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Alex Kimani

Alex Kimani

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com. 

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How To Play The Chinese Energy Market

With China stocks looking increasingly attractive, and analysts urging investors to restructure their portfolios to be at least 20%, Chinese oil stocks are the exception due to last-minute trade war potshots, but should you buy the dip? 

At the beginning of the year, President Trump and his surrogates touted his supposed acumen as a great dealmaker, brandishing the Phase One Trade Deal with China as "the biggest deal ever seen"

But 10 months since the deal was inked, the President's repeated claims that trade wars are good and easy to win don't seem to be backed by facts. There's growing evidence that the deal has been inimical to U.S. companies without solving the underlying economic concerns it was meant to resolve. Trump's final months in office have seen a surge in tensions with Beijing, and U.S. investors are likely to be on the receiving end this time around.

The Trump administration is set to add China's third-biggest oil and gas company CNOOC Limited (NYSE:CNOOC), and chipmaker SMIC (OTCQX:SMICY) to a blacklist where it charges companies with military ties.

The newest additions to the dreaded list also include China International Engineering Consulting Corp. and China Construction Technology, bringing the total to 35 companies. According to Reuters, the administration is moving closer to adding 89 Chinese aerospace and other companies with military ties to the blacklist.

An addition to the list is accompanied by a recently signed executive order that prevents U.S. investors from buying securities of the listed companies.

CNOOC sold off heavily on the news, tanking nearly 20% on Monday's session and giving up all its gains for the month of November. Meanwhile, close peers China Petroleum & Chemical Corporation (NYSE:SNP) and PetroChina Co. (NYSE:PTR) lost 6.3% each on the day. Related: Oil Price Crash Crushes New Mexico’s Hope For Free College

The Hang Seng Index tumbled 2.1% on the blacklist development as well as due to fears of a fourth wave of Covid-19 infections.

Major outflows

U.S. investors hold ~16.5% of CNOOC's shares in its Hong Kong-listed unit, something that could potentially trigger major outflows if Trump's ban takes hold and the company is forced to divest its holdings.

CNOOC is one of China's so-called big three NOCs (National Oil Companies), the others being China National Petroleum Corp. (CNPC) and China Petrochemical Corp., also known as Sinopec.

It's only natural to wonder why CNOOC was targeted and not CNPC or Sinopec. Lin Boqiang, dean of the China Energy Policy Research Institute at Xiamen University in southern ChinaSo, suspects CNOOC's drilling activity in the South China Sea area is responsible for putting it at loggerheads with U.S. authorities.

CNOOC is China's main deepwater explorer, with its partnerships with ExxonMobil (NYSE:XOM) in offshore Guyana some of its most successful to-date.

CNOOC, Exxon, and Hess Corp. (NYSE:HES) have made 18 discoveries totaling ~9B boe in Guyana's massive Stabroek block southwest of Kaieteur. Unfortunately, other discoveries by the trio have not been as promising as the Stabroek find with their Tanager-1 well--the deepest well drilled so far in offshore Guyana--revealing hydrocarbons but initial analysis showing that the well might not be economical on a standalone basis. 

Further, CNOOC's operations in the South China Sea have run into controversy because Beijing has been claiming drilling rights in waters far from its borders and as close as 200 miles off the coasts of the Philippines and Vietnam.

China's LNG Imports Grow

It's not yet clear how the growing antipathy between the two nations will affect the U.S. natural gas sector, given that CNOOC is China's largest importer of LNG. The new sanctions bite the hand that's expected to feed it. 

Back in June, Natural Gas Intelligence (NGI)  reported that China's LNG imports from the U.S. have actually been rising on a year-on-year basis, with the U.S. stealing market share from traditional powerhouses Australia and Qatar. 

According to Wood Mackenzie via NGI, China took in 10 LNG cargoes from U.S. suppliers between April and May at the expense of Australia, whose market share slipped up in May. 

There are several plausible explanations as to why China is buying U.S. LNG despite Washington and Beijing feuding over everything from the novel coronavirus to Hong Kong to 5G networks.

First off, China could be using the crisis as a bargaining chip to renegotiate its contracts with long-term suppliers, including Turkmenistan and Uzbekistan. 

Second, Beijing could be trying to increase its sphere of influence in Central Asia, a region that has long been a geopolitical battleground between Beijing and Moscow. 

Lastly, Beijing might simply be trying to stick to the January trade agreement with Washington to prevent another full-blown trade war. Although the accord did not specify quantities of the products, it committed Beijing to purchase an extra $52.4 billion of U.S. energy supplies over the next two years. 

Under the deal, China's deal amount increases to $18.5 billion in 2020 and another $33.9 billion in 2021 from a baseline of just $9.1 billion in 2017. 

China has already instructed state-owned firms to suspend large-scale purchases of U.S. farm produce, including soybeans and pork, in retaliation to Trump's Hong Kong stance but has not said anything about energy products. 

Whatever the case, U.S. LNG suppliers appear to be cozying up to a second major customer after recently doing so with Turkey.

And in the meantime, with China experiencing a bit of a post-COVID revival that has market analysts all excited, it's still difficult to convince investors to go all-in on Chinese oil stocks until they see what Joe Biden plans to do about the trade war uncertainty. 

By Alex Kimani for Oilprice.com

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