Top Picks on the Path of Gradual Recovery —— The Investment Strategy of Oil & Gas Industry in 2H2009 & 2010 Titus Wu May 25, 2009.

Top Picks on the Path of Gradual Recovery —— The Investment Strategy of Oil & Gas Industryin 2H2009 & 2010

Titus Wu

May 25, 2009

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申万研究 2

The Path of Industry Recovery & Top Picks

Downstream sectors recovery

Sinopec (386)Refined oil products &

petrochemical markets recovery

Crude oil demand recovery

Upstream sectors recovery

Honghua (196) COSL (2883), Tianda (839), Molong (568)

CNOOC (883), PetroChina (857)

Top pick

Beneficiaries

Sinopec Shanghai (338), PetroChina (857)

Sinopec (386)

Current stage

Next

stage

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申万研究 3

Logics – Final Momentum

Auto consumption

Transportation & Logistics

Consumption recovery in petrochemical market

Diesel consumption

Gasoline consumption

Output and prices of individual petrochemical products

Whether refined oil products consumption can recover from

the weak demand?

Industrial structure optimizing

Central China Rural areas

Prices of refined oil products

Emission standard Price subsidies

Momentum

Control

Whether petrochemical sector leaves hard time behind earlier

than expectation?

Indicators

Demand factors

Two key questions

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申万研究 4

1. Outlook of Refined Oil Products is Bright

2. Downstream Petrochemical Markets are Going to Rebound from the Trough

3. Valuation: Top Picks on the Recovery Path

Contents

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申万研究 5

1.1 Refined Products Consumption Depended on China Economy

-10

-5

0

5

10

15

2019

91

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

E

GDP Growth Rate (%)

Gasoline Consumption Growth Rate (%)

Diesel Consumption Growth Rate (%)

In 1994, China began to impose Consumption Tax from gasoline and

diesel oils.

Asian Financial Crisis

Increase of investment and stimulation of

domestic demand Beijing Olympic

Games

Source ： CPCIA, SWS Research

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申万研究 6

1.2.1 Consumption Structure Evolves: Need More Diesel

Diesel/Gasoline Consumption Ratio

Gasoline Consumption Structure Evolvement

Diesel Consumption Structure Evolvement

1.41 1.93 2.26

1994 2000 2007

Residential2%Wholesale,

Retail andCatering

5%

OtherIndustries

7%

Construction3%

Industry14%

Agri,Husbandry,Fishery &

WaterConservancy

15%

Transport,Storage,Post andTelecom

54%


37%


WaterConservancy

19%

Industry24%

Construction3%

OtherIndustries

12%Wholesale,Retail andCatering

4%

Residential1%

Residential0%

Wholesale,Retail andCatering

2%

OtherIndustries

15%

Construction3%

Industry29%


WaterConservancy

25%


26%


6%

Residential8%

OtherIndustries

17%

Transport,Storage, Postand Telecom

51%


WaterConservancy

4%Industry

10% Construction4%


6%

Residential4%

OtherIndustries

25%

Construction3%

Industry17%


WaterConservancy

5%


40%


32%


WaterConservancy

6%Industry

28%

Construction4%

OtherIndustries

23%

Residential2%


5%

Source ： CEIC, SWS Research

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申万研究 7

1.2.2 Historical Experience in 1998: Big Investment Works

-1%

4%

9%

14%

19%

24%

29%

34%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008Diesel Consumption Growth Rtae Gasoline Consumption Growth RtaeFreight Ton Kilometer Carried Growth Rtae

Infrastructure & Logistics will benefited firstly from government investment of RMB 4 trillion.


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申万研究 8

1.2.3 East China Consumed More Diesel for 1998 Big Investment

In 1998, government investment was around RMB 3 trillion.

The highways and infrastructures in East China significantly upgraded.

1998 2007

0-2

2-4

4-6

6-8

8+ Mn tons

0-2

2-4

4-6

6-8

8+ Mn tons

1998 2007


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申万研究 9

1.2.4 Diesel Consumption

The growth rate of diesel consumption in 2009 will maintain positive, because of gradually warm up of China’s economy.

Output Apparent consumption


0

5

10

15

20

25

Jan-Feb 08

Mar-08Apr-08 May-08

Jun-08 Jul-08 Aug-08

Sep-08

Oct-08Nov-08 Dec-08

Jan-Feb 09

March09

-15%

-10%

-5%

0%

5%

10%

15%

20%

Diesel oil output MOM

0

5

10

15

20

25

Jan-Feb 08

Mar-08Apr-08 May-08


Sep-08

Oct-08Nov-08 Dec-08

Jan-Feb 09

March09

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Apparent Diesel consumption MOM

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Jan-Feb 08

Mar-08Apr-08 May-08


Sep-08

Oct-08Nov-08 Dec-08

Jan-Feb 09

March09

-1000%

0%

1000%

2000%

3000%

4000%

5000%

6000%

Diesel oil import MOM

0.0

0.1

0.1

0.2

0.2

0.3

0.3

0.4

0.4

0.5

0.5

Jan-Feb 08

Mar-08Apr-08 May-08


Sep-08

Oct-08Nov-08 Dec-08

Jan-Feb 09

March09

-200%

0%

200%

400%

600%

800%

1000%

1200%

Diesel oil export MOM

Import Export

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申万研究 10

1.3.1 Hot Areas of Auto Consumption Shift from First-tier Cities

The urbanization rate is deepening in Central and West China.

The growth poles mainly locate in second-tier and third-tier cities, even in fourth-tier cities.

0%10%

20%30%40%50%

60%70%80%

90%100%

2005 2006 2007 2008

First-tier Second-tier Third-tier

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

北京上海成都市广州市东莞市武汉市郑州市厦门市银川市唐山市福州市泉州市南宁市合肥市

乌鲁木齐市海口市徐州市洛阳市

张家口市南阳

市赣州市赤峰市遵义市

First-tier Second-tier Third-tier Fourth-tier

The proportion of First-tier cities was declining

The growth poles shift from first-tier cities

Source ： SWS Research

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申万研究 11

1.3.2 Long Story: Auto is Going into China’s Families

Huge potential of gasoline consumption in Central and West China

1998 2007

0-1

1-2

2-3

3-4

4+ Mn tons

0-1

1-2

2-3

3-4

4+ Mn tons


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申万研究 12

1.3.3 Gasoline Consumption

The growth rate of gasoline consumption in 2009 can be stay at the level of 3%, which is significantly lower than that of previous year.

Output Apparent consumption


0

2

4

6

8

10

12

Jan-Feb 08

Mar-08Apr-08 May-08


Sep-08

Oct-08Nov-08 Dec-08

Jan-Feb 09

March09

-10%

-5%

0%

5%

10%

15%

20%

Gasoline output MOM

0

2

4

6

8

10

12

Jan-Feb 08

Mar-08 Apr-08 May-08


Sep-08

Oct-08Nov-08 Dec-08

Jan-Feb 09

March09

-5%

0%

5%

10%

15%

20%

25%

30%

Apparent Gasoline consumption MOM

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

Jan-Feb 08

Mar-08Apr-08 May-08


Sep-08

Oct-08Nov-08 Dec-08

Jan-Feb 09

March09

-200%

-100%

0%

100%

200%

300%

400%

500%

600%

700%

800%

Gasoline import MOM

0.0

0.1

0.2

0.3

0.4

0.5

0.6

Jan-Feb 08

Mar-08Apr-08 May-08


Sep-08

Oct-08Nov-08 Dec-08

Jan-Feb 09

March09

-100%

-50%

0%

50%

100%

150%

200%

Gasoline export MOM

Import Export

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申万研究 13




Contents

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申万研究 14

2.1 Petrochemical Markets Significantly Depend on Economy

0%

2%

4%

6%

8%

10%

12%

14%

Mar

-01

Sep-0

1

Mar

-02

Sep-0

2

Mar

-03

Sep-0

3

Mar

-04

Sep-0

4

Mar

-05

Sep-0

5

Mar

-06

Sep-0

6

Mar

-07

Sep-0

7

Mar

-08

Sep-0

8

Mar

-09

-100%

-50%

0%

50%

100%

150%

200%

250%

300%

GDP growth rate (LHS) Total profit growth rate (RHS)

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

GDP Growth rate (LHS) Net Profit Margin_US Chemicals (RHS)

China

US

Source ： Thomson Reuters, SWS Research

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申万研究 15

2.2.1 RMB 4 Trillion Investment Brings Definitely Positive Effects

40002800

37003700

18000 15000

15004002100350037001600

10000 10000

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Announced by the Developmentand Reform Commission at the

end of 2008

Announced by NPC and CPPCCin 2009

Post-disaster restoration andreconstruction

Ajustment of independentinnovation structure

Energy-saving and ecologicalconstruction

Medical, health, culture andeducation

Railway, highway, airport, urbanand rural power grid

Rural livelihood projects andrural infrastructure

Residential protection program

Crude /Coal Price

GlobalChemicalPrice

Construction/ Real Estate

AutoTextile &Clothing

Grain PriceHabitPreference

CapacityInput

Fertilizer ＋＋＋－New ChemicalMaterials ＋＋＋＋＋－Chemical RawMaterials ＋＋＋＋＋－Daily-useChemical ＋Chemical Fiber －＋－

Details of RMB 4 trillion investment

Impacts to the demand of petrochemicals


Thanks for the contribution from Shawn Zhou

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申万研究 16

2.2.2 Demand Spurred By Urbanization

Urbanization

PVCHard Goods

Construction & Real Estate

Automobile

Caustic soda

Engineering Plastics

Organic Silicon

Glass Fiber

Glass

Electrical Appliance

RefrigeratorAggregated

MDI

59%

40%

30%

50%

10%

6%

10%

30%

25%

30%

20%

80%

80%

30%

30%

Merchandise ChemicalsIndustries DemandDemand



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申万研究 17

2.2.3 Demand Spurred By New-Countryside Construction

New-Countryside

Construction

DyePrinting &

Dyeing

Textile, Clothing, & Luggage

Agriculture

DMF

Pure MDI

Fertilizer

Pesticide

Leather & Chemical

Fiber

Shoemaking& Spandex

Chemical Fiber

Acetic Acid

100%

60%

50%

15%

99%

100%

100%

100%

100%

100%

Merchandise ChemicalsIndustries DemandDemand



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申万研究 18

2.3.1 Worst Time is Going to Behind

-500%

-400%

-300%

-200%

-100%

0%

100%

1Q08 2Q08 3Q08 4Q08 1Q09

New Chemical Materials Chemical FiberChemical Raw Materials ChemicalsPetrochemicals Petroleum Exploiting

-10%

0%

10%

20%

30%

40%

50%

1Q08 2Q08 3Q08 4Q08 1Q09

New Chemical Materials Chemical FiberChemical Raw Materials ChemicalsPetrochemicals Petroleum Exploiting

Net profit growth rate

Gross margin


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申万研究 19


Urea

Sulphuric acid

1500

1700

1900

2100

2300

2500

2700

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-0

7

Nov-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-0

8

Nov-08

Jan-

09

Mar

-09

150

170

190

210

230

250

270

Price (LHS) Output (RHS)

300

800

1300

1800

2300

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-0

7

Nov-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-0

8

Nov-08

Jan-

09

Mar

-09

300320340360380400420440460480500



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申万研究 20


Caustic soda

Calcined soda

2400

2600

2800

3000

3200

3400

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-0

7

Nov-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-0

8

Nov-08

Jan-

09

Mar

-09

80

100

120

140

160

180

200


1000

1200

1400

1600

1800

2000

2200

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-0

7

Nov-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-0

8

Nov-08

Jan-

09

Mar

-09

100110120130140150160170180190200



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申万研究 21


Pure benzene

Glacial acetic acid

3000

4000

50006000

7000

8000

900010000

11000

12000

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-0

7

Nov-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-0

8

Nov-08

Jan-

09

Mar

-09

20

25

30

35

40

45

50


30003500400045005000550060006500700075008000

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-0

7

Nov-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-0

8

Nov-08

Jan-

09

Mar

-09

02468101214161820



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申万研究 22




Contents

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申万研究 23

3.1 Assumption & Scenario

Assumption: global crude price will edge up

• Average crude price: 55 $/B in 2009, 73 $/B in 2010

• Average crude price in long run will maintain at the level of 75-80 $/B

Scenario of Top Pick

Other Like: Tianda Oil Pipe (839.HK)

Dislike: Sinopec Shanghai (338.HK)

Bull Normal Bear

During 2H2009

Average crude price in 2H2009 ($/B) 74 64 54

Top pick in oil majors CNOOC Sinopec Sinopec

Top pick in oilfield services Co. COSL Honghua

During 2010

Average crude price in 2010 ($/B) 80 73 60

Top pick in oil majors CNOOC PetroChina Sinopec

Top pick in oilfield services Co. Honghua COSL Honghua

Average crude price was 46.13 $/B, up to May 15

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申万研究 24

3.2.1 Sinopec (386.HK) – TP: HK$ 7.38

Results in 2H2009 will beat the expectation.

Catalysts:

• The demand of refined oil products and chemicals are out of woods earlier than expectation.

• The much stricter emission standard in country wide.

– High quality & high price

– Higher wholesale price of 200 RMB/ton


09 P/E 9.42 Last price(HK$) 6.10

10 P/E 8.01 Target Price (HK$) 7.38

09 P/B 1.45 09 Divident yield 2.79


09EV/EBITDA 3.66 09 ROE 15.41

10EV/EBITDA 3.16 10 ROE 13.96

Sinopec（386.HK） Outperform

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

386 HK Equity FXI/SYWG Triple C Index

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申万研究 25

3.2.2 PetroChina (857.HK) – TP: HK$ 9.20

Go well quarter by quarter

Catalysts:

• Crude price edges up

• The new pricing mechanism of natural gas is coming.

– We expect that PetroChina can achieve 0.024 RMB/EPS, if the average realized price will increase 0.1 RMB/cubic meter.


-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09


09 P/E 11.87 Last price(HK$) 8.09




09EV/EBITDA 5.93 09 ROE 13.13

10EV/EBITDA 4.80 10 ROE 15.38

PetroChina（857.HK） Outperform

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申万研究 26

3.2.3 CNOOC (883.HK) – TP: HK$ 12.69

Sustainable higher growth rate than other two oil majors

Catalysts:

• Crude price edges up

• Full support from CNOOC Group

Sensitivity analysis on crude price


2009 averagecrude price ($/B) 40 50 55 60 70

EPS (RMB) 0.56 0.68 0.75 0.81 0.94

2010 averagecrude price ($/B) 60 70 73 80 90

EPS (RMB) 0.95 1.09 1.14 1.24 1.39

09 P/E 11.71 Last price(HK$) 9.98




09EV/EBITDA 7.74 09 ROE 17.56

10EV/EBITDA 5.22 10 ROE 23.95

CNOOC（883.HK） Buy

-80%-70%

-60%-50%

-40%-30%

-20%-10%

0%10%

20%

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09


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申万研究 27

3.2.4 Honghua (196.HK) – TP: HK$ 2.05

New production contracts for the edge-up of crude price; Improvement of Russian clients’ cash flow status

Worst Case Normal Case Best Case

2009 Sales Volume of Rigs 65 95 110

ESP (RMB) 0.10 0.20 0.25

2010 Sales Volume of Rigs 100 110 120

ESP (RMB) 0.22 0.27 0.32

Keycomponents

70%

Steel14%

Manufacturecost9%

1% 2% 4%

Steel Key components Manufacture cost DepreciationSalary Others

Stress test on sales volume Cost structure


-80%

-60%

-40%

-20%

0%

20%

40%

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09


09 P/E 6.78 Last price(HK$) 1.54




09EV/EBITDA 4.73 09 ROE 11.90

10EV/EBITDA 3.62 10 ROE 14.21

Honghua（196.HK） Outperform

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申万研究 28

3.2.5 Valuation Summary


Company nameTicker

SymbolP/E 09E P/E 10E P/B 09E P/B 10E

ROE (%)2009E

ROE (%)2010E

DividendYield 09E

Sinopec 386 9.42 8.01 1.45 1.12 15.41 13.96 2.79

PetroChina 857 11.87 9.37 1.56 1.44 12.25 15.38 3.09

CNOOC 883 11.71 7.70 2.06 1.85 17.56 23.95 2.85

Sinopec Shanghai 338 15.31 12.09 0.88 0.84 4.06 6.35 2.61

COSL 2883 7.69 5.86 1.32 1.12 17.09 19.05 2.57

Honghua 196 6.78 5.02 0.81 0.71 11.90 14.21 2.95

Tianda Oil Pipe 839 4.67 3.81 0.90 0.69 19.28 18.28 5.24

Global peers

Integrated oil 13.44 8.76 1.41 1.32 8.96 13.02 4.05

Independent E&P 19.55 15.13 2.06 1.78 8.15 13.20 1.55

Oilfield Services 12.79 12.40 1.28 1.20 12.39 10.96 3.02

Oilfield Equipment 11.31 11.87 1.79 1.61 15.52 13.46 1.43

Data: May 15, 2009

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申万研究 29

The views expressed in this report accurately reflect the personal views of the analyst. The analyst declares that neither he/she nor his/her associate serves as an officer of nor has any financial interests in relation to the listed corporation reviewed by the analyst. None of the listed corporations reviewed or any third party has provided or agreed to provide any compensation or other benefits in connection with this report to any of the analyst, the Company or the group company(ies). A group company(ies) of the Company confirm that they, whether individually or as a group (i) are not involved in any market making activities for any of the listed corporation reviewed; or (ii) do not have any individual employed by or associated with any group company(ies) of the Company serving as an officer of any of the listed corporation reviewed; or (iii) do not have any financial interest in relation to the listed corporation reviewed or (iv) do not, presently or within the last 12 months, have any investment banking relationship with the listed corporation reviewed.

Undertakings of the AnalystTitus WuI am conferred the Professional Quality of Securities Investment Consulting Industry by the Securities Association of China or have equivalent professional competence. I issue this report independently and objectively with due diligence. This report distinctly and accurately reflects my research opinions. I have never been, am not, and will not be compensated directly or indirectly in any form for the specific recommendations or opinions herein. Information Disclosure with respect to the CompanyThe Company fulfills its duty of disclosure within its sphere of knowledge. The clients may contact [email protected] for the relevant disclosure materials.

Introduction of Share Investment RatingSecurity Investment Rating ：When measuring the difference between the markup of the security and that of the market’s benchmark within six months after the release of this report, we define the terms as follows: Buy ： with a markup more than 20% better than that of the market ；Outperform ： With a markup 5% to 20% better than that of the market ；Neutral ： with a markup less than 5% better or worse than that of the market ；Underperform ： with a markup more than 5% worse than that of the market.Industry Investment Rating:When measuring the difference between the markup of the industry index and that of the market’s benchmark within six months after the release of the report, we define the terms as follows: Overweight ： Industry performs better than that of the whole market ；Neutral ： Industry performs about the same as that of the whole market ；Underweight ： Industry performs worse than that of the whole market.

We would like to remind you that different security research institutions adopt different rating terminologies and rating standards. We adopt the relative rating method to recommend the relative weightings of investment. The clients’ decisions to buy or sell securities shall be based on their actual situation, such as their portfolio structures and other necessary factors. The clients shall read through the whole report so as to obtain the complete opinions and information and shall not rely solely on the investment ratings to reach a conclusion. The Company employs its own industry classification system. The industry classification are available at our sales personnel if you are interested.CSI300 is the benchmark employed in this report for A-share listed firms and FXI/SYWG Triple-C Index is the benchmark employed in this report for HK-listed firms.

Disclaimer

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申万研究 30

This report is to be used solely by the clients of Shenyin & Wanguo Securities Research Institute Co, Ltd. (hereinafter referred to as the “Company”). The Company will not deem any other person as its client notwithstanding his receipt of this report.This report is based on published information which the Company believes to be reliable, however, the authenticity, accuracy or completeness of such information is not warranted by the Company. The materials, tools, opinions and speculations contained herein are for the clients’ reference only, and are not to be regarded or deemed as an invitation for the sale or purchase of any security or other investment instruments. The clients understand that the text message reminder and telephone recommendation are no more than a brief communication of the research opinions, which are subject to the complete report released on the Company’s website (http://www.sw108.com). The clients may ask for follow-up explanations if they so wish.The materials, opinions and estimates contained herein only reflect the judgment of the Company on the day this report is released. The prices, values and investment returns of the securities or investment instruments referred to herein may fluctuate. At different periods, the Company may release reports which are inconsistent with the materials, opinions and estimates contained herein. The clients shall consider the Company’s possible conflict of interests which may affect the objectivity of this report, and shall not base their investment decisions solely on this report. The investment and services referred to herein may not be suitable for certain clients and shall not constitute personal advice for individual clients. The Company does not ensure that this report fully takes into consideration of the particular investment objectives, financial situations or needs of individual clients. The Company strongly suggests the clients to consider themselves whether the opinions or suggestions herein are suitable for the clients’ particular situations; and to consult an independent investment consultant if necessary.Under no circumstances shall the information contained herein or the opinions expressed herein forms an investment recommendation to anyone. Under no circumstances shall the Company be held responsible for any loss caused by the use of any contents herein by anyone.Independent investment consultant should be consulted before any investment decision is rendered based on this report or at any request of explanation for this report where the receiver of this report is not a client of the Company.

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申万研究 31

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Titus Wu

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