ERHC Energy Inc (ERHE)

[jbofthecloth]

Toronto Globe and Mail. Good analysis of the potential valuation and price paid for oil in situ. It sure would be nice if a credible journalist mentioned ERHC just once.

http://www.theglobeandmail.com/report-on-business/commentary/chinas-petroleum-bargain/article1200302/

Eric Reguly
Last updated on Monday, Jun. 29, 2009 07:13AM EDT

Look at the price paid by Sinopec for Addax Petroleum and you would conclude the Chinese are stark, raving mad. Or are they?

Addax was no bargain by any conventional investment measure (which partly explains the takeover competition's distinct lack of U.S. and European bidders). Sinopec, formally China Petroleum and Chemical Corp., last week agreed to pay $8.3-billion - $52.80 a share - for the Toronto-listed company. That was a 47-per-cent premium to the share price the day before Addax announced it was in play. The fat premium made Addax CEO and controlling shareholder Jean Claude Gandur the happiest man in the industry. His haul was about $3-billion.

Certain bragging rights come with such a high-profile purchase. The headline price makes Addax the largest oil-and-gas investment made by a Chinese company.

Shame about the value. Add in Addax's debt and Sinopec is paying somewhere between $16 (U.S.) and $20 a barrel for Addax's proven and probable reserves of 537 million barrels, measured at the end of 2008. Compared with the current oil price of about $70, that doesn't seem outrageous. But consider that the average price paid for African and Middle Eastern oil deals - Addax's output comes from West Africa and Kurdistan - was less than $5 a barrel in 2008.

And that was a year when the average price was close to $100.

Sinopec would argue that Addax has a good record of shifting potential reserves into the so-called P2 category - proven and probable. If that were to happen, the price per barrel in the ground would drop dramatically.

But oil investors would be fools to pay for "good guess" reserves, all the more so because a fair chunk of Addax's holdings are in Iraqi Kurdistan; Baghdad has yet to bless Kurdistan with the right to independent resources management.

Measured another way, Sinopec (read the Chinese government) got a bargain.

Barring a global depression, the Chinese know oil prices have nowhere to go but up. They know this because their own voracious demand will make them go up.

Any commodities trader will tell you that China is starved for commodities, even as its growth rates slow.

If China's per capita resources production were even half that of the industrialized world, the country would consume 100 per cent of the world's new production.

With this reality in mind, they are underwriting their long-term security by buying the asset rather than the commodity produced by the asset.

Oil is especially important to China's growth because the country is industrializing quickly.

According to BP, China consumes 250 million tonnes of oil (or oil equivalents, such as natural gas) to produce $1-trillion (U.S.) of GDP at purchasing power parity, or PPP.

The equivalent figure in the United States is 164 million tonnes. In other words, the Chinese are 54 per cent more dependent on oil to fuel their economy than the Americans.

Since the start of the year, commodities overall have climbed about 15 per cent, in good part because of Chinese stockpiling, some economists say.

Oil prices have doubled from their lows, though they are still half of their 2008 peak of $147. Again, Chinese demand seems the driver.

And just watch what happens when the U.S. economy revives.

The world's two biggest economies pulling in tandem could easily restore triple-digit prices.

Demand, both current and expected, isn't the only reason behind rising oil prices and oil company values.

China has a massive portfolio of U.S. Treasuries. Acquiring commodities denominated in U.S. dollars might be an indirect hedge against the ailing dollar.

Toss in fear of inflation as governments everywhere print money to try to reignite their economies and you have a compelling argument for rising commodity prices. Commodities are a natural hedge against inflation.

The oil industry will see more deals like Addax; that is, Chinese buyers buying at seemingly inflated prices. Sinopec itself called Addax "a transformational transaction," one that would accelerate its international growth.

Through Addax, Sinopec will gain access to Kurdistan, a potentially prolific oil producer. Note the number of Chinese companies bidding in Iraq's first oil licence round. The list includes Sinopec, China National Petroleum Corp., China National Offshore Oil Corp. and Sinochem Group.

They are going up against the Big Oil establishment, including Chevron, Exxon Mobil, Shell and Anadarko.

If the value paid for Addax is any indication, the Western biggies will have a real fight on their hands.

The main shareholder of the Chinese bidders is the Chinese government, which probably has a pretty good idea what Chinese oil demand will look like 10 years down the road.

What might seem like a bubble price to the Americans and Europeans and their value-conscious shareholders probably seems a bargain to the Chinese.