What Do Lower Crude Prices Mean for Emerging Markets?

Chances are that oil prices will make a correction throughout the first quarter of 2014. In fact, WTI crude oil contracts for February are already dropping in price, affected by a very likely increase in crude oil world supply after Iran's agreement to stop its nuclear program. Traders expect that Iran will soon be allowed to produce oil and export it at full capacity, increasing world supply by at least 1 million barrels a day. Moreover, the slow but steady increase in interest rates in the U.S. is also pushing capital away from commodities and, consequently, allowing price drops in oil in the mid-term.

Within the emerging world, the Brazilian and Chinese emerging markets still present strong demand for energy. Their energy companies might be able to withstand a correction in better shape than their peers as well. Let's see what the future may look like for CNOOC (NYSE: CEO  ) , China Petroleum & Chemical (NYSE: SNP  ) , and Petroleo Brasileiro (NYSE: PBR  ) .

A good quarter
The third quarter came in with good news for China's dominant producer of offshore crude oil and natural gas, CNOOC, as net production increased 17.8% and revenues went up 15.9% year over year. Average realized prices went up 1.5% in oil but dropped 6.9% in natural gas.

Looking ahead, CNOOC's growth should experience a boost within the next three to five years coming from numerous development projects in offshore China, international growth from acquisitions, and programs with partners. CNOOC believes it will maintain a 6% to 10% compound annual production growth rate (CAPGR) over the next five years. This quarter the company achieved two new discoveries and 10 successful appraisal wells in offshore China.

Let's not forget that the company remains heavily influenced by the Chinese government, however, which through a subsidiary owns 64.41% of the company. Shareholder's interests may differ from the government's when issues arise, and considering that CNOOC is the only company permitted to conduct exploration and production activities with international oil and gas companies off the shores of China, there is the potential for conflict.

Maturing fields
Second, we have China Petroleum & Chemical, also known as Sinopec.

Sinopec saw a net profit growth of 20.15% year over year in the third quarter. However, the company has been witnessing a drop in crude oil prices, which has weighed on its exploration and production segment.

The key issue with Sinopec is that its oil fields are mature, and rising associated costs will continue to be a drag on performance. In addition, the company has to deal with the fact that Chinese oil companies are unable to charge close-to-market prices for their crude oil since the government defines the pricing for refined products to control inflation.

Although Sinopec has been exploring expansion and acquisition opportunities abroad to offset its exposure to mature domestic areas, progress should not come in the near term. Competition from peers, along with the loss of focus coming from government deregulation and internal restructuring, will make it difficult to succeed on this front any time soon. In addition, the Chinese state owns 73% of the company, raising the same concerns as with CNOOC.

Better local pricing
Finally, we look at the state-run Brazilian energy giant Petroleo Brasileiro. Also known as Petrobras, it is the largest publicly traded Latin American oil company.

The company will enjoy the benefits of a new domestic pricing policy that will lead to an automatic adjustment of gasoline and diesel local prices. In fact, the recent increase in pump fuel prices should already boost Petrobras' margins in the near term.

However, some issues might restrain the company's growth potential. These include a declining production trend and the huge investments that will be necessary to fully exploit its offshore discoveries. Moreover, state interference can also create problems since the company is the only Brazilian fuel importer willing to take a loss on imports. Getting the revenue needed to finance its ambitious expansion plans on decreasing crude oil prices will be tough.

Final thoughts
Declining oil prices are almost never good news for an oil company. In fact, it makes exploration and access to capital more difficult and affects the companies' guidance. What we do not know yet is how strong this correction will be or how long it will last, considering that demand could catch up and offset the increase in world oil supply.

Despite the government's presence, CNOOC's premium asset portfolio, excellent execution strategy, and growth potential make it a good investment candidate for long-term positions.

Maturity of fields is affecting Sinopec, and unless the company manages to get capital and expand overseas and/or offshore, the stock will likely remain under pressure.

Petrobras should post good results in the near term thanks to the adjustment in local fuel prices. However, its long-term outlook is more uncertain given the huge investments that the company needs to develop its offshore fields.

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  • Report this Comment On January 22, 2014, at 12:05 AM, JClinton wrote:

    I am long on PBR, this state owned company is extremely undervalued. It has been approaching its 52 week low... I'm buying it. Great article.

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