Sinopec Yizheng H [1033.HK] SELL...Share Price Performance Market Cap US$3,422m Shares Outstanding...

1

Sinopec Yizheng - H [1033.HK]

We believe Sinopec Yizheng, after completing the acquisition of Sinopec Oilfield Service Corporation (SOSC), will face several challenges in 2015 and 2016: (1) Lack of sustainability in the company’s construction engineering revenue after the completion of the Xinjiang-Guangdong-Zhejiang coal-to-gas pipeline; (2) slowdown of drilling activities in the shale gas project in Fuling, Sichuan, after 2015; (3) poten-tial contracts cut by overseas customers. Besides, the recent investigation of SOSC’s ex-Vice Chairman will add uncertainty to the company’s outlook. We expect it will be challenging for Yizheng to reach its profit target for 2015E, as we believe weaker revenue will make it difficult to achieve meaningful margin expansion. We expect Yizheng’s earnings growth to slow starting 2016E. Initiate with SELL and a target price of HK$1.97 (based on 6.7x 2015E PER, 10% discount to peer average).

Xinjiang-Guangdong-Zhejiang coal-to-gas pipeline construction will be

“one-off” in nature. SOSC stated clearly that its construction engineering rev-enue in 2015E will be driven by this project. We see this large-scale project as a “one-off” contribution, and completion will imply that SOSC needs to find a new large-size project to support revenue growth, which we believe is highly uncertain in terms of visibility at this stage.

Fuling shale gas drilling activities may peak in 2015E. According to Si-

nopec’s existing drilling plan for Fuling, the number of drilling wells is expected to decline from 100/135 in 2014E/2015E to 107/75 in 2016E/2017E. We expect the additional wells in phase two or other new projects will be similar to that in phase one, suggesting a slowdown of SOSC’s drilling revenue.

Increasing overseas revenue suggests higher risk. SOSC grew its interna-

tional revenue share from 15% in 2011 to 25% in 1H14. SOSC targets to main-tain the oversea revenue portion at 25% in 2015E. SOSC mentioned that over-seas revenue will be driven by new contracts on offshore rigs and seismic geo-physical operations in Saudi Arabia and Kuwait. We believe these contracts are subject to cancellation risks given the recent sharp decline in oil price.

Challenging to reach profit target. We believe SOSC’s own profit target is

based on assumptions when the oil price was close to US$100/barrel, vs. US$66 currently. Our earnings forecast for 2015E is 15% below the company’s projection and we only expect 5% increase in 2016E earnings.

Upside risks: (1) Sharp rebound of oil and gas price; (2) stronger than ex-

pected order flow; (3) better than expected cost reduction and efficiency im-provement.

Oilfield Services Sector Three negatives factors suggest downside risk to 2015 earn-

ings; Initiate with SELL

SELL (Initiation)

Close: HK$2.51 (Dec 8, 2014)

Target Price: HK$1.97 (-22%)

Share Price Performance

Market Cap US$3,422m

Shares Outstanding

(before/after restruc-

turing)

6,000m/12,809m

Auditor (for SOSC) Grant Thornton

Free Float 28%

52W range HK$1.35-4.11

3M average daily T/O US$20m

Major Shareholding

(after restructuring) Sinopec Group (72%)

December 9, 2014

Wayne Fung, CFA —Analyst

(852) 3698-6319

[email protected]

Harry He—Research Assistant

John Mulcahy—Head of Research

(852) 3698-6889

[email protected]

Key Financials (RMB m) 2012 2013E 2014E 2015E 2016E

Revenue 87,337 89,729 81,704 85,758 85,382

Change (YoY) 17.6% 2.7% -8.9% 5.0% -0.4%

EBIT 1,827 2,794 3,997 4,845 4,795

Change (YoY) 53.9% 53.0% 43.0% 21.2% -1.0%

Core net profit 1,046 1,515 2,415 2,986 3,129

Change (YoY) -9.4% 44.9% 59.4% 23.7% 4.8%

Core EPS (HK$) - - 0.239 0.296 0.310

Change (YoY) - - - 23.7% 4.8%

ROE 6% 7% 10% 11% 10%

Net debt/equity 69% 57% 50% 42% 20%

PER (core earnings) (x) - - 10.5 8.5 8.1

Dividend yield - - 0.0% 0.0% 0.0%

PBR (x) - - 1.0 0.9 0.8

EV/EBITDA (x) - - 3.4 3.1 3.1

Sources : Company, CGIHK Research estimates

2

Investment case

SOSC is a key beneficiary of shale gas exploration activities in

Fuling region; but sustainability uncertain

The recent reduction of government’s official target for shale gas production volume for

2020 from 60-100bn to 30bn m3 suggests that the government is more focused on medi-

um-term shale gas production, in our view. With an aim to achieve 400-420bn m3 of natu-

ral gas annual consumption in 2020, the new shale gas target, though lowered, will still

represent 7.0%-7.5% of gas consumption by 2020, up significantly from only 0.18% in

2013. After revising the target, annual shale gas production should grow at 52% CAGR

between 2015E and 2017E, and 26% CAGR between 2017E to 2020E, which we think is

still aggressive.

Figure 1: National & Sinopec Fuling Shale Gas Production Target

Sources: Sinopec, “China’s 12th Five-Year Plan for Shale Gas”, CGIHK Research

1

3.2

7

1.5

6.5

15

30

0

5

10

15

20

25

30

35

2014E 2015E 2017E 2020E

Fuling Production Target (bn m3) National shale gas production target (bn m3)

China’s shale gas target remains

aggressive after recent target cut.

3

Fuling shale gas project introduction

Fuling shale gas project, owned by Sinopec, is the first national shale gas pilot project

granted by the Ministry of Land and Resources (MLR) in 2013. The Fuling shale gas dis-

covery was typical marine shale gas, characterized by its high quality, widespread distri-

bution, thickness, high abundance and moderate burial depth, making it ideally suited to

large-scale production. According to MLR, Chongqing has abundant shale gas proven

reserves of 12.75 trillion m3, including recoverable reserves of 2.05 trillion m3. Fuling

commenced commercial production in March 2013. The reserves are divided into five sub

-blocks: Da JiaoShiBa, DingShan, NanChuan, LinTanChang-RenHuai and NanTianHu

respectively as illustrated in Figure 2 below.

Figure 2: Map of Sinopec’s shale gas exploration area in southeast Sichuan

Source: Sinopec, CGIHK Research

4

Figure 3: Fuling Shale Gas Exploration Block details

Source: Sinopec, CGIHK Research

5

According to the first round shale gas block bidding document, the “Chongqing-Guizhou-

South Sichuan Shale Gas Block” won by Sinopec in 2011 has an area of 1,604.5 km2

(after cancelling 593.44 km2 in July 2014 as Sinopec did not invest enough in E&P there

as planned). Fuling block is around 200km2 which accounted for a small part of

“Chongqing-Guizhou-South Sichuan Shale Gas Block” won by Sinopec in 2011 through

bidding. Fuling block represents only 12.5% of current total area of the “Chongqing-

Guizhou-South Sichuan Shale Gas Block”, leaving about 87.5% of the area unexploited.

According to Fuling local government, the total investment in E&P and relevant facilities

construction in Fuling is expected to reach ~RMB50bn by 2017 (http://www.fl.gov.cn/Cn/

Common/news_view.asp?lmdm=008011&id=6086841). According to Chongqing govern-

ment’s statistics, around RMB7.1 bn already invested in 9M 2014. (http://www.cq.gov.cn/

zwgk/zfxx/2014/10/11/1337469.shtml).

For Sinopec, as disclosed by Chairman Fu Chengyu in March 2014, total E&P spending

in Fuling shale gas project will be RMB24bn for phase 1. Currently, the shale gas pro-

duced in Fuling was sold directly to the industrial users and commercial users in the vicin-

ity of Chongqing. According to the Fuling local government, the daily output of shale gas

in Fuling reached 300,000 m3 on average in 9M14.

SOSC is the major provider of mud, well cementing, directional drilling, logging, mud log-

ging, well completion and fracturing in the Fuling shale gas project. There were 200 engi-

neering teams as of end June 2014, according to media reports. The 200 teams consist

of 138 Sinopec teams, 13 Sinopec restructured enterprises teams, 6 CNPC teams, 2 oth-

er SOE teams, 35 private teams and 6 foreign teams.

SOSC will also provide engineering construction services such as gas gathering and

transmission facility design and construction, implying the engineering construction seg-

ment will also benefit with the further development of the Fuling shale gas project.

Total E&P and facilities construc-tion capex is expected to be

RMB50bn by 2017.

SOSC is the major services pro-

vider.

http://www.fl.gov.cn/Cn/Common/news_view.asp?lmdm=008011&id=6086841

http://www.fl.gov.cn/Cn/Common/news_view.asp?lmdm=008011&id=6086841

http://www.cq.gov.cn/zwgk/zfxx/2014/10/11/1337469.shtml

http://www.cq.gov.cn/zwgk/zfxx/2014/10/11/1337469.shtml

6

But the number of drilling well may slow after 2015E

Sinopec targets to build 5bn m3 annual production capacity in Fuling shale gas field by

2015 (phase 1) and further raises the capacity to 10bn m3 by 2017, representing 77%

and 67% of national targets set by the government.

According to Sinopec’s existing plan, a total of 417 wells are to be drilled between 2014E

and 2017E (figure 4). The number of drilling wells is expected to increase from 100 in

2014E to 135 in 2015E, but to drop from to 107/75 in 2016E/2017E. These wells include

253 development wells for phase 1. We estimate this implies an average daily output of

55,000 m3, which we believe is a reasonable projection. We therefore estimate another

250 wells to be drilled in order to build another 5bn m3 capacity, suggesting only stable

revenue for SOSC.

Figure 4: Planned number of drilling wells in Fuling region

Source: Company, CGIHK Research

1

17

100

135

107

75

0

20

40

60

80

100

120

140

160

2012 2013 2014E 2015E 2016E 2017E

No. of new wells for the year

7

Figure 5: Details of shale gas industry policies

Sources: Government, CGIHK Research

Policy Name Chinese Name Issuing Date Highlights

Circular of the general office of the state council on

Strategically Explore Mineral Resources (2011-2020)

国务院办公厅关于转发国土资源部等部

门找矿突破战略行动纲要

（2011—2020年）的通知

Jun 2012

China would focus on unconventional shale gas and coal-bed methane E&P and achieve

technological breakthroughs. Shale gas E&P would be mainly in Sichuan, Chongqing, Yunnan,

Guizhou, Hubei, Shanxi, Shanxi etc.

China’s 12th Five-Year (2011 to 2015) Plan for Shale Gas关于印发页岩气发展规划（2011-

2015年）的通知Mar 2012

In the 12th FYP, China aims to produce 6.5 bcm of shale gas annually by 2015 and 60-100

bcm by 2020. It sets to complete the country’s shale gas surveying and evaluation by 2015,

select 30-50 shale gas prospects and 50-80 favorable target areas, achieve major

breakthroughs in geological survey technology, and develop shale gas exploration technology

and equipment suited to China’s geological conditions.

Circular of the Ministry of Land and Resources on

Strengthening the Prospecting, Exploitation, Supervision

and Administration of the Shale Gas Resources

国土资源部关于加强页岩气资源勘查开

采和监督管理有关工作的通知Oct 2012

The circular stipulates that the prospecting and exploitation of shale gas shall be subject to the

principle of "opening market" to encourage various investors to participate in the prospecting

and exploitation of shale gas in accordance with law, but only the qualified enterprises that are

approved by the State Council may engage in the prospecting and exploitation of the oil and

natural gas. The Circular specifies that any independent legal person who has appropriate

capitals and qualification for prospecting the oil and natural gas or gas mines may apply for the

right of exploration of shale gas; any applicant who does not have such qualification may

cooperate with the prospecting units with the relevant qualification in engaging in the

prospecting and exploitation of shale gas. Thus, all types of investors may engage in the

Natural gas development 12th FYP国家发展改革委关于印发天然气发展“十

二五”规划的通知Oct 2012

The Natural Gas development 12th FYP promotes to jointly develop conventional and

unconventional gas due to their overlapped distribution areas, identical transmission and

utilization ways; to carry out national shale gas resource potential investigation and evaluation;

and to improve shale gas transmission infrastructure facilities.

Subsidy Policy on Shale Gas Development and Utilization关于出台页岩气开发利用补贴政策的通

知Nov 2012

The subsidy provided by the central government to shale gas mining enterprises is RMB

0.4/cubic meter during the period from 2012 to 2015, and the rate of subsidy will be adjusted

based on the development of the shale gas industry. Local government may also provide

subsidy to shale gas development based on actual local state of shale gas development and

utilization. Specific rates and administrative measures of such a subsidy shall be formulated by

local authorities based on actual local conditions.

Natural Gas Utilization Policy 2012 天然气利用政策 2012 Dec 2012

Encourage shale gas, coal bed methane to be utilized at resources vicinity (for civil use or

power generation) and to be transmitted externally in LNG, CNG format or via pipeline under

national quality standards for natural gas products.

Energy development 12th FYP国务院关于印发能源发展“十二五”规划

的通知Jan 2013

Develop unconventional gas resources, especially focusing on CBM and shale gas E&P based

on the resources prospects and current development.

May 2013

Jan 2009

Shale Gas Industry Policy 页岩气产业政策 Oct 2013

1) The Shale Gas Policy calls on government authorities to formulate and adopt new tax

incentives to encourage shale gas exploitation. It also reiterates certain existing financial

support measures including: subsidies for shale gas production enterprises; mineral resources

compensation fees; and exemption from customs tariffs for equipment imported for shale gas

exploration and development projects.

2) The National Development and Reform Commission and the NEA have approved several

shale gas Pilot Development Zones (PDZs), most of which are located within or around Sichuan

Basin. Under the Shale Gas Policy, the Chinese government has stated its commitment to

expedite the approval process for land use and has encouraged the construction of supporting

facilities within the PDZs. In addition, the Shale Gas Policy places particular emphasis on the

importance of PDZs in: joint collaboration of shale gas participants; technology integration;

production costs control and production safety.

3) The Shale Gas Policy encourages private investments in the construction of new gas

pipelines and infrastructure. Perhaps more important, the Shale Gas Policy also explicitly

states, for the first time, that the shale gas producers and distributors should have access to

the existing pipeline network and infrastructure on a “non-discriminatory” basis.

4) The Shale Gas Policy affirms that shale gas falls within China’s strategic emerging

industries. It also restates China’s policy that Sino-foreign joint ventures and non-state-owned

enterprises are encouraged to engage in shale gas exploration and development in China.

Foreign entities with advanced shale gas-related technologies are encouraged to partner with

Chinese enterprises.

Energy Development Strategic Action Plan (2014-2020)国务院办公厅关于印发能源发展战略行

动计划（2014-2020年）的通知Jun 2014 Shale gas production target of 2020 has been reduced to 30 billion cubic meters.

Circular of State Administration of Taxation on VAT for oil

and gas companies developing coal bed methane gas and

shale gas

国家税务总局-

关于油气田企业开发煤层气

页岩气增值税有关问题的公告

This circular specifies that CaiShui [2009] No.8 Clause No. 5, regulating VAT for oil and gas

producers to be 17%, applies to shale gas enterprises as well

8

SOSC to benefit from the kick-start of “Xinjiang-Guangdong-

Zhejiang” pipeline project; but more like “one-off” contribution

The “Xinjiang-Guangdong-Zhejiang” coal to gas pipeline construction is a key revenue

contributor to SOSC for 2015E. The pipeline, with annual transmission capacity of 30bn

m3, is specifically designed for the transmission of the coal-to-gas (produced by the

“Xinjiang Zhundong coal to gas project”) in Xinjiang to the consumption regions in the

southern and eastern China. The project is expected to start generating meaningful reve-

nue to SOSC in 2015E (SOSC mentioned that the growth of its construction engineering

revenue in 2015E will be largely driven by this project). While we expect a further reve-

nue contribution in 2016E, the visibility is very limited. Most importantly, given the “one-

off” nature of this large-scale project, we see earnings risk after completion of the project.

The Xinjiang-Guangdong-Zhejiang pipeline

The Xinjiang-Guangdong-Zhejiang pipeline project consists of one trunk and five branch-

es, with the trunk from Xinjiang Yining to Guangdong Shaoguan (Figure 6). The five

branches are Huaidong branch, South Xinjiang branch, Henan-Shandong branch, Jiangxi

-Zhejiang-Fujian branch and Guangxi branch. The pipeline will pass Xinjiang, Gansu,

Ningxia, Shanxi, Henan, Shandong, Hubei, Hunan, Jiangxi, Zhejiang, Fujian, Guangdong,

Guangxi, total 13 provinces and autonomous regions, with total length of 7,927km. Total

investment is budgeted at ~RMB140bn, including the construction of pipeline, gas reser-

voirs and LNG emergency gas source.

Sinopec will form a JV with Guanghui Energy Co.,Ltd., Suxin Energy, Zhejiang Provincial

Energy Group, Huaneng Group, Xinjiang Longyu Energy Co., Ltd and the Xinjiang Pro-

duction and Construction Corps, named “China Petrochemical Xinjiang coal to gas pipe-

line transmission Co., Ltd.” to be the owner of the pipeline project.

After obtaining NDRC approval for commencing preliminary work in July 2013, the site

location, surveying and environmental assessment were completed in February 2014.

Currently the project is awaiting public bidding and tendering.

Figure 6: Location of Xinjiang Guangdong Zhejiang pipeline

Source: Chinagasmap.com

9

Xinjiang Zhundong coal to gas project

Coal to gas is one of the forms of unconventional gas highlighted in the 12th FYP. Coal

gasification requires coal as raw materials, and therefore Xinjiang and Inner Mongolia

(where abundant coal is available) attracted the majority of coal to gas projects over the

past few years. Low cost of coal and the availability to develop coal gasification projects

provide room for Sinopec to launch new coal- related clean energy projects.

NEA announced in July 2014 its “Circular regarding constraining coal-to-oil (gas) industry

development” (国家能源局关于规范煤制油、煤制天然气产业科学有序发展的通知),the

objective of which is to recognize the need to develop the coal to gas industry, but it

must be strictly regulated to avoid overheating and regulation breaches. Principles of coal

to oil (gas) industry development should fully consider water resources load, promote

high energy conversion rate, encourage pilot projects ahead of stimulating industry devel-

opment, guarantee rational macro industrial blueprint and to stress innovation. While we

believe coal to gas project approvals may become stricter in the foreseeable future due to

excess investment and environmental concerns over the past few years, existing projects

should be less affected.

Jointly constructed by Sinopec, Guanghui Energy Co.,Ltd., Suxin Energy, Zhejiang Pro-

vincial Energy Group, Huaneng Group, Xinjiang Longyu Energy Co., Ltd and the Xinjiang

Production and Construction Corp (Figure 7), the “Xinjiang Zhundong Coal to Gas Pro-

ject” is one of the 15 deep coal processing pilot projects listed in the PRC’s 12th FYP for

deep coal processing industry.

The “Xinjiang Zhundong Coal to Gas Project” has been planned with a total investment of

RMB183bn and is expected to be completed by 2017. Of the RMB183bn spending, Si-

nopec alone will invest RMB70bn for the construction of two coal mines with annual coal

production capacity of 15m tonnes each and one coal gasification plant with annual ca-

pacity of 8bn m3.

Figure 7: Details of Xinjiang-Guangdong-Zhejiang pipeline gas source

Sources: Companies, CGIHK research

Sinopec accounts for a large por-tion (~38%) of total joint invest-

ment.

Gas Source Company Coal to Gas(bn m3) Tol. Investment(RMBbn) Current Stage Expected Commencement

WuCaiWan Huaneng Group 4 22.9 Preliminary Stage n.a

Xinjiang Production and Construction Corps 4 21.2 Registered n.a

Xinjiang Longyu Energy Co., Ltd 4 21.1 Preliminary Stage n.a

Kamisti Guanghui Energy Co.,Ltd. 4 24.8 Preliminary Stage 2017

XiHeiShan Zhejiang Provincial Energy Group 2 24.4 Preliminary Stage End 2017

HeFeng Suxin Energy 4 20 (Est.) Preliminary Stage End 2017

DaJing Sinopec 8 70 Preliminary Stage June of 2017

Total. 30 204.4

10

Figure 8: Details of coal to gas industry policies

Sources: Government, CGIHK Research

Policy Name Chinese Name Issuing Date Highlights

Circular of the National Development and Reform

Commission on Regulating Coal to Gas Industry

Development

国家发展改革委关于规范煤制天然

气产业发展有关事项的通知Jun 2010

The circular points out that the coal to gas industrial development strategy in China:

with consideration of the resource load, energy consumption, environmental capacity,

natural gas distribution pipeline network, regional market capacity and some other

complementary conditions, China should plan coal to gas source points distribution

reasonably; give priority to coal to gas project in coal production areas; encourage the

use of domestic proprietary technology and equipment; encourage energy saving and

water saving technologies; implement sustainable economy; protect environment;

jointly develop coal , electricity and gas; maximize energy utilization efficiency ;

comply coal to gas development with natural gas pipeline network plan; carry out

transmission channels and gas sales market construction; and promote high-efficiency

end use of natural gas.


Commission on Ensuring Energy Saving and Emission

Reduction Goals in 2013

国家发展改革委关于加大工作力度

确保实现2013年节能减排目标任务

的通知

Aug 2013The circular promotes widely use of clean renewable energy such as natural gas, coal

to gas etc.

Atmospheric Pollution Prevention Action Plan国务院关于印发大气污染防治行动

计划的通知Sep 2013

The action plan calls on restructuring energy consumption matrix of China by

increasing the weight of natural gas and decreasing the weight of coal. It sets out the

target that by 2017, coal consumption constitutes less than 65% of the total energy

consumption matrix. It promotes strengthening the development and application of

coal to gas, natural gas and CBM under the condition of strict environmental protection

requirements and guarantee of civil water supply.


Commission on the Surge in Natural Gas Demand

during 2013 Winter Period

国家发展改革委关于做好2013年

天然气迎峰度冬工作的意见Oct 2013

To fully utilize unconventional resources by facilitating coal to gas projects in Inner

Mongolia Datang and Xinjiang Qinghua into production as soon as possible. Also, the

circular emphasizes the Datang to Beijing coal to gas pipeline project should be

constructed in a timely manner.

Emergency Circular of the National Development and

Reform Commission on Implementing Gas Resources

and Gas Supply Contracts to Ensure "Coal to Gas"

国家发展改革委国家能源局关于切

实落实气源和供气合同确保“煤改

气”有序实施的紧急通知

Nov 2013The circular promotes the implementation of the "coal to gas," "oil to gas" and other

natural gas replacement projects.


Commission on Long-term Stable Natural Gas Supply

国务院办公厅转发发展改革委关于

建立保障天然气稳定供应长效机制

若干意见的通知

Apr 2014

The circular specifies to enhance nation's natural gas supply capacity to 400~420 billion

cubic meters by 2020 and to progressively carry forward coal to gas pilot projects

construction.

Circular of the National Energy Administration on coal

to oil (gas) industry development

国家能源局关于规范煤制油、煤制

天然气产业科学有序发展的通知Jul 2014

1) Objective of the circular is that coal to gas industry needs development but must be

under stringent regulation to avoid overheating and regulations breaking. Principles of

coal to oil (gas) industrial development should fully consider water resources load,

promote high energy converting rate, encourage pilot projects ahead of widely

pushing on industry development, guarantee rational macro industrial blueprint and

insist innovation.

2) Specifically, the circular bans coal to gas projects with annual capacity less than two

billion cubic meters. Those projects exceeding the requirement need to apply for

construction permission from relevant authorities. It also emphasizes that coal

resources for civil use and power generation has higher priority than those used for

coal to gas production. Due to the high water-consuming essence of coal to gas, NEA

explicitly prohibits occupying civil water or using underground water for coal to gas

production and development. Pilot coal to gas projects in the industry should be

planned cautiously.

11

Rising overseas exposure suggests higher risk after the crude

price declined

SOSC grew its international revenue proportion from 15.2% in 2011 to 24.7% in 1H14

(Figure 10). SOSC’s main international business operations were based in Saudi Arabia,

Kuwait, Ghana, Algeria, Brazil and Mexico over the past few years. SOSC targets to ex-

pand its overseas business over the longer term and SOSC will further expand in Central

Asia, south and southeast Asia. SOSC expects the revenue from overseas will maintain

at 25% in 2015E, a similar level to 1H14.

While we think the industry trend is for Chinese oilfield services companies like SOSC to

expand into overseas markets, we believe the recent sharp decline in oil price will in-

crease their overseas expansion risk, as entering the international market suggests high-

er risks to SOSC. It will be faced with fierce competition from overseas oilfield services

players, creating risks on contract pricing and job volumes. Besides, geopolitical risk will

be higher.

In the profit forecast provided by SOSC, aside from the contribution of the Xinjiang-

Guangdong-Zhejiang pipeline engineering construction, revenue growth in 2015E will be

driven by new overseas contracts on offshore rig operations and seismic geophysical

operations in Saudi Arabia and Kuwait. We believe the risk of these overseas contracts

will be higher than previously assumed, given the potential suspension of work.

Figure 10: Revenue breakdown by region (%)

Sources: Company, CGIHK Research estimates

84.8% 85.0%79.1% 75.8% 75.0%

15.2% 15.0%20.9% 24.2% 25.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2011 2012 2013 2014E 2015E

China Overseas

Figure 9: Revenue breakdown by region


0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

2011 2012 2013 2014E 2015E

RMB m

China Overseas

12

Improvement in operating efficiency will be more challenging

given a weakening topline

Before SOSC’s internal restructuring, its subsidiaries had their own engineering team,

equipment and development targets. In other words, there was little cooperation or com-

petition among the subsidiaries. After the restructuring in 2012, SOSC started streamlin-

ing its operation through internal transfers of resources and gradually improve operating

efficiency. For example, after restructuring some drill rigs and engineering teams were

transferred to Jianghan Oil Engineering Company from Shengli Oil Engineering and

Zhongyuan Oil Engineering respectively. This effectively improves SOSC’s utilization rate

and efficiency.

SOSC improved its EBIT margin from 1.6% in 2011 to 3.1% in 2013. SOSC expects its

EBIT margin to further improve to 6.1% in 2015E through continuous improvement in

operating efficiency. However, we believe the margin improvement will likely be affected

by potential weakness of its oilfield services segment performance, making its efficiency

improvement more difficult to execute.

Figure 11: Sinopec E&P capex

Sources: Company, CGIHK Research

62%

0%2%

3%

9%

37%

72%

6%

-11%

2%12%

33%

35%

-17%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

0

20,000

40,000

60,000

80,000

100,000

120,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E

Sinopec E&P capex (RMB m) Change (YoY)

13

Potential earnings miss in 2015E; Initiate with SELL

Company earnings target: SOSC forecasts total revenue in 2014E to drop 9% YoY to

RMB81.7bn due to the decrease in domestic oil companies’ investment, which affected

all business segments except down-hole operations. However, SOSC expects revenue to

rebound 6% YoY to RMB86.9bn, helped by a 15% YoY increase in revenue from engi-

neering construction, contributed by the Xinjiang-Guangdong-Zhejiang coal to gas pipe-

line engineering and a pipeline project in South Bolivia. Besides, SOSC expects the off-

shore drilling and geophysics prospecting business will grow steady in 2015E.

SOSC forecasts net profit to grow 59%/45% in 2014E/2015E, much faster than revenue

growth, driven by margin expansion from a low base as a result of efficiency improve-

ment.

Our estimates are more conservative than the company’s projection. We believe

SOSC’s earnings forecast for 2014E should be achievable. However, we see risks in

2015E given its overseas drilling and geophysics segments will potentially be hurt by the

recent crude oil price decline (Note: drilling and geophysics revenue are expected to ac-

count for 47% and 7% respectively of total revenue in 2015E according to SOSC’s esti-

mates). We note that the crude oil price was close to US$100/barrel (Brent) when SOSC

released the profit forecast, while the latest price is US$66/barrel (Figure 12). We believe

the company’s profit forecast was based on a much higher oil price assumption.

We estimate SOSC to deliver only 24% earnings growth in 2015E due to a weak drilling

segment. We expect growth to be largely driven by efficiency improvement. We expect

earnings to slow further to 5% in 2016E as benefits from cost reduction will be reduced.

Valuation: We are initiating coverage on Yizheng with a SELL rating and a target price of

HK$1.97, based on 6.7x 2015 PER which is a 10% discount to the 7.4x average for its

Hong Kong-listed peers. Our valuation discount is justified by the following factors:

(1) Potential corporate governance concerns. The investigation of XUE Wandong

(who resigned as General Manager of SOSC after the announcement of the investi-

gation) suggests there could be uncertainties regarding SOSC’s existing operation,

which is difficult to quantify at this stage.

(2) The engineering construction of the “Xinjiang-Guangdong-Zhejiang” pipeline

is “one-off” in nature. Our earnings estimates for 2015E include revenue from this

project. However, we see uncertainties regarding the sustainability of this type of

mega project contribution.

(3) More fund raising exercise. The total number of outstanding shares of Yizheng will

increase from 6bn to 12.8bn after the restructuring. Yizheng stated in the circular that

it plans to issue a further maximum of 2.3bn new A shares at a price of at least

RMB2.61 per share, representing a discount of 40% to the A share closing price of

RMB4.34 (as of Dec 8).

14

Figure 13: Key assumptions for SOSC


RMB m 2011 2012 2013 2014E 2015E 2016E

Revenue breakdown by business segment

Drilling engineering 37,618 41,744 41,457 39,591 39,987 39,187

Logging and mud logging 4,096 5,060 5,120 4,403 4,482 4,617

Special down-hole operations 6,644 8,256 9,423 9,706 9,997 10,297

Geophysical 6,101 7,412 6,642 5,580 5,747 5,460

Engineering construction 17,828 22,577 24,484 20,322 23,370 23,604

Others 1,966 2,289 2,603 2,103 2,175 2,218

Total 74,254 87,337 89,729 81,704 85,758 85,382

Gross profit

Drilling engineering 3,157 4,258 3,702 5,564 5,598 5,408

Logging and mud logging 685 823 929 903 944 969

Special down-hole operations 411 426 971 1,363 1,471 1,514

Geophysical 543 502 553 708 747 710

Engineering construction 1,522 1,845 1,872 944 1,705 1,723

Others 155 176 501 260 281 286

Total 6,474 8,030 8,528 9,742 10,746 10,610

Gross margin

Drilling engineering 8.4% 10.2% 8.9% 14.1% 14.0% 13.8%

Logging and mud logging 16.7% 16.3% 18.1% 20.5% 21.1% 21.0%

Special down-hole operations 6.2% 5.2% 10.3% 14.0% 14.7% 14.7%

Geophysical 8.9% 6.8% 8.3% 12.7% 13.0% 13.0%

Engineering construction 8.5% 8.2% 7.6% 4.6% 7.3% 7.3%

Others 7.9% 7.7% 19.3% 12.4% 12.9% 12.9%

Average 8.7% 9.2% 9.5% 11.9% 12.5% 12.4%

Figure 12: Crude oil price (as of Dec 08,2014)

Sources: Bloomberg, CGIHK Research

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WTI (US$/Barrel) Brent (US$/Barrel)

15

Figure 14: Earnings projection


(RMBm) 2011 2012 2013 2014E 2015E 2016E (RMBm) 2011 2012 2013 2014E 2015E 2016E

Income statement (Y/E Dec) Cash flow statement (Y/E Dec)

Revenue 74,254 87,337 89,729 81,704 85,758 85,382 Pretax profi t 1,599 1,528 2,230 3,364 4,334 4,172

Cost of sa les (67,780) (79,307) (81,201) (71,962) (75,012) (74,772) Depreciation 2,793 3,185 3,601 3,967 4,263 4,443

Gross profit 6,474 8,030 8,528 9,742 10,746 10,610 Amortization 3,483 3,518 3,191 3,214 3,215 3,216

Bus iness tax and surcharge (840) (1,003) (1,145) (1,043) (1,109) (1,093) Share of results of associates/JCE 0 0 0 0 0 0

Sel l ing and dis tribution expenses (84) (78) (95) (99) (103) (111) Interest expenses 640 885 823 832 728 874

Adminis trative expenses (4,362) (5,122) (4,493) (4,603) (4,689) (4,611) Change in working capita l (4,904) (5,541) (6,354) (2,995) (4,373) (1,924)

EBIT 1,187 1,827 2,794 3,997 4,845 4,795 Interest pa id (433) (849) (777) (832) (728) (874)

D&A 6,275 6,703 6,792 7,181 7,478 7,659 Income tax pa id (426) (463) (687) (942) (1,348) (1,043)

EBITDA 7,462 8,530 9,587 11,178 12,323 12,454 Others 235 1,042 803 0 0 0

Finance expenses (640) (885) (823) (832) (728) (874) Operating cash flow 2,985 3,306 2,831 6,608 6,091 8,864

Investment ga ins 3 11 3 1 0 0

Impairment of assets (44) (43) (136) (115) (83) 0 Purchase/(disposal ) of PP&E (2,539) (7,461) (7,136) (6,000) (5,000) (3,000)

Other income 1,148 679 455 338 300 250 Purchase of intangible assets (32) (19) (16) (11) (12) (12)

Other expenses (55) (61) (62) (25) 0 0 Acquis i tion of subs idiaries 0 0 0 (100) (100) (100)

Pretax profit 1,599 1,528 2,230 3,364 4,334 4,172 Investment in associates/JCE 0 0 0 0 0 0

Income tax (426) (463) (687) (942) (1,348) (1,043) Dividend received from associates/JCE 0 0 0 0 0 0

After tax profit 1,173 1,065 1,543 2,422 2,986 3,129 Others (48) 81 167 0 0 0

MI (18) (19) (28) (7) 0 0 Investing cash flow (2,618) (7,398) (6,984) (6,111) (5,112) (3,112)

Net profit 1,155 1,046 1,515 2,415 2,986 3,129

Reta ined profi t 2,415 2,986 3,129 Proceed from/(repayment of) borrowings (961) 3,479 (4,120) 1,200 1,000 400

Dividend 0 0 0 Proceed from equity 499 4,925 1,149 0 0 0

Core net profit 1,155 1,046 1,515 2,415 2,986 3,129 Proceed from CB 0 0 0 0 0 0

EPS (HK$) - - - 0.239 0.296 0.310 Dividend paid (700) (1,447) (1,414) 0 0 0

Core EPS (HK$) - - - 0.239 0.296 0.310 Others 0 0 6,547 0 0 0

Financing cash flow (1,163) 6,956 2,162 1,200 1,000 400

(RMBm) 2011 2012 2013 2014E 2015E 2016E

Balance sheet (as of end-Dec) Net change in cash (796) 2,864 (1,992) 1,697 1,979 6,152

Current assets

Cash and equiva lents 929 3,777 1,622 3,319 5,298 11,450 FY2011 FY2012 FY2013 FY2014E FY2015E FY2016E

Notes receivable 13 51 186 186 186 186 Valuation

Accounts receivables 12,683 14,425 25,541 12,513 27,429 12,338 PER (core net profit) (x) - - - 10.5x 8.5x 8.1x

Prepayments 536 558 748 748 748 748 Dividend yield - - - 0.0% 0.0% 0.0%

Other receivables 5,819 6,007 2,679 2,679 2,679 2,679 PBR (x) - - - 1.0x 0.9x 0.8x

Inventories 8,526 13,954 12,549 11,110 13,551 11,031 EV/EBITDA (x) - - - 3.4x 3.1x 3.1x

Current portion of non-current assets 1,335 1,447 1,318 1,318 1,318 1,318 Growth rate

Total current assets 29,842 40,218 44,641 31,872 51,208 39,749 Revenue n/a 17.6% 2.7% (8.9%) 5.0% (0.4%)

EBIT n/a 53.9% 53.0% 43.0% 21.2% (1.0%)

Non-current assets EBITDA n/a 14.3% 12.4% 16.6% 10.2% 1.1%

Property, plant and equipment 25,949 28,514 30,940 33,072 33,909 32,566 Recurring net profi t n/a (9.4%) 44.9% 59.4% 23.7% 4.8%

Intangible assets 101 105 107 104 101 98 Recurring EPS n/a n/a n/a n/a 23.7% 4.8%

Investment in associates/JV/JCE 0 0 0 0 0 0 Operating ratios

Long term deferred expenses 4,395 4,270 3,629 3,629 3,629 3,629 Gross margin 8.7% 9.2% 9.5% 11.9% 12.5% 12.4%

Others 1,688 1,845 2,608 2,608 2,608 2,608 EBIT margin 1.6% 2.1% 3.1% 4.9% 5.6% 5.6%

Total non-current assets 32,133 34,733 37,285 39,414 40,248 38,901 EBITDA margin 10.0% 9.8% 10.7% 13.7% 14.4% 14.6%

Recurring net margin 1.6% 1.2% 1.7% 3.0% 3.5% 3.7%

Total assets 61,975 74,951 81,926 71,286 91,456 78,650 Asset Turnover n/a 1.28 1.14 1.07 1.05 1.00

Adjusted ROE n/a 5.6% 6.7% 9.7% 10.9% 10.2%

Current liabilities Adjusted ROA n/a 1.5% 1.9% 3.2% 3.7% 3.7%

Short-term borrowings 1,380 18,157 14,415 15,715 16,815 17,215 Interest coverage 11.7x 9.6x 11.6x 13.4x 16.9x 14.3x

Notes payable 0 0 742 742 742 742 Net debt / equity 3% 69% 57% 50% 42% 20%

Accounts payable 17,013 21,379 29,804 15,542 31,726 15,391 Current Ratio 0.6 0.8 0.8 0.7 0.8 0.9

Tax payable 1,877 1,609 2,371 2,371 2,371 2,371 Quick Ratio 0.5 0.5 0.6 0.5 0.6 0.6

Other payables 20,998 4,213 2,627 2,627 2,627 2,627 Days inventories n/a 52 60 60 60 60

Current portion of long-term l iabi l i ties 0 0 200 200 200 200 Days receivables n/a 57 81 85 85 85

Others 4,673 7,061 7,464 7,464 7,464 7,464 Days payables n/a 88 115 115 115 115

Total current l iabi l i ties 45,942 52,419 57,623 44,661 61,944 46,010

Non current liabilities

Long-term borrowings 50 650 580 480 380 380

Others 52 57 54 54 54 54

Total non-current l iabi l i ties 102 707 634 534 434 434

Total liabilities 46,044 53,126 58,256 45,194 62,378 46,443

Equity

Equity attributable to owners of the parent 15,857 21,747 23,585 26,000 28,986 32,115

MI 74 78 85 92 92 92

Total Equity 15,931 21,825 23,670 26,092 29,078 32,207

Total liabilities and equity 61,975 74,951 81,926 71,286 91,456 78,650

BVPS (RMB) - - - 2.03 2.26 2.51

16

Figure 15: Peer comparison table

Sources: Bloomberg, CGIHK Research estimates for stocks under our coverage

Ticker Company Rating Price Market cap PB (x) EV/EBITDA (x)

(local currency) (US$ m) 2013A 2014E 2015E 2013A 2014E 2015E 2013A 2014E 2015E

Chinese (HK listed)

2178 HK Equity Petro-king HOLD 1.32 184 6.6 9.1 7.8 0.6 0.6 0.6 3.9 3.8 3.1

3337 HK Equity Anton Oilfield SELL 1.60 456 7.5 12.4 10.1 1.2 1.2 1.1 5.8 6.3 5.6

1251 HK Equity SPT Energy - 1.51 299 6.5 5.8 4.6 1.1 0.9 0.8 3.5 3.2 2.5

2883 HK Equity China Oilfield Services-H BUY 13.74 12,392 7.3 7.0 7.3 1.3 1.1 1.0 6.4 5.3 5.4

196 HK Equity Honghua Group - 1.03 431 5.2 6.2 5.3 0.5 0.5 0.5 6.3 6.4 5.6

1623 HK Equity Hilong Holding SELL 1.97 431 6.2 8.3 7.9 1.0 0.9 0.8 6.3 5.6 5.3

1033 HK Equity Sinopec Yizheng - H SELL 2.51 3,422 - 10.5 8.5 - 1.0 0.9 - 3.4 3.1

Average 6.5 8.5 7.4 1.0 0.9 0.8 5.4 4.9 4.4

Chinese (SZ listed)

002353 CH Equity Yantai Jereh 33.18 5,175 23.8 21.6 15.4 4.1 3.7 3.2 24.8 16.6 12.0

002554 CH Equity China Oil HBP Science & Technology 11.71 867 46.1 35.1 25.8 4.0 3.7 3.3 56.6 17.4 13.0

000852 CH Equity Kingdream 20.67 1,345 109.8 53.0 42.2 7.2 n/a n/a 36.7 n/a n/a

300309 CH Equity Gi Technologies 20.03 707 58.9 43.8 31.2 3.5 3.3 3.0 40.8 25.5 17.8

300157 CH Equity Landocean Energy Services 12.24 1,189 48.2 28.5 19.1 3.3 2.9 2.6 35.9 20.5 14.0

Average 57.4 36.4 26.7 4.4 3.4 3.0 39.0 20.0 14.2

International

HAL US Equity Halliburton 40.37 34,212 10.7 10.0 9.2 2.2 2.1 1.5 5.7 5.5 5.0

SLB US Equity Schlumberger 87.16 112,157 16.0 15.6 14.7 2.8 2.8 2.5 9.0 8.6 8.1

BHI US Equity Baker Hughes 57.02 24,667 16.8 14.4 12.7 1.4 1.3 1.2 6.8 6.0 5.5

WFT US Equity Weatherford 12.82 9,921 19.7 12.2 9.7 1.3 1.2 1.1 7.8 6.0 5.5

NOV US Equity National Oilwell Varco 66.89 28,801 11.1 11.1 10.9 1.3 1.3 1.2 6.2 6.1 6.0

TS US Equity Tenaris 31.66 18,688 12.0 12.1 12.2 1.4 1.4 1.3 6.1 6.3 6.1

VK FP Equity Vallourec 25.56 4,052 12.8 14.8 13.3 0.7 0.7 0.6 5.7 6.5 6.3

Average 14.2 12.9 11.8 1.6 1.5 1.4 6.8 6.4 6.1

International (Drilling services focus)

NBR US Equity Nabors Industries 12.21 3,534 8.7 10.3 7.2 0.6 0.6 0.5 4.2 4.1 3.7

HP US Equity Helmerich & Payne 67.44 7,301 11.1 10.5 10.4 1.5 1.4 1.3 4.5 4.1 4.0

PDS US Equity Precision Drilling 5.98 1,751 9.1 9.0 8.7 0.8 0.8 0.6 4.2 4.1 3.7

ESI CN Equity Ensign Energy 10.31 1,391 12.3 11.0 12.4 0.8 0.8 0.7 4.4 4.3 4.4

EDCL LI Equity Eurasia Drilling 15.25 2,239 5.4 5.6 5.6 1.2 1.1 0.9 3.1 3.3 3.3

SPM IM Equity Saipem SPA 9.53 5,183 7.9 15.1 8.6 0.9 0.8 0.8 5.8 6.9 5.7

RIG US Equity Transocean 18.72 6,781 3.9 3.9 7.3 0.5 0.5 0.4 4.0 4.0 5.1

SDRL US Equity Seadrill 12.32 6,075 n/a 4.5 4.3 0.6 0.6 0.5 6.9 6.7 6.5

Average 8.3 8.7 8.1 0.8 0.8 0.7 4.6 4.7 4.5

PE (x)

Figure 16: AH discount (As of Dec 08,2014)

Sources: Bloomberg, CGIHK Research

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Sinopec Yizheng AH discount (Negative numbers represent H shares discount to A shares)

17

Company Background

Sinopec Oilfield Service Cooperation (SOSC) is an oil and gas engineering and tech-

nical services provider in China. It deploys engineering equipment and technologies to

deliver a wide range of services, including geophysics, drilling and completion, logging

and mud logging, special down-hole operations and engineering construction, and is

able to provide oil and gas fields with comprehensive engineering and technical ser-

vices throughout their life spans. SOSC has operated in China for more than 50 years,

and has provided oil and gas engineering services in 76 basins with business in over

20 provinces in China. Benefiting from its extensive experience, leading technologies,

advanced equipment and highly specialized engineering team in the oil and gas engi-

neering and technical service industry, SOSC is capable of undertaking engineering

projects across a variety of complicated onshore and offshore topographical and geo-

logical conditions.

SOSC owns eight regional subsidiaries in different provinces across China, each of

which provides integrated oil and gas engineering and technical services. It also has

four specialized subsidiaries engaged in geophysics, engineering construction, off-

shore oil engineering and international business, respectively.

Figure 17: SOSC business details Sources: Company, CGIHK Research

Exploration Drilling Completion Production Gathering and Transportation Abandonment

GeophysicsAcquisition, processing and

interpretation services

Micro-seismic

monitoring

Reservoir geophysical

prospecting services

Drilling EngineeringDrilling planning, pre-drilling

engineering

Drilling

engineeringPost-drilling treatments Abandonment operation

Perforating

Mud logging

Oil (gas) testing Mature w ell sidetracking

Engineering

Construction

Logging and Mud Logging

Special Downhole

Operation

Engineering planning, procurement and construction

Abandonment operation

Workover, fracturing & acidizing

Mud logging

Logging

18

Deal structure

Yizheng announced its long-awaited restructuring plan in mid-September this

year. Yizheng will sell its existing chemical products business to Sinopec

[0386.HK; Not rated] and purchase Sinopec’s parent Sinopec Group’s oilfield

services arm. The restructuring plan consists of two major parts as follows:

Disposal agreement and repurchase agreement. Yizheng will sell its existing

chemical products business to Sinopec at a consideration of RMB6,491m. At the

same time, Yizheng will repurchase its 2,415m A-shares held by Sinopec (40.25%

of Yizheng’s total current o/s shares) at a cost of RMB6,303m and will de-register

the repurchased shares. The repurchase price of RMB2.61 (HK$3.24) represents

an 83% premium over the H-share closing price of Yizheng [HK$1.77 at that time].

The difference of RMB188m (RMB6,491 minus RMB6,303m) will be paid by Si-

nopec in cash. Yizheng expects it will report a net gain of RMB1,145m on the dis-

posal.

Acquisition agreement. Yizheng will acquire Sinopec Oilfield Services Corpora-

tion (SOSC) from Sinopec Group at a consideration of RMB24,075m. The pay-

ment will be settled by issuing 9,224m new shares at a price of RMB2.61

(HK$3.24).

In our view, the transactions are value accretive to Yizheng. First, the previous

chemical products business has been loss making since 2012, while the disposal

price represents 1.2x PBR (book value as of end-June 2014) which is positive to

Yizheng. Second, Yizheng will need to issue 6,809m new shares (9,224m minus

2,415m) to finance the deal (representing 53% of the enlarged outstanding capi-

tal), but at a price of HK$3.24 which represents a substantial premium of 83%

over the closing price at that time. Third, the acquisition cost for SOSC implies

9.9x/6.9x SOSC’s estimated earnings for 2014E/2015E, which is not demanding in

our view.

Figure 18: Shareholder structure before reorganization Sources: Company, CGIHK Research

Figure 19: Shareholder structure after reorganization


73.39% 100%

40.25%*

100%

* A Shares

Sinopec Group

Sinopec Corp. SOSC

Sinopec Yizheng

Chemical fiber business

72.01%* 73.39%

100% 100%

Sinopec Group

Sinopec Yizheng Sinopec Corp.

SOSC

* A Shares and not taking into account of the Proposed Subsequent A Share Placement

Chemical fiber business

19

Major Customers

Sinopec has been SOSC’s biggest client, accounting for 65.9%, 68.4%, 66.5% and

58.7% of total revenue for 2011/2012/2013/1H2014 respectively. SOSC also provides

oilfield services to CNPC, CNOOC and Shaanxi Yanchang Oil Corporation in China.

In the overseas market, SOSC provides services to the national oil companies of Saudi

Arabia, Kuwait, Ghana, Algeria, Brazil, Ecuador and Mexico, as well as international oil

companies and local governments, and also the overseas businesses of Chinese oil com-

panies.

Figure 20: Breakdown of SOSC revenue by customer (%)


Figure 21: Breakdown of SOSC revenue by customer


1,972 1,984 2,0381,116

4,7687,128 6,088

2,683

18,576 18,52221,938

10,327

48,938

59,703 59,664

20,059

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

2011 2012 2013 1H14

Arabian American Oil Co. CNPC Others Sinopec

2.7% 2.3% 2.3% 3.3%6.4% 8.2% 6.8% 7.8%

25.0%21.2%

24.4%30.2%

65.9%68.4% 66.5%

58.7%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

2011 2012 2013 1H14

Arabian American Oil Co. CNPC Others Sinopec

20

SOSC purchases equipment, raw materials and assembling tools used in its services

from a group of suppliers.

Sinopec is the biggest supplier (figure 22). For 1H14, except for the two biggest suppliers,

the remaining suppliers each accounted for less than 1% of the total purchases.

Major Suppliers

Others (<1% each), 53.3%

Sinopec, 44.6%

Al-Kifah Trading Company, 2.1%

Figure 22: Breakdown of purchase from major suppliers of 1H14


Figure 23: Breakdown of purchase from major suppliers


14,181

20,154 18,135

5,560

29,544

39,830 42,570

12,466

48.0%

50.6%

42.6%

44.6%

38%

40%

42%

44%

46%

48%

50%

52%

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

2011 2012 2013 1H14

Purchase from Sinopec (RMBm)

Total Purchase (RMBm)

% of Sinopec

21

Figure 24: SOSC revenue breakdown by segment


Figure 25: SOSC revenue breakdown by region


2.6% 2.6% 2.9% 2.5%

5.5% 5.8% 5.7% 4.5%8.2% 8.5% 7.4% 8.0%

8.9% 9.5%10.5%

9.3%

24.0%25.9% 27.3%

23.6%

50.7%47.8%

46.2%

52.1%

0%

10%

20%

30%

40%

50%

60%

2011 2012 2013 1H14

Others Logging and mud logging

Geophysics Revenue (RMBm) Special down-hole operations

Engineering construction Drilling engineering

2.8%3.9% 3.8%

6.7%4.2%

3.2% 5.5%5.7%

5.5%3.6% 4.3%

7.1%

84.8% 85.0%

79.1%75.3%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

2011 2012 2013 1H14

America Africa Middle East China

22

Figure 26: SOSC gross profit breakdown


2.4% 2.2%5.9%

0.8%

10.6%10.2% 10.9%

8.7%8.4%6.2% 6.5%

8.6%6.3%

5.3%11.4%

9.9%

23.5% 23.0% 22.0%

12.8%

48.8%

53.0%

43.4%

59.2%

0%

10%

20%

30%

40%

50%

60%

70%

2011 2012 2013 1H14

Others Logging and mud logging

Geophysics Revenue (RMBm) Special down-hole operations

Engineering construction Drilling engineering

23

Geophysics

Figure 27: Geophysics segment equipment owned by SOSC


Geophysics is the process of utilizing geologic and physical principles to detect and

analyze the underground characteristics in probable areas, aiming at identifying proba-

ble oil and gas reservoirs. This is the initial step of oil and gas exploration. Geophysics

can effectively reduce exploration risks and improve recovery efficiency, and play an

important technical support role in exploration breakthroughs and discovery as well as

the increase in oil and gas reserves and production stabilization.

SOSC provides onshore and offshore geophysical prospecting and development tech-

nical services. Its business mainly includes research on geophysical prospecting theo-

ry and methodology, technology design, data acquisition, processing and comprehen-

sive interpretation, basin evaluation and exploration deployment, software R&D and

sales, engineering seismology, surveying and mapping, and R&D/ manufacturing of

seismic exploration equipment.

SOSC has 78 acquisition teams, including 68 onshore seismic teams, three offshore

seismic teams, three VSP teams, one cross-hole seismic team and three comprehen-

sive geophysical and geochemical teams.

In 1H14, SOSC’s equipment in geophysical segment is listed in figure 27 below. Also,

SOSC has 3 12-streamer seismic vessels which are able to collect 22,000 km 2D and

6,000 km2 3D offshore data, and process 100,000km 2D and 30,000km2 3D offshore

data respectively. As of June 2014, SOSC has completed a total of 495 international

and domestic geophysical projects and it was in 1992 when SOSC entered into the

international market for the first time.

Equipment Nos. Units

Seismic data colleting tools 428 XL and 408 UL 105 sets

Vibroseis NOMAD65 134 sets

Seismic receiving channels 450,000 channels

Full digital seismic 3C geophones 25,500 sets

Single-component digital geophones 10,000 sets

24

Figure 28: Geophysics segment revenue, gross profit and margin


Exploration methods applied by SOSC include seismic exploration, gravity exploration,

magnetic exploration and electronic exploration, of which seismic exploration is the most

precise and most frequently used. It consists of three stages: data acquisition, processing

and interpretation.

Seismic data acquisition: Seismic waves are manually generated, and the propaga-

tion process of seismic waves is recorded by professional equipment.

Seismic data processing: Cluster computers and professional software are used to

image the acquired data so as to obtain accurate underground structure form.

Seismic data interpretation: Computers and professional software are used to ana-

lyze imaging results and determine favorable oil and gas accumulation parts.

543 502 553 338

6,101

7,412

6,642

2,728

8.9%

6.8%

8.3%

12.4%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2011 2012 2013 1H14

Geophysical gross profit (RMBm)

Geophysics revenue (RMBm)

Gross profit margin (RHS)

25

Drilling

SOSC is one of China’s domestic integrated drilling contractors. It has drilling capacity of

1.65m meters/year and could drill up to 9,000m depth. SOSC can provide a wide range of

services in drilling segment covering three major categories, namely engineering contract-

ing, technical services and product manufacturing.

Figure 30: Drilling segment operation details


• Drilling contracting

• Pre-drilling engineering

• Post-drilling management

• Directional w ell services

• Drilling and completion f luid services

• Cementing services

• Underbalanced drilling services

• Well control services

• Pipe services

• Coring services

• Casing running services

• TDS services

• Drilling design and professional training

• Drilling instruments

• Dow nhole measurements

• Mud logging units

• Drill bits

• Drilling and completion tools and control instruments

• Bits and solid control equipment

Engineering contracting

Technical services

Product manufacturing

Drilling

Figure 29: Drilling segment business operation details


2011 2012 2013 1H14

Nos. of drilled w ells 4,911 5,004 5,340 2,228

Drilling footages (km) 12,227 13,212 13,398 5,652

Average w ell depth (m) 2,535 2,644 2,666 2,517

Where offshore

Nos. of drilled wells 109 100 85 23

Drilling footages (km) 243 232 205 58

Average well depth (m) 2,177 2,297 2,312 2,932

26

Figure 31: Drilling segment revenue, gross profit and margin


Featured technologies of SOSC are summarized below:

Deep and ultra-deep well drilling and completion technologies:

SOSC could handle complex underground conditions of high sulfur content, high tem-

perature and high pressure etc. It could drill wells up to 9,000m deep.

Horizontal well drilling and completion technologies

Underbalanced/managed pressure drilling technologies: Though not as common

as overbalanced drilling, underbalanced drilling is achieved when the pressure exerted

on the well is less than or equal to that of the reservoir. Performed with a light-weight

drilling mud that applies less pressure than formation pressure, underbalanced drilling

prevents formation damage that can occur during conventional or overbalanced drilling

processes. The negative differential pressure obtained during underbalanced drilling

between the reservoir and the wellbore encourages production of formation fluids and

gases. In contrast to conventional drilling, flow from the reservoir is driven into the well-

bore during underbalanced drilling, rather than away from it.

Drilling fluid technologies for complex formations: SOSC has water-base drilling

fluids and full set of oil-base drilling fluids which enable SOSC to deal with complex

underground geotechnical conditions such as high temperature, high pressure, high

water sensitivity and collapse-prone formation.

Cementing technologies for complex formations: SOSC has the largest domestic

well cementing equipment R&D base and has R&D capability for the whole well ce-

menting equipment industrial chain. Also, SOSC has a leading position in the domestic

liner hanger market.

Offshore drilling and completion technologies: Rigs’ working depth ranges from 2m

to 610m with drilling capability ranges from 6000m to 9000m.

SOSC formed a JV in 2014 with Weatherford. The JV focuses on the high-end market with

the long-term goal of becoming an integrated oilfield services provider. Through introduction

of high-end equipment and technologies from Weatherford, the JV has projects in South-

west, Northwest and offshore China.

3,157 4,258 3,702 2,337

37,618 41,744 41,457

17,814

8.4%

10.2%8.9%

13.1%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

2011 2012 2013 1H14

Drilling gross profit(RMBm)

Drilling revenue (RMBm)


27

Logging

Logging has been divided into well logging and mud logging.

Well logging, also known as borehole logging, is the practice of making a detailed record (a

well log) of the geologic formations penetrated by a borehole after the well been drilled.

Mud logging is the creation of a detailed record (well log) of a borehole by examining the

cuttings of rock brought to the surface by the circulating drilling medium (most commonly

mud). SOSC has advantages on complex reservoirs logging technology and R&D on log-

ging productions. Up to the three consecutive years ended in 2013, SOSC has completed

mud logging for 17,029 wells which mainly included comprehensive logging, geologic log-

ging and gas logging; It also completed 111,000 loggings which mainly are open-hole log-

ging, production logging and perforation.

Figure 32: Logging segment business details


•Open hole logging

•Production logging

•Perforation

•Wireline formation test

•Logging data processing, interpretation & application

• Well position surveying and mapping

• Drilling geology design

• Mud logging data acquisition

• Mud logging information transmission

• Mud logging data processing, interpretation

• Mud logging equipment R&D and manufacturing

Logging

Logging

Mud logging

Figure 33: Logging segment revenue & gross profit


685 823 929

342

4,096

5,060 5,120

1,546

16.7% 16.3%18.1%

22.1%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

0

1,000

2,000

3,000

4,000

5,000

6,000

2011 2012 2013 1H14

Logging gross profit (RMBm)

Logging revenue (RMBm)


28

Logging is applied over the whole life span of oilfields. Logging services of SOSC have in-

cluded the following:

Open-hole logging: Logging the open hole that has not started oil and gas production

before the running casing. SOSC has an annual service capacity for open hole logging

of 20,000 well-times;

Production logging: Production logging is the measurement of fluid parameters and

flow contributions on a zone-by-zone basis to yield information about the type and

movement of fluids within and near the wellbore. SOSC has production logging capacity

of over 5,000 well-times;

Perforation: A perforation in the context of oil wells refers to a hole punched in the

casing or liner of an oil well to connect it to the reservoir. SOSC has perforation capacity

of 13,000 well-times;

Wireline formation test: Wireline formation test uses wireline tools along the well to

measure the underground fluid and pressure characteristics; and

Processing, interpretation and application of the logging data: Besides processing

and explaining the logging data, SOSC could further put the logging information into

practical use according to certain specific needs of clients. It has a capacity of 20,000

well-times for logging data processing, interpretation & application.

SOSC’s mud logging segment has included the following detailed services items:

Well position surveying and mapping: It refers to precisely locate the well on spot

based on design coordinate. SOSC has well location survey capacity of over 2,000

wells / year;

Drilling geology design: It refers to geotechnical predictions on fluids, pressure etc. for

candidate wells. SOSC has geotechnical design capacity of 2,000 wells / year;

Mud logging data acquisition: It consists of mainly comprehensive logging, geologic

logging, gas logging. SOSC has mud logging data collecting capability of over 6,000

wells / year;

Mud logging information transmission: This refers to transmission of on-site infor-

mation to support base, which in return would provide solid technical support for on-site

operations. SOSC has mud logging data transition capacity of over 2,000 wells /year;

Mud logging data processing and interpretation: SOSC has capacity of 6,000 wells /

year for mud logging processing, interpretation and application; and

Mud logging equipment R&D and manufacturing: SOSC has an annual production

capacity for the R&D and manufacture of 100 comprehensive logging units and devel-

opment well logging units.

29

Special Downhole Operation

Special downhole operations are an integral part of the oil and gas well bore engineering

business. SOSC’s special downhole operation segment has covered a wide range of ser-

vices such as conventional and unconventional oil and gas and offshore oil and gas reser-

voir stimulation, production testing, completion, oil, gas and water well work-over and side-

tracking. As of 2013 end, SOSC has a total of 354 special downhole operation teams.

SOSC has formed a JV named “Huamei Futai” with FTS International Services LLC (FTS),

a leading provider of well completion services, including pressure pumping, wireline and

pressure control, and water management. SOSC owns 55% and FTS owns 45% of the JV.

The JV mainly focuses business on Sichuan and Chongqing where unconventional reser-

voirs are common.

Figure 34: Special downhole operation segment revenue, gross profit and


411 426 971

392

6,644

8,256

9,423

3,175 6.2%5.2%

10.3%

12.3%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

2011 2012 2013 1H14

Special downhole gross profit (RMBm)

Special downhole revenue (RMBm)


30

Engineering Construction

SOSC has over 50 years’ experience in engineering construction, providing onshore and

offshore construction services.

Engineering Design and Consultancy Services: SOSC’s consulting services include

feasibility studies, preliminary designs and detailed designs for engineering projects.

SOSC has five design firms, with more than 3,000 professional design and consulting

staff with professional qualifications across 20 disciplines, including process, piping,

equipment, storage and transportation, sewage, automation, electrical, structural, ar-

chitectural, general plan, environmental protection, fire and information technology.

SOSC has developed six core technologies for crude oil treatment and storage, gas

gathering and treatment, waste water treatment and re-injection, marine engineering,

long-distance pipeline projects and energy saving and green corrosion resistance with

18 patents.

EPC contracting: SOSC is capable of offering engineering, procurement and con-

struction (EPC) contracting services and other types of general contracting services.

Construction Business: SOSC has eight specialized construction subsidiaries and

has registered national qualifications in fields of oil & chemical, offshore oil engineer-

ing, building, highways, hydraulics, municipals etc. As of June 30, 2014 SOSC has

technical posts and management posts totaling 5,670, and operational posts totaling

6,460.

Figure 35: Engineering construction segment revenue, gross profit and margin


1,522 1,845 1,872 504

17,828

22,577

24,484

8,054

8.5%8.2%

7.6%

6.3%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

0

5,000

10,000

15,000

20,000

25,000

30,000

2011 2012 2013 1H14

Engineering construction gross profit (RMBm)

Engineering construction revenue (RMBm)


31

Selected Management Profile

JIAO Fangzheng, 51, candidate for Chairman. JIAO is a professor-level senior engineer with a Ph.D. degree. In Jan-

uary 1999 JIAO was appointed Chief Geologist of Zhongyuan Petroleum Exploration Administration of China Petro-

chemical Corporation; in February 2000, JIAO was appointed Vice President and Chief Geologist of Sinopec Zhong-

yuan Oilfield Company; in July 2000, JIAO was appointed Deputy Director General of Sinopec Petroleum Exploration

& Development Research Institute; in March 2001, JIAO was appointed Deputy Director General of Sinopec Explora-

tion & Production Department; in June 2004, JIAO was appointed Director of Northwest Petroleum Administration of

China Petrochemical Corporation and as President of Sinopec Northwest Oilfield Company; in October 2006, JIAO

was appointed Vice President of Sinopec Corp; in July 2010, JIAO was appointed Director General of Sinopec Explo-

ration & Production Department; and in July 2014, JIAO was appointed Deputy General Manager of China Petro-

chemical Corporation. JIAO was appointed Director of SOSC in August 2012.

YUAN Zhengwen, 58, candidate for Vice Chairman. YUAN is a professor-level senior engineer with a Ph.D. degree.

In January 1999, YUAN was appointed Deputy Director of Yunnan-Guizhou-Guangxi Petroleum Prospecting Admin-

istration of China Petrochemical Corporation; in February 2000, YUAN was appointed Director of Yunnan-Guizhou-

Guangxi Petroleum Exploration Administration of China Petrochemical Corporation and Manager of Sinopec Yunnan-

Guizhou-Guangxi Oilfield Company; in November 2001, YUAN was appointed Director of Henan Petroleum Prospect-

ing Administration of China Petrochemical Corporation and representative of Sinopec Henan Oilfield Company; in

November 2005, YUAN was appointed director of Oilfield Operations Department of China Petrochemical Corpora-

tion; in March 2010, YUAN was appointed director of Petroleum Engineering Management Department of China Pet-

rochemical Corporation. Since June 2012, YUAN has served as Vice Chairman of SOSC.

ZHOU Shiliang, 56, candidate for Director and Deputy General Manager. ZHOU is a professor-level senior engineer

with an M.A. degree. In February 2000, ZHOU was appointed Deputy Director of Yunnan-Guizhou-Guangxi Petrole-

um Exploration Administration of China Petrochemical Corporation; in September 2000, ZHOU was appointed Man-

ager of Sinopec Yunnan-Guizhou-Guangxi Oilfield Company; in April 2002, ZHOU was appointed Party Secretary

and Deputy Manager of Sinopec South Prospecting and Exploiting Company; in April 2006, ZHOU was appointed

Party Secretary and Deputy Director of Henan Petroleum Exploration Administration of China Petrochemical Corpora-

tion; in November 2007, ZHOU was appointed HR Department Head of China Petrochemical Corporation; and in May

2009, ZHOU was elected Employee Representative Supervisor of Sinopec Corp. Since June 2012, ZHOU has acted

as Chairman of the Supervisory Board, Secretary of CPC Committee and Discipline Inspection Committee, and

Chairman of the Labor Union of SOSC.

LI Lianwu, 57, candidate for Director. LI is a professor-level senior engineer with an M.A. degree. In January 2000, LI

was appointed Deputy Director of Henan Petroleum Exploration Administration of China Petrochemical Corporation;

in April 2006, LI was appointed Director of Henan Petroleum Exploration Administration of China Petrochemical Cor-

poration; in August 2000, LI was appointed Manager of Sinopec Henan Oilfield Company; and in December 2008, LI

was appointed General Manger of Sinopec Henan Oilfield Company. Since September 2014, LI served as Party Sec-

retary of Sinopec Oil and Gas Exploration and Development Company and Deputy Director of Oil Field Exploration

and Development Department of Sinopec Corp.

32

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BUY share price will increase by >20% within 12 months in absolute terms :

SELL share price will decrease by >20% within 12 months in absolute terms :

HOLD no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL :

Sinopec Yizheng H [1033.HK] SELL...Share Price Performance Market Cap US$3,422m Shares Outstanding...

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