Why China's CNPC Got Cold Feet Over Hot Argentine Oil Prospect

The Wall Street Journal Online

BEIJING -- Conventional wisdom says Chinese oil companies are buying every oil barrel in sight -- no matter where, no matter the cost. Mr. Conventional is sometimes wrong.

The parent company of Hong Kong-listed PetroChina, No. 1 China oil and gas producer China National Petroleum, turned down a chance to buy a stake in the South American assets of Spanish oil company Repsol YPF. People familiar with the proposed deal said CNPC feared the wave of nationalization spreading across South America could imperil the return on investment.

"In terms of the Chinese, the name surfaced amongst many others," says William Gartland, a spokesman for Repsol, confirming that Repsol had talked to CNPC. Instead, Enrique Eskenazi, an Argentine banker with close ties to the government, is likely to win the stake.

To some analysts and industry consultants, the only way for Chinese oil companies to grow significantly is to buy overseas firms. Any gains at home are quickly gobbled up by China's fast-growing economy. But Chinese oil companies, despite backing from the state and access to lots of cash, are finding their choices abroad limited -- often for political reasons.

Two years ago No. 3 oil-and-gas producer Cnooc withdrew a $18.5 billion bid for California-based Unocal, after a protectionist backlash in the U.S. Congress. Since then, the three Chinese oil giants, including China Petroleum & Chemical, the No. 2 company commonly known as Sinopec, have made more-modest ventures abroad -- a move some analysts fear could stunt their growth potential.

Even as global oil prices near records, international oil companies are finding it harder to bring more production on stream. The majority of the world's reserves are either controlled by the national oil companies of the Middle East -- whose priority is keeping state coffers flush -- or extremely expensive to develop, such as Canada's tar sands. Chinese oil companies have, in some cases, helped the global energy balance as they were willing to go places Westerners couldn't, such as Sudan, against which the U.S. government has imposed sanctions. But the Chinese now appear to be making more-tempered bets.

In recent years, China's companies have spent more time and money investing at home than abroad. According to oil consultancy Wood Mackenzie, China's three biggest oil and gas companies spent $21.5 billion last year on domestic exploration and development, compared with $12.6 billion in 2004. By comparison, the total spent overseas in 2005 and 2006 combined was $8 billion.

The results on the domestic front have been impressive, with some major discoveries of oil and gas fields helping to boost reserve-replacement ratios -- a measure of how much oil is found to replace each barrel pumped out and sold.

That may not be enough for longer-term growth, some analysts fear. "They're running to stand still," says Bradley Way, Beijing-based analyst for BNP Paribas. "They have lots of cash, but they will need new reserves to balance volume and margin declines in their domestic fields." Mr. Way has a 12-month target of HK$13 (US$1.66) for PetroChina, which he downgraded to "hold" from "buy" earlier in July.

Many oil-industry analysts argue the only way for China's oil companies to really grow is through overseas acquisitions. That's where the Repsol deal comes in.

On offer: a 25% stake in Repsol's Argentina-based YPF unit, whose collection of aging oil and gas fields has been valued from $2 billion to $4 billion. Repsol acquired YPF in 1999. Facing shareholder pressure to reverse underperformance, the Spanish company is looking to sell a stake in YPF and then list 20% in the Argentine stock market to raise cash.

The deal could have played to CNPC's strengths. CNPC engineers have a reputation for being able to squeeze supply out of old fields -- an expertise that dates from long practice on the company's flagship Daqing oil field, a nearly 50-year-old find in northeastern China. As well as substantially increasing oil reserves -- and aiding China's energy security -- the YPF stake would have also offered CNPC access to Argentina's growing domestic market, say people familiar with the proposed deal.

CNPC and PetroChina declined to comment.

It's surprising CNPC didn't buy. Chinese oil and gas companies have no shortage of cash. By some estimates, CNPC has the capacity to make a $40 billion acquisition. On top of that, it has access to cheap loans from China's state-owned banks.

Yet, in Argentina, CNPC has passed up what people familiar with the proposal believed would have been a good deal. In part, its hesitation is tied to the wave of nationalizations sweeping South America, spearheaded by Venezuela where last month, Exxon Mobil and ConocoPhillips walked away from their multibillion-dollar investments after refusing to hand majority stakes to the government-controlled oil company.

Another factor that may be keeping PetroChina and its parent away from a big acquisition now is that its forecasts for long-term oil prices remain very conservative. Mr. Kwan, who recommends buying the stock and has a 12-month target of HK$13, says the company's long-term oil price projection is $40 a barrel when it assesses whether or not to invest. That's lower than Exxon's $45 a barrel threshold, he said.

Oil futures in traded in New York have breached $76 a barrel, and some analysts are predicting that prices won't fall below $60 anytime soon.

That could also be a factor in CNPC's reluctance to investment more in Canada's tar sands, a costly-to-develop oil that needs to be processed before it can be refined into fuel. On Friday, CNPC issued a statement denying it was scaling back in Canada. The statement appears to be an attempt to deflect comments widely reported in the Canadian press from a CNPC official saying the company would reduce its presence in Canada because of rising production costs and tougher regulations.

Lurking in the background is the coming Communist Party Congress in the autumn, a meeting held every five years at which big leadership changes and policy initiatives are announced. The heads of top state-owned companies, including CNPC and its listed unit are appointed by the government, which is essentially the same as the party. That has quashed any ambitious plans, some industry observers say.

"PetroChina would rather err on the conservative side," Mr. Kwan says. "Nobody gets fired for doing nothing."