China's Offshore Oil Driller Seen Winning Rights Dispute

TAIPEI ( TheStreet) -- China's CNOOC Ltd. (0883.HK), the massive state-run offshore driller, in May began looking for oil and natural gas under a tract of ocean south of its home base that is angrily disputed by five other governments.

CNOOC and its share prices will pull through.

The firm, whose acronym stands for China National Offshore Oil Corp., is on the prowl for proven undersea oil reserves estimated at 7.5 billion barrels. Its drilling site 320 kilometers southeast of Hong Kong effectively follows Beijing's unbending, sometimes belligerent claim to the South China Sea.

The search for South China Sea deposits, apparently also a first for Beijing, faces possible competition from PetroVietnam (PVF:HoSE), which is run by the government in Hanoi and has started surveying. Vietnam claims the same 3.5 million-square-kilometer (1.4 million-square-mile) sea area, as does the Philippines. T Manila will give out 15 exploration contracts, including one to the British firm Forum Energy ( FET), the U.S. think tank Council on Foreign Relations says. But Malaysia is the most active of all claimants, owning half of a current total South China Sea production of 1.3 million barrels per day, according to research website

About More Than Oil and Gas

What's going on at sea is more than a race for oil or gas. China and the Philippines entered a tense standoff in April when military and fishing boats met at a disputed shoal near Luzon Island. It's still not quite clear whose ships are where.

China and Vietnam verbally opened fire over sea rights before reaching a patchy deal last year. Those flaps raised fears of a broader war and generated keen interest from the United States, in turn angering China, which does not want to see the world's other superpower involved in anything off its south coast.

Economists warn that a skirmish -- real or diplomatic -- could suddenly shut down expensive efforts to find oil and gas deposits that are still tough to estimate despite some enticing numbers. Investors hate a war, or even the threat of war, so it could be argued that anyone exploring now will just end up taking a bath.

Mark Williams, chief Asia economist at Capital Economics in London, states the obvious: "Clearly the dispute adds another layer of risk in an industry where risks are already high. Oil and gas projects take years to deliver a return. The prospect that rigs may at some point end up caught in a standoff between two navies is likely to be a chilling one for prospective investors."

But CNOOC shows no sign of cooling, and its shares should remain attractive at least through the end of 2012. First, it's coming off two quarters of high prices. Crude oil topped $120 per barrel in March, a year-to-date peak. Second, CNOOC serves the eternally stable Chinese domestic market, where a $7.4 trillion economy led largely by manufacturing thirsts for more fuel sources to keep its plants running.

"Its profits are higher, compared to oil companies overseas, so it's a good investment," says Liu Chia-jen, petrochemicals analyst with KGI Securities in Taipei. "Downsides are relatively few."

Share Impact

Share prices of CNOOC have fallen 14% in Hong Kong since July 2011 because of global economic weakness and the closure of an oilfield in China. But prices have picked up steadily so far in 2012.

Large Chinese energy companies in general have seen no share price impact, despite selling after oil prices peaked in March, notes Joseph Tang, investment director with Invesco Hong Kong. Government-ordered energy pricing reforms this year have also helped company performances, Tang argues. He says stable oil prices, reduced inflation and valuations should keep those firms ahead of foreign peers.

Share prices for the Chinese firm's offshore kin Exxon ( XOM) and BP ( BP) are stable, though not quite surging.

CNOOC's ADR ( CEO) also has received positive reviews because the company sits on exclusive rights to find oil for its hungry parent nation. It has cash and a steadily improved expertise to find what it's looking for from the waters of China to Africa to North America.

Company revenues grew from 91 billion yuan to 241 billion yuan between 2007 and 2011, with pre-tax profits up from 43 billion yuan to 93 billion over the same period, according to CNOOC's 2011 annual report. Investment income grew from 902 million to 1.28 billion yuan, the report says.

CNOOC also happens to be China's biggest producer of offshore natural gas. Natural gas may turn out to be the top resource in the South China Sea, as the U.S. Geological Survey has estimated that resource, not oil, makes up 60% to 70% of the ocean's hydrocarbon deposits.

The greasy truth about the South China Sea dispute is that China will probably win it. It has the world's second largest world economy, surpassing Japan's as Asia's most important. Fellow South China Sea claimants increasingly depend China for tourism, economic cooperation and a market for exports, so the smaller countries are likely to keep pressing for a diplomatic resolution that keeps China happy.

For economic and geopolitical reasons, the U.S. doesn't want a fight with China, despite a series of gestures this year in support of its former colony, the Philippines. Whatever Washington does next, it should fall way short of sending warships to pursue the Chinese. All this means that CNOOC will be left alone to see how much it can dig up from beneath the ocean floor.

At the time of publication, the author had no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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