PetroChina Cut to Underperform

Following PetroChina Company Limited’s (PTR - Analyst Report) dismal third quarter financial results, we have downgraded the Chinese energy giant to Underperform from Neutral.

Beijing-based PetroChina is the largest integrated oil company in China. The firm’s activities include: exploration, development, production and sale of crude oil and natural gas, refining, transportation, storage and marketing of petroleum products, manufacture and sale of chemical products, and transmission of natural gas, crude oil and refined products.

Recently, PetroChina – which last year overtook Exxon Mobil Corporation (XOM - Analyst Report) as the world’s biggest listed oil producer – announced its third quarter 2012 earnings of RMB 24.9 billion or RMB 0.14 per diluted share, compared with RMB 37.4 billion or RMB 0.20 per diluted share in the year-earlier period. Earnings per ADR came in at $2.22. The decline can be primarily attributable to a challenging operating environment and persistent refining losses.

We also remain concerned by PetroChina’s oil production growth prospects. With about a third of its current crude oil volumes coming from the Daqing Oil region, the company is heavily exposed to this area. The Daqing Oil region is the largest crude oil producing area in China, but has significantly matured over the years and is currently well past its prime. As the degree of difficulty in extracting crude oil from the mature Daqing field increases over time, costs at these fields continue to increase.

Other near-term headwinds include high-priced gas imports amid low domestic gas sale prices, policy uncertainty and an ambitious investment program.

Considering these factors, we see PetroChina as a risky bet from which ordinary investors should exit. Our new long-term Underperform recommendation is supported by a Zacks #5 Rank (short-term Strong Sell rating).