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Investors buying CNOOC are crazy – like a fox

Why would a sane individual invest in a Chinese state-owned enterprise? Consider CNOOC, China's largest offshore oil company. This year, it made the largest ever bid by a Chinese oil and gas group with its $15-billion offer for Canada's Nexen. The deal awaits approval but the price is a 60 per cent premium to Nexen's undisturbed share price. Investors might be forgiven for thinking that CNOOC cares more about an agenda to secure energy than shareholders.

But there is more to CNOOC than this hefty bid. Yes, CNOOC, like its peers Sinopec and PetroChina, is state-owned. Its government-backed parent holds a 64.5 per cent stake. It has not lost sight of returns, though – 30 per cent over the past five years, compared with a one-sixth loss for the Hang Seng index. Only foreign energy peers BG Group and Chevron have delivered anything better. Moreover, CNOOC's average return on capital employed of almost a fifth over the past five years is double that of peers at home and up there with ExxonMobil, according to CapitalIQ data. And trading on nine times forward earnings, CNOOC is cheaper than domestic peers.

CNOOC's third-quarter results, released on Wednesday, also show that, now production has resumed at Bohai Bay after last year's oil spill, it is not so bad at organic growth either. Oil and gas production was up 9 per cent from last year over the quarter prompting it to bump up its full-year target by five million barrels of oil equivalent to equal annual growth of as much as 4 per cent.

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Bernstein calculates that CNOOC's offer prices Nexen's proven reserves at $20 a barrel while it costs CNOOC $18 to expand organically. But CNOOC's Chinese assets are relatively mature. Including Nexen's probable reserves, CNOOC's price is nearer $9, and adding contingent reserves (not yet commercially viable), it is more like $3. The interests of investors and the state can be aligned.

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