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Risk, Reward Balance CNOOC

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We maintain our long-term Neutral recommendation on CNOOC Ltd. (CEO - Free Report) − one of the three leading oil companies in China and largest independent oil and gas exploration and production companies of the world.

The company’s premium assets portfolio, excellent execution strategy, unique position as a pure oil player and potential transactions in the merger and acquisition space are offset by its weak production profile.

In the first quarter, CNOOC registered net production of 79.8 million barrels of oil equivalent (MMBOE), down approximately 6.6% from the year-ago level. This underperformance was related to the overhaul of Penglai 19-3 oilfield production at Bohai. The company’s gas volume dropped nearly 5%, while its liquid production declined more than 7% year over year in the three-month period.

We believe the most important catalyst for CNOOC remains the resumption of Penglai 19-3 going forward. Although CNOOC and partner ConocoPhillips (COP - Free Report) are operationally ready, details on the timing of start-up remain unknown.

However, we remain positive on CNOOC’s performance going forward and believe that the company’s growth will be amplified by significant capital injection for upstream activities in the next five years.

During the first quarter, CNOOC has made significant progress in its scheduled project agenda and announced five new discoveries including Kenli 2-1 (considered a mid-to-large size oil discovery) and Dongfang 13-2 discovery in the West South China Sea. The company confirmed Penglai 9-1 as the most material discovery in the Bohai Bay for many years and Dongfang 13-2 as a large new high-pressure high-temperature (HPHT) field in west South China Sea.

The company believes that it will be able to maintain a 6–10% compound annual production growth rate over the next five years backed by various organic and inorganic measures. Management expressed confidence that its four new domestic projects would aid in achieving its 330–340 MMBOE production target for the year. We believe that the projects under construction and ramp-up in capex will prove supportive.

CNOOC’s growth profile should get a boost over the next 3 to 5 years from the resumption of operations in Penglai post-spill, 16 development projects in offshore China, international growth from recent acquisitions, as well as intensive exploration and development programs with its partners.

In late November 2011, CNOOC completed the acquisition of Canadian oil sands operator OPTI Canada Inc. for a total consideration of $2.1 billion. This will help CNOOC remain a step ahead in the expansion of its oil sands business.

While we continue to be positive on the long-term growth options for CNOOC, we are skeptical about the near term due to the loss of production momentum and absence of catalysts. Hence, we foresee limited upside potential for the stock.

CNOOC retains a Zacks #3 Rank, which is equivalent to a short term Hold rating.


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