China Oil & Gas Sector:SOE reform unlocking value

Reform will unlock value. SOEs dominate both the upstream anddownstream of China’s oil & gas sector such that any reform of the SOEs tendsto have major knock-on effects throughout the industry. We look on reform as apositive force which will create value in three ways: (1) improvement in theoperational efficiency of the SOEs, e.g. Sinopec (386 HK, Not Rated) andPetroChina (857 HK, Not Rated); (2) revaluation of assets spun-off and injectedinto SOE subsidiaries, e.g. Kunlun Energy (135 HK, Outperform), SinopecKantons (934 HK, Outperform) and Yanchang Petro (346 HK, Not Rated); and(3) new business opportunities opening up to private companies, e.g. Brightoil(933 HK, Not Rated) entering the upstream exploration and production (E&P)business.

How will reform take shape? We expect reform within China’s oil & gasindustry to (1) allow for mixed ownership, (2) lower entry barriers, and(3) introduce market-based pricing. Sinopec is a good example of the firstcategory of reform: introducing mixed ownership. The company recentlyannounced plans to restructure its oil products marketing unit. This would be amilestone for the industry for several reasons: (1) it would be the first instanceof mixed-ownership at the parent-company level of a national oil company(NOC), (2) it would be the biggest-ever sale of equity in an SOE, and (3) itwould be the first instance of a large well performing subsidiary being sold off.

Reforms to expect in the next 6-12 months. Reforms most likely tomaterialize in the next 6-12 months include: (1) the opening up of importationrights for crude oil and oil products, (2) the restructuring of oil & gas pipelineassets, and (3) additional social and private capital directed towards oil & gasE&P activities.