China Oilfield Services:Fundamentally challenged,On the sidelines...despite a bullish oil price view

At Macquarie we think spot oil prices need to structurally rise by 60% to US$75per barrel long term. COSL’s share price has historically been highly correlatedto oil prices and the company is less vulnerable to balance sheet stress.

However we opt to remain on the sidelines as the significant earnings downsiderisk for COSL–regardless of what the oil price does–dominates our thinking. Seecompanion Global sector note ‘Defensive oil optionality’.

Global offshore rig markets materially oversupplied and rigrates will remain under pressure

While COSL was relatively insulated to global rig-rate dynamics in the past, it isnow facing increasing pressure from CNOOC to lower rates. With current marketrates for jack-ups and semi-subs 35%-55% below what COSL earns (fig 10-11),we see ongoing downside risk. Further about 65% of COSL’s fleet needs to bere-marketed in 2H16/2017. With significant excess capacity in global offshore rigmarkets (fig 12-13), we expect the current muted day-rate environment to persistin 2017/18 with risks skewed to the downside, even in a rising oil priceenvironment.

Material consensus downgrades ahead

COSL’s domestic revenue has traditionally been highly correlated to sistercompany CNOOC’s capex (R2 93% 2002-15). CNOOC has earmarked its Chinacapex to fall 16% in 2016, while COSL’s key overseas client Statoil has alreadycancelled two key contracts. We model COSL’s revenue to fall 25% y/y in 2016.

This then translates to a more meaningful c.60% decline in clean EBITDA and aloss at the EBIT line. Even assuming a rising CNOOC capex profile, our 2016-18E base-bear clean EBITDA forecast for COSL is 40-60% below consensus.

The Bull Case—CNOOC capex could rise materially

CNOOC’s proven reserve life of 8 years is low versus global peers. In a bull casescenario CNOOC targets maintaining its reserve life at current levels and if weassume US$25/boe finding & development cost then the implied annual capexfor CNOOC would be 65% above 2016 levels (math outline in fig 5), and in turnequate to 40% upside to COSL’s revenue and our valuation. We would bebuyers of COSL if we had visibility on this outcome.