$10.66 per barrel of oil equivalent (boe). That price per barrel goes down a
bit if you add the probable and possible holdings, to about $6-7/boe. As a
rough comparison, Chevron paid about $5/boe for Unocal's probable and possible
reserves. CNPCI is to arrange the financing through the market, Citigroup is
guaranteeing the transaction, and if the deal works out at this price, it will
not unduly strain CNPC's balance sheet."
When asked about some analysts' assertions that PetroKazakhstan's reserves were
depleted and at a production peak, Magee said, "No way. The good thing about
their fields is that they are close to fully developed with most of the
infrastructure is in place. Existing reserves have a 10-year life. More oil is
being added by a successful and growing exploration program."
Bureaucracy, transportation seen as obstacles
But PetroKazakhstan has indeed had some problems. Molyneaux says, "The
challenge in operating in Kazakhstan is not the fields. It's the regulatory
environment, the bureaucracy in changing how things work, not the assets
themselves. To the wellhead is easy. Beyond the wellhead is challenging." One
of these challenges has been transportation cost, a major driver of the overall
cost of oil, according to Molyneaux. In the past, CNPC has had to move its
Kazakhstan-based oil into China via pipeline and later by rail. But with its
new pipeline ventures, says Molyneaux, "The Chinese will negate the
transportation troubles." He adds, "It will allow China to improve 'netback,'
which is lowering the cost of transporting and marketing the oil."
According to Knell, "Transportation, processing, and distribution are amongst
the issues China has been addressing. Downstream investments in Xijiang
province and across western China have been directed to improve capacity, and I
would not expect any significant delays in getting the Kazakh production from
the west across the country to markets in the east."
Regarding political risks, Magee says, "I think there is no risk for CNPC. The
Kazakh government is not likely to anger their huge neighbor, whereas they
would pick on a small Canadian company [like PetroKazakhstan regarding] gas
flaring and marketing, for example. They are unlikely to do the same to one of
the largest companies in the world. Also, the Chinese bring a lot of expertise
and technology to Kazakhstan." What will China do with PetroKazakhstan? "That
remains to be seen," says Magee. "They have to provide about 70,000 barrels a
day to the local market. Therefore, at a maximum, they can only take about
80,000 barrels to China."
"China will likely be looking to use PetroKazakhstan's position to expand into
other oil projects in [the] country, too," says Molyneaux. Kazakhstan has an
estimated 39.6 billion barrels of oil reserves. "Ultimately, China's
aspirations in Kazakhstan extend west to the Caspian," according to Magee.
"Eventually, the Kazakhstan government wants to build a pipeline from the
Caspian to China. And China wants to expand into the Caspian. And this current
deal - buying PetroKazakhstan - is a nice step along the way."
Indians down but not out
The deal is not done, however, and there are a few wild cards left on the
table. "From PetroKazakhstan's point of view, is there another bidder? India,
perhaps," says Molyneaux. OME, a consortium between India's Oil and Natural Gas
Corporation (ONGC) and the Mittal Steel group, had been actively pursuing
PetroKazakhstan.
Subir Raha, Chairman of India's Oil and Natural Gas Corporation (ONGC), told
Bloomberg on August 22 that he was willing to make a competitive bid if
PetroKazakhstan was open to it. But CNPC and PetroKazakhstan have a deal
whereas the latter will refrain from actively seeking alternate bids. However,
the same deal says its executives can recommend to shareholders offers it deems
more profitable as long as CNPC gets to compete. The "breakup fee" for dumping
CNPC is $125 million. Says Knell, "It's an interesting indication that the
story is not complete. ONGC claims to have narrowly missed out with its first
proposal and at a share price of $55, so there is room to lodge a higher
counter offer for PetroKazakhstan. This is especially so with oil sitting at
around $65 a barrel."
"India and China are increasingly in direct competition to acquire energy
reserves abroad," he adds. "And despite their heavy domestic appetites for
hydrocarbons, they have also touted cooperation in this arena, so it will be
interesting to see how this deal plays out. They both have something to gain."
Molyneaux offers another wild card. "Where does [the] government of Kazakhstan
sit? It has the right of first refusal regarding property sales, but this is a
private concern. It's not clear what will happen." He also wonders, "where are
the Russians in [all] this? It's possible the Russian energy ministry might
dislike seeing Kazakh oil moving 'east and not west'."
"And then there are PetroKazakhstan's investors," continues Molyneaux. "They
are deep value investors. They take on high political risks to get better
returns. It is not clear where they will be left to put their money."
Reportedly, CNPC is mulling over a $76 million proposal to the
PetroKazakhstan's shareholders to incorporate a new oil and gas company, which
could allay their concerns regarding the CNPC deal. Knell says, "The spin-off
deal is still uncertain, but it appears it would create a subsidiary of CNPC
that would operate outside of PetroKazakhstan's more defined, national
standing. Seventy-six million in cash is not much, but it's enough to look
around for opportunities. And it would give the CEO of PetroKazakhstan, Bernard
Isautier, the opportunity to continue his successful run across Central Asia at
the head of this new company. It's likely he's not done yet."
Molyneaux cautions, "And the trading does not look right, either. At least not
right now. As of August 22, PetroKazakhstan was trading at 64.61 Canadian
dollars (US$54). The [CNPC] bid is [for] Can$66.52, and [the disparity] should
be tighter if it was a slam-dunk deal. It should be within 40-50 cents." In the
end, however, Knell leans toward success for CNPC. "After the litany of failed
approaches for energy reserves abroad that has beset China, they are due for a
positive return. Perhaps ONGC will come back with a counter bid, but expect
CNPC, with the might behind it, to carry the day."
Jeff Moore is an employee of Science Applications International Corp, a
consultancy with headquarters in San Diego, California, and MacLean, Virginia.
He has researched and written more than 15 country profiles of countries in
Southeast Asia, Eastern Europe, Africa, and Latin America. He lived in Vietnam
in the late 1990s and has spent time in Cambodia.
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production], and it's not good for the environment. So the government went
after them right now, not later, even though the company had a plan to have it
all cleaned up ... by mid-2006."
