SUMMARY:

Strong Interim Results: net production jumped by 40.8% yoy.

According to the Company's interim results, net production reached 149mmboe, up by 40.8% yoy. Of which, production of crude oil and natural gas increased 37.8% and 56.8% yoy, reaching 120.3mmbbl and 166.7bcf respectively. Revenue and net profit recorded RMB83.16 billion and RMB25.99 billion, up by 104.6% and 109.6% separately. Profit margin remains almost flat at 31.25%, as compared to 30.5% in 2009.

Medium term target already achieved. Stock has priced in.

Stock performance of CNOOC jumped more than 25% as compared to HIS's 9.6% since the Company announced its interim results. CNOOC is currently trading at 14.5x forward p/e. In terms of medium-term valuation, we believe the price of COONC is already rich. A production growth rate of 6-10% is already achievable, and an average of US$75-80/bbl realized price is expected to carry into early 2011. Nothing can really excite the investors and push up the price to a higher level.

Aggressive acquisition continues.

Rumors that COONC is still in talk with BP for its 60% stake in Pan American. In our last Company report published on July 19th, we indicated our concern that PAE might be a high-risk asset. We continue believing the value of PAE, but the question is whether CNOOC would want to take such a risk to go all the way alone or find a partner?

Several potential assets acquisitions in Uganda, Ghana, and Brazil are currently in talk. CNOOC grew at a CAGR of 8.7% from 2005 to 2009 and is expected to reach a CAGR of 9-10% in the following 5 years. Given the fast growth pace, large capex in acquisition is highly anticipated in the future.

Valuation

We raise our 12 month target price to HK$15.84 from HK$14.29, based on 2011e p/e of 11.85x. We estimate CNOOC's production CAGR from 2010 to 2015 to be 9%, within management's 6-10% guideline. CNOOC remains to be our top pick within the industry in the long run for (i) strong production growth rate; (ii) expending M&A activities to support production and to replenish reserves; (iii) direct linkage with oil and gas prices, which still have plenty of upside potentials. The Company stock increased more than 25% as compared to HIS's 10% since its announcement of interim results. The company is currently trading at almost HK$16.50 and we believe the stock price is already rich at this level.

Interim Results at a Glance

LONG-TERM UPSIDE POTENTIAL STILL STRONG, AIMING HK$25 BY LATE 2012

We believe the long-term growth potential of the Company mainly for three reasons. First, we very conservatively estimate the production CAGR from 2010-2015e to be 9%. Management guideline for the production growth rate is 6-10%, yet management has shown to be over conservative in their past announcements. Our confidence of the production growth rate comes from the recent acquisition of Chesapeake Energy, JV with Bridas, TSC for Missan in Iraq, the great potential in deep water South China Sea, significant development projects like PL9-1, and important overseas assets like the Nigeria Akpo oil field. Secondly, oil price is still a key driver, and we expect long-term oil price to reach at least the US$90/bbl zone as long term WTI futures contracts are currently priced around US$90/bbl to US$100/bbl. Third, acquisitions will prevail organic growth given the size of the Company. World wide per barrel acquisition price dropped from approximately US$11.6/boe in 2009 to approximately US$10.2/boe in 2010.

SHALE PROJECT COOPERATION AGREEMENT WITH CHESAPEAKE ENERGY

On October 11, CNOOC announced its plan of purchasing 33.3% undivided interest in Chesapeake's 600,000 net oil and natural gas leasehold acres in the Eagle Ford Shale project in South Texas with a total consideration of US$1.08 billion in cash. Chesapeake is currently operating 10 rigs and with the additional capital from CNOOC, it expects its drilling activity to increase to approximately 40 rigs by the end of 2012. Peak production is expected to reach 400 to 500 thousand boe in the next decade.

Chesapeake is CNOOC's first asset acquired in the US and the second largest investment made by a Chinese oil and gas company in the US. In the competition with India for the global resources, we believe it is a good deal for CNOOC as Eagle Ford is a rich land with estimated reserves of 80 billion bbl. CNOOC jumped 4.5% after this announcement, reaching its historical high since October 30, 2007.

OPERATION RESULTS

Net production reached 149mmboe, up by 40.8% yoy. We believe CNOOC will have no problem completing the upper end of its production target of 290mmboe set at the beginning of 2010. We expect that the Company will be able to exceed its target as 2H10 will have more projects come on stream, namely Luda 32-2, Bozhong 29-4, Bozhong 19-4 all located in Bohai Bay.

There were nine discoveries and seven appraisals in 1H10, of which, PL9-1 is expected to have significant production potential.

All-in cost increased 7.28% yoy, yet still leads its peers

All-in cost grew 7.28% yoy to US$23.85/bbl. The growth of all-in cost was mainly due to the 21.8% yoy jump of DD&A. The CAGR of all-in cost was 11.6% and 9.2% without DD&A from 2005 to 2009. The slow down of cost growth in 1H10 was mainly due to the controllable items like Opex and SG&A. We expect the Opex and SG&A will reach approximately US$6.5 and US$1.2-1.25 in the long run as production increases and unit cost drops. Yet, we inflate DD&A cost by an annual growth of 18% from 2010 – 2015e with the expectation of more assets acquisition in the future. We estimate the CAGR of all in cost will be 8% in the following 5 years.

Cost is one major concern in all the upstream companies. CNOOC still stays in a very strong position among its global competitors.

More reserves are needed to support the production growth: necessary assets acquisitions.

Production increased more 46.7% from 2005; yet, proved reserves and proved developed reserves only increased 12.6% and 10.7% since then. Now, the biggest question is if reserves growth can match up with production growth. World wide per barrel acquisition price is approximately US$10/boe in 2010, dropped from US$11-12/boe in 2009. We assume the average per bbl acquisition rate from 2010 – 2015e to be US$12-13. We believe the Company will have to improve its reserves from asset acquisitions, thus increasing the potential Capex in 2011 and on. Resources have indicated CNOOC's interest in assets in Uganda, Ghana, Argentina and Brazil.

PEER COMPARISON

RISKS

Upside:

1. Higher than expected crude oil and natural gas prices

2. Higher than expected growth rate

3. New M&A activities or faster than expected completion of assets acquisitions

Downside:

1. Lower than expected growth rate. The Company drilled more than 283 wells in 2009 whereas less than half were drilled in 2008 (~110). We are concerned if the fast growth rate is due to the increase amount of wells or higher flow rates per well, as management gave no details regarding this. If the former was the case, growth rate had the possibility to slow down.

2. Lower than expected energy prices as CNOOC has a very strong correlation with the oil price.

3. RMB appreciation will hurt sales as they are priced in US dollar

VALUATION

We raise our 12 month target price to HK$15.84, based on 2011e p/e of 11.85x. We estimate CNOOC's production CAGR from 2010 to 2015 to be 9%, within management's 6-10% guideline.

Fundamentally, CNOOC remains to be our top pick within the industry in the long run; yet the Company is currently trading at HK$16.78 with a forward p/e of 14.5x, higher than +1 historical standard deviation. We believe the stock price is already rich at this level and will see some correction.

FINANCIAL STATEMENT

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