China National Offshore Oil Corporation

China National Offshore Oil Corporation (CNOOC LTD) Industry: Oil & Gas Operations Segment: Exploration, Drilling and Production

Exchange and Ticker Information Hong Kong Stock Exchange New York Stock Exchange

CNOOC (883) CEO

Sales and Earnings Record 2007 Sales (RMB 000) EPS ($ per ADR)

$

90,723,831 9.80

2008 125,977,382 $ 14.28

EPS Projections Projected EPS ($ per ADR)

$

2009 9.68

$

2010 13.16

2008 Key Statistics Recent Share Price (ADR, US $) YTD ADR Return 52-Week Price Range Shares Outstanding Market Capitalization (HKD) 5-year Net Income Growth Rate Inventory Turnover Asset Turnover Current Ratio Debt to Assets Debt to Equity Gross Margin Operating Margin Operating Return on Assets Return on Equity Cash Flow to Total Debt Working Capital to Total Assets

$

161.52 61% 76.63 - 162.83 $ 44,623,856 576,232,679,794 33.32% n/a 0.65 3.39 7% 9% 94% 43% 27.88% 30.13% 4.47 21.76%

Investment Summary  China National Offshore Oil Corporation (CEO) has excellent profits, strong margins and almost no debt.  It is the smallest of the 3 companies, competing on the domestic crude oil and natural gas market.  PRC government owns 64% of CEO and sets domestic gasoline prices.  Production, revenues and net income grew 13%, 39% and 42% respectively YOY.  NYSE-listed ADR is up 61% YTD.

Business Description Hong Kong-based China National Offshore Oil Corporation (CEO) is engaged in exploration, development and production of crude oil and natural gas, with activities primarily concentrated around Bohai Bay and the China Sea in offshore Chinese territories. The People’s Republic of China (PRC) government owns a 64% stake in the company and has granted CEO exclusive rights to form joint ventures with foreign companies (38 contracts with 28 partners to date) to explore, drill and pump oil and gas in PRC offshore territories. With proven reserves of 1.58 billion barrels of crude oil and 5.6 trillion cubic feet of natural gas, CEO is one of the largest oil and gas companies in the world. The company has drilled 1,011 exploratory and production wells and pumps an average of 422,000 barrels of oil and 621 million cubic feet of natural gas daily. CEO has one of the lowest production costs ($10.37 per BOE) in the industry and, having tapped only 40% of its proven reserves so far, could potentially maintain production at current levels for 13 years without any new exploration and well development. In addition to China Sea wells, CEO has oil and gas interests in Indonesia, Myanmar (Burma), Australia and Nigeria, representing 16% of proven reserves combined. The company sold 72.3% of its 2008 output in China and exported the balance. Industry Overview and Competitive Position Crude oil and natural gas are undifferentiated commodities with volatile prices on the world energy markets. Demand is strongly correlated with economic activity levels and industrial production trends in the developed countries. Not only do economic activity expectations influence current prices, but the cost of energy, a vital industrial production input, also shapes future economic activity. This creates a feedback loop where expectations of market participants become a reality as their business decisions affect prices and trends. In 2008 crude oil prices fluctuated between $33.87 and $147.27 per barrel, with an average price of $97.26 per barrel. 2008 world consumption of crude oil increased 10% YOY. In the domestic market, where CEO derives ¾ of its revenues, it competes with PetroChina Company LTD and China Petroleum & Chemical Corporation (Sinopec). Because PRC government restricts and taxes oil imports, as well as limits access to foreign currency needed to pay for imported oil, the effect of foreign competition on CEO market share and profits is negligible. The table below compares CEO, PetroChina, and Sinopec using FY08 revenues, net income, proven reserves, annual output, and lifting or production cost.

China National Offshore Oil Corporation

PetroChina Company LTD

China Petroleum & Chemical Corporation

Assets (RMB million)

206,669

1,194,174

767,827

Revenues (RMB million)

125,977

1,071,146

1,502,443

44,375

126,651

26,200

1,580

8,324

2,841

5,600

26,667

6,959

154

871

297

1,860

293

Lifting Cost ($ per barrel)

227 $ 10.37

Employees

3,584

Net Income (RMB million) Proven Oil Reserves (million barrels) Proven Natural Gas Reserves (billion cubic meters) Oil Output (million barrels) Natural Gas Output (billion cubic feet)

$

9.48 477,780

$

12.68 358,304

With only a fraction of the assets and employees of its larger competitors, CEO has superior efficiency, as well as low lifting cost, notwithstanding its smaller size. Financial Analysis CEO has strong profitability, excellent margins and practically no debt. After exercising an early call option on RMB 2.2 million of convertible bonds in 2008, the company has RMB 13.9 billion of debt remaining, all of it denominated in U.S. dollars. Foreign currency earned from exporting ¼ of annual output is more than adequate for debt service and equipment purchases, as debt represents only 6.7% of assets and 8.65% of equity. In addition to an exceptional solvency position, CEO has excellent liquidity, with a current ratio of 3.39. The company has access to a RMB 39,263 million revolving credit banking facility, which remained untapped in FY2008. Production, revenues and net income grew 13%, 39% and 42% respectively YOY. This strong performance was helped by a 35% increase in average realized crude oil prices and hindered by a Special Oil Levy (Windfall Tax) of 12.9% of sales, imposed by the PRC government in FY2008. An alarming 24.3% increase in operating expenses, which is twice the production increase figure, can be somewhat explained by unusually severe weather in the China Sea in FY08, as well as higher service fees and raw material costs. Profitability has improved in 2008, aided by 35% and 16% increases in market prices in crude oil and natural gas respectively. The gross profit margin was an astonishing 93.7%, the operating margin was 42.8%, and the net margin was 35.2%

CEO generated a 23% return on assets and a 30.1% return on equity in 2008, which can be attributed as follows: Tax burden of 0.76 x Interest burden of 0.99 times EBT margin of 0.46 times Asset turnover of 0.65 times leverage of 1.31. Extremely low debt explains the negligible interest burden and unusually low financial leverage. EBT margin is very respectable. In FY2008 the company earned RMB 44,375 million, or RMB 0.99 per share, and paid RMB 14,651.8 in dividends, an increase of 27% from the prior year. Investment Risks PRC government is a majority shareholder in CEO. In addition to fixing gasoline prices in China, the government controls the company and can limit its profitability by imposing additional taxes, limiting export sales, or by other legislative means. A Windfall Tax of RMB 16.2 billion (USD 2.38 billion) was imposed in FY2008. CEO does not hedge against declines in market price for oil by selling oil futures against its expected production, or use forward contracts. The company is thus exposed to the risk of declining oil prices. Supply contracts with natural gas customers specify that the sale price is reset regularly, depending on world energy prices, inflation rates, and production costs. CEO may demonstrate its lack of experience with liquid natural gas production and delivery with a spectacular and costly accident. 96% of the company’s debt is U.S. dollar denominated, and 47% of it is issued at floating rates of interest. Currency and interest rate risk is insignificant, however, due to very low debt levels. In addition, CEO sells 25% of its output on the export market for U.S. dollars. The foreign currency obtained from exports is sufficient for debt service. With 60% of proven reserves untapped, the company has 13 years of production in the ground at current output levels and is unlikely to run out of oil in the immediate future. Storms and hurricanes in the China Sea may interrupt production and damage equipment. CEO has insurance for the equipment, but no coverage for any weather or accident-related production disruptions. Being the smallest of the three domestic competitors, CEO may be acquired by either PetroChina or Sinopec for less than the market value of its stock, subject to PRC government approval. CEO depends on PetroChina and Sinopec, who buy a significant portion of CEO oil production.

Calculations

Liquidity Ratios Current Ratio = Current Assets divided by Current Liabilities Current Assets 63,770,281 Current Liabilities 18,799,243 Current Ratio 3.39

Quick Ratio = Cash + short-term securities + receivables divided by Current Liabilities Cash 19761618 Short-term Securities 32960649 Receivables 6244177 Current Liabilities 18,799,243 Quick Ratio 3.14

Cash Ratio = Cash + Sort-term Securites divided by Current Liabilities Cash 19761618 Short-term Securities 32960649 Current Liabilities 18799243 Cash Ratio 2.80

Solvency Ratios Debt to Assets ratio = Total Debt divided by Total Assets Total Debt

13,864,006

Total Assets Debt to Assets Ratio

206,669,014 6.71%

Debt to Equity Ratio = Total Debt divided by Shareholder Equity Total Debt

13,864,006

Shareholder Equity Debt to Equity Ratio

160,237,708 8.65%

Financial Leverage Ratio = EBIT divided by Average Shareholder Equity Average Total Assets Average Shareholder Equity Financial Leverage Ratio

193,231,129 147,276,223 1.31

Net Debt = Short-term Debt + Long-term Debt - Cash & Cash Equivalent

Profitability Ratios Gross Profit Margin = Gross Profit divided by Sales Gross Profit

118,083,699

Sales Gross Profit Margin

125,977,382 93.73%

Operating Profit Margin = Operating Income divided by Sales Operating Income

53,865,154

Sales Operating Profit Margin

125,977,382 42.76%

EBITDA Profit Margin = EBIT divided by Sales EBITDA Sales EBITDA Profit Margin

Pretax Profit Margin = EBT divided by Sales EBT

57,880,286

Sales Pretax Profit Margin

125,977,382 45.94%

Net Profit Margin = Net Income divided by Sales Net Income

44,375,254

Sales Net Profit Margin

125,977,382 35.22%

Operating Return on Assets = Operating Income divided by Average Assets Operating Income

53,865,154

Average Assets Operating Return on Assets

193,231,129 27.88%

Return on Assets = Net Income divided by Average Assets Net Income

44,375,254

Average Assets Return on Assets

193,231,129 22.96%

Return on Equity = Net Income divided by Average Equity Net Income

44,375,254

Average Equity Return on Equity

147,276,223 30.13%

Credit Analysis Ratios Cash Flow to Total Debt = Cash Flow From Operations to Average Total Debt CFFO Average Total Debt Cash Flow to Total Debt

55,738,435 12,463,290 4.47

Return on Assets = Net Income divided by Average Assets Net Income 44,375,254 Average Assets 193,231,129 Return on Assets 22.96%

Total Debt to Total Assets = Total Debt divided by Total Assets Total Debt 13,864,006 Total Assets 206,669,014 Total Debt to Total Assets 6.71%

Working Capital to Total Assets = Working Capital divided by Total Assets Working Capital 44,971,038 Total Assets 206,669,014 Working Capital to Total Assets 21.76%