PetroChina's November 5 listing on the Shanghai Stock Exchange drew attention
from all around the world. This event instigated a storm of punditry hailing
the rise of the largest corporation the world has ever seen. However, such
pronouncements may be shortsighted. All of these events leave the concerned
observer contemplating three questions: What is the true value of PetroChina,
what are its prospects, and what does this mean for the business climate of
Asia?
Roughly 86% of the firm is owned by the Chinese government. Almost 12% of the
firm is traded on the Hong Kong and New York stock exchanges. Monday's A-share
initial public offering made
the remaining 2.2% of the firm available to mainland Chinese investors, raising
US$8.9 billion for PetroChina.
The initial offer was $2.24 per share, priced competitively with the Hong Kong
price of about $2.30. By the end of the day, however, the Shanghai price had
nearly tripled to $5.90. If one were to apply this price to all shares, both
traded and non-traded, the value of the corporation would be roughly $1.08
trillion. This would make PetroChina the world's first trillion-dollar
enterprise. It would also make PetroChina more valuable than ExxonMobil and
General Electric combined.
However, for multiple reasons, this method of valuation is not accurate.
Firstly, the shares traded in New York have their own price just as the shares
traded in Hong Kong have their own price. There is no reason whatsoever to
apply the Shanghai price to New York and Hong Kong shares. Secondly, it is not
clear that the shares held privately by the Chinese government would attain the
Shanghai price if they were listed publicly.
In fact, it may be the case that the Shanghai price was driven up precisely
because the majority of the company remained unlisted, thus limiting available
share supply relative to demand. Therefore, one cannot say with any degree of
certainty that the Shanghai price can be used to determine the value of the
entire company.
For that matter, one cannot say with any more certainty that the Hong Kong
price can be used to determine the overall value. All one can say for certain
is that the value of the equity on a given exchange can be determined by the
price on that exchange - nothing more.
The value of the 86% that remains in government hands is a matter of
speculation. But whether those shares are valued at the Shanghai price, the
Hong Kong price, or anywhere in between, it is clear that PetroChina is a
monumentally valuable and important company. On this basis, the firm's
conditions and prospects merit further analysis.
It is worth remembering that in mid-October, billionaire investment guru Warren
Buffett expressed his opinion that PetroChina was overpriced. At the time, the
Hong Kong shares were trading between US$2.18 and US$2.57. This provides some
frame of reference for the appropriateness of the Shanghai price. While it is
possible that Buffett's analysis of PetroChina was flawed, it seems far more
likely that the Shanghai price is flawed. This conclusion is based not only on
Buffett's nonpareil track record as a value investor, but also on the
fundamentals of PetroChina's business.
PetroChina's technology lags far behind international giants such as ExxonMobil
and British Petroleum. Catching up will require a substantial commitment of
resources. Last year, PetroChina produced two thirds as much oil as its largest
rival, Exxon. PetroChina's revenue was one fourth as great as Exxon's, and
profit was less than one half.
In Shanghai, PetroChina is trading at 50 times earnings. In Hong Kong it is
trading at 20 times earnings. By comparison, Exxon is trading at 13 times
earnings in New York. Obviously the way that investors on the mainland valuate
companies is at odds with international practice. Perhaps this can be
attributed to greater optimism on the mainland about the prospects of domestic
champions.
This brings us to the greatest question about PetroChina: optimism for
prospects. The National Development and Reform Commission (NDRC), China's top
economic planner and price regulator, maintains fixed prices for oil products
such as gasoline and other fuels. It hadn't increased prices of oil products
over the past 17 months until the beginning of this month.
Only from the beginning of this month did the NDRC allow prices to go up by
10%, with average retail prices of gasoline and diesel oil lifted to 5,980 yuan
(US$805) and 5,520 yuan per tonne from 5,480 and 5020 yuan respectively.
Given these prices, most refineries can barely break even when the price of
crude on the international market is at $70 per barrel. At the present price of
US$97, refineries are hemorrhaging money. Businesses like China Petroleum and
Chemical Corporation, China's other oil giant whose principle activity is
refining, can only stay afloat with massive government bailouts.
Integrated oil businesses, such as PetroChina, are involved in production as
well as refining. The profit from the production business helps to offset the
losses from the refining business. In a more liberal climate, PetroChina might
maximize profits by reorienting its production business to direct supplies to
the international market where the end price is substantially higher. However,
the government does not permit this. As a result, the government-imposed price
caps have a significant impact on the bottom line.
All of this raises the question: What is the meaning of PetroChina stock?
Traditionally, owning stock means that one owns the right to future profit
flows. Given that PetroChina cannot freely choose to whom it sells its product
or at what price, the firm does not appear to be in control of the principal
determinants of profit.
If the government decides to raise the price ceiling, PetroChina will be more
profitable. If it decides not to, then inflation will ensure that PetroChina is
less profitable. What, then, is the meaning of a share of stock? Does it mean
that one owns the right to future government beneficence? Does it mean that one
owns a share of the government itself? Does it mean a vote of confidence in the
government? If the latter is the true meaning of PetroChina stock, then the
government is right to feel tremendously confident.
Whatever the meaning of the stock may be, astute investors are looking at two
numbers: the price of crude on the international market and the price of diesel
at the pump in China. A rational decision to invest in PetroChina will depend
on balancing the prospect of increases in the crude price with the prospect of
increases in the pump price. The price of crude on the international market is
quite volatile. In the third quarter of this year alone, the price fluctuated
by nearly 50%. The price may experience a short-term dip, depending on the
machinations of the Organization of Petroleum Exporting Countries, but in the
long run increasing scarcity will likely lead to higher prices.
Given the concerns of stability and inflation, at present it seems unlikely
that the NDRC will raise the price ceiling in any significant way prior to the
2008 Summer Olympic Games. It remains to be determined whether the NDRC will
raise the price after the Olympics, and whether the political and social
climate will tolerate increases sufficient to keep pace with the international
market.
Richard Komaiko's research fields include all facets of Sino-American
relations, economic policy, as well as terrorism and national security. He
holds a degree in economics from the University of Illinois, and has studied
Chinese language and culture at the University of Illinois, University of
Chicago, and Beijing Institute of Education. He speaks English, Mandarin,
Spanish and Hebrew.
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