This is positive for oil companies œ using US$60/bbl for 2009, EPS upside is 14% for PetroChina and 7% each for Sinopec and CNOOC. Gains under lower oil price scenarios are limited.
Note that resource tax increases are on the cards and this adjustment could be a precursor to such a hike. Our conversation with oil companies suggests that resource tax hike could be heading for NPC approval this year.
Although this is positive in the short term, structural issues remain for Chinese oil and gas companies. Their ROEs are heading for all-time lows since their IPOs and their P/B multiples could follow with consensus estimates downgrades.
We maintain our UNDERWEIGHT stance on the China oil sector and recommend selling into current strength. We prefer Sinopec over PetroChina (strictly on a relative basis). We like CNOOC as a business, but lower oil price would be an overhang in 1H09, as top line gets crunched and as costs continue to rise.
China Business News, quoted by Bloomberg, suggests that according to unidentified experts, the windfall tax trigger could be raised from US$40/bbl to US$60/bbl.
Windfall taxes were introduced in 2006 œ companies were taxed progressively as their realisation rose above US$40/bbl. Effectively, this tax would therefore be applicable as WTI oil prices rose above US$48-50/bbl.
On the face of it, this is a positive. It will reduce costs œ for example for PetroChina, assuming a US$60/bbl WTI oil price, it would reduce the windfall tax by about US$2.5/bbl. This could raise EPS by about 14%. For Sinopec the benefit is smaller (7% on EPS). For CNOOC, given the inherently high margins, the benefit is muted (7%).
The case for raising the trigger is to an extent fair œ costs have galloped and as a result, the definition of windfall tax should change. As we have noted in our piece Venus or Venus Flytrap (published on 28 November 2008), the all-in costs per barrel are now above US$35/bbl. Including capex, the number is close to US$50/bbl.
The article quoted unnamed experts and does not even attribute this to the NDRC (only indirectly). As such, the article appears to be more on the lines of expert opinions rather than based on concrete developments. Sinopec suggested that this was not something that was on its agenda from a lobbying point of view (although PetroChina has been lobbying for it). That said, the government works in mysterious ways œ costs have gone up, and under the threat of lower production growth, the NDRC might be looking to act.
At US$60/bbl WTI, the impact of the increase in the threshold of windfall tax would be 14% for PetroChina, 7% for Sinopec and about 7% for CNOOC. PetroChina would be the biggest beneficiary. As oil prices fall below US$60/bbl and stay there, the gains are limited. Tax under the existing regime would also be tending towards zero i.e,. if oil was US$40-45/bbl, the EPS would not be different even if windfall tax is adjusted.
We also note that there is still the talk of resource taxes œ which had resurfaced at the beginning of the year. Our conversations with the oil companies suggest that the resource tax increase could be heading for approval to the NPC later in March this year. As such, any adjustment in windfall taxes could be a precursor to an increase in resource taxes which have been on the cards for a few years.
Under a low oil price environment, the cut in windfall taxes is immaterial œ however, with consensus forecasting a sharp recovery in oil prices in 2010, the EPS upgrades could be material. As such, the stocks could perform in the short term. That said, we note that: a) the government could tax these benefits away if oil does rise once again b) resource taxes are on the cards and c) this proposal is not yet final.
Structural issues with oil stocks in China remain as costs continue to rise œ we expect the lowest ROEs in their history in 2009. P/B multiples could follow œ we see 20-30% downside if multiples do get to historical lows. We prefer Sinopec over PetroChina (strictly on a relative basis). We like CNOOC as a business, but note that it faces challenging times in 1H09, as top line gets crunched and as costs continue to rise.
We maintain our UNDERWEIGHT stance on the China oil sector, and would sell into the current strength.
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