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On Apr 13, Zacks Investment Research downgraded Chinese energy giant PetroChina Co. Ltd. (PTR - Analyst Report) to a Zacks Rank #4 (Sell).

Why the Downgrade?

On Mar 21, Beijing-based PetroChina – the world's biggest listed oil producer by volume ahead of Exxon Mobil Corp. (XOM - Analyst Report) – announced weak 2012 results, primarily attributable to high natural gas import prices, as well as government caps on domestic fuel prices that eroded refining margins.

In particular, as more high-priced gas imports (from Turkmenistan) are being brought in through the ‘Central Asian Gas Pipeline’, there is an urgent need for PetroChina to press the government to raise artificially low domestic gas sale prices in line with global levels. As of now, gas imports are coming at a loss, thereby pressuring the company’s profitability.

Moreover, though the Chinese oil companies are able to charge close to market prices for their crude oil volumes (typically with about a one-month lag and heavily taxed by the government), the government caps the prices of refined-products (particularly gasoline and diesel) to control inflation. These price regulations do not allow PetroChina to pass high refining costs to consumers.

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.

Stocks that Warrant a Look

While we expect PetroChina to perform below its peers and industry levels in the coming months and see little reason for investors to own the stock, one can look at Cheniere Energy Inc. (LNG - Snapshot Report) and EPL Oil & Gas Inc. as good buying opportunities. These domestic upstream energy operators – sporting a Zacks Rank #1 (Strong Buy) – have solid secular growth stories with potential to rise significantly from current levels.
 

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