With global stock markets fluctuates heavily on a daily basis, investors could be forgiven for missing one other big move, the oil price. Since the start of the year, the price of oil has plummeted by around 40% to just above US$30 per barrel. With that in mind, should investors be looking to pick up “cheap” oil & gas stocks in the current environment?
Although many analysts are saying the big Chinese giants of Sinopec (386.HK), PetroChina Company Limited (857.HK) and CNOOC Ltd (883.HK) are oversold and attractive at their current levels, here are few reasons why we believe that long-term investors might want to avoid them in the long run.
1. Oil Consumption To Be Lower In 2020
Not surprisingly, oil consumption this year is projected to be substantially lower than last year. This will be mainly down to the world’s second-largest economy as well as the second-largest oil consumer, effectively shutting down for a period of up to three weeks following the quarantine of Hubei province.
IHS Markit, a global information provider, estimates that demand for oil is set to fall by 3.8 million barrels a day in the first quarter of this year – the biggest quarterly drop in demand ever seen.
This obviously, is going to have major impact on 3 Chinese oil giants in the short term. Although some of the companies specialise more in the downstream part of the process, e.g. Sinopec, while others focus on upstream e.g. PetroChina, but the impact of this fall in demand is going to hit all three companies hard in 2020.
2. Economy Outlook Goes From Bad To Worse
As if the short-term hit of the coronavirus isn’t severe enough for Sinopec, PetroChina and CNOOC to contend with, they also have to battle the reality that they exist in a challenging industry.
Of course, the extent of how long the shift towards clean power and renewable energy is still debatable. However, one thing is for sure; the Chinese government is determined to pave China’s economy into greener and cleaner route.
With the rise of global campaigners, such as teenager Greta Thunberg, and philanthropists such as Bill Gates now focusing on the threat of climate change, governments and businesses worldwide are starting to wake up to the long-term threat of a reliance on fossil fuels.
That is going to spell trouble for the oil & gas industry further down the road as large, capital-intensive, multi-year projects are financed but with very little visibility on whether the demand will be there. The ongoing shift to renewable sources of power is one longer-term trend that these three companies can’t avoid.
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3. State Ownership & Abysmal Track Records
Most investors will be aware that all three, Sinopec, PetroChina and CNOOC, are Chinese state-owned enterprises (SOEs). Existing in a strategic sector of the Chinese economy, they’re viewed as important state assets in terms of the government’s aims for energy security.
Misalignment abounds here between management goals and minority shareholders. Why do I say this? Because even though these SOEs have ready access to credit, given their state ties, their valuations are cheap and they’re cheap for a reason.
According to calculations by JPMorgan Chase & Co, SOEs in China trade at an equity valuation gap of an astounding 40% compared to privately-owned companies. Taking a look at their track records in shareholder returns (over a 10-year window) will tell you the whole story (see below).
Sinopec, PetroChina, and CNOOC share price performance (2010-2020)
|Share price on 1 March 2010 (HK$)||Share price on 6 March 2020 (HK$)||10-year price return (%)|
Source: Yahoo Finance, author compilation.
Amazingly, if you had held on to all three of the companies’ shares for the past decade, you would now be underwater in terms of the share price return.