China Continues Game-Changing Energy Moves with Sinopec's $7 Billion Brazil Buy

Chinese state oil company China Petroleum & Chemical Corp. (Sinopec) (NYSE ADR: SNP) said Friday that it would invest $7.1 billion in the Brazilian unit of Spain's Repsol YPF S.A. (NYSE ADR: REP) to form one of the largest private energy companies in Latin America.

The investment is the second-largest overseas purchase by a Chinese company and drives the market capitalization of Repsol's Brazilian arm up to $17.8 billion. Analysts estimated the company's value at $10.7 billion earlier this year. Sinopec's investment gives it a 40% stake in Repsol's Brazil business, and access to the highly valued Brazilian offshore sub-salt oil fields.

The move highlights South America's importance to China as the Asian powerhouse goes on a spending spree to meet its fast-growing energy demand.

"China's increased reliance on imported oil is prompting state companies to accelerate the hunt for resources globally," Wang Aochao, head of energy research at Shanghai's UOB-Kay Hian Ltd., told Bloomberg. "The trend is set to continue as the country's fast economic growth won't stop."

The deal is almost as big as Sinopec's 2009 acquisition of Switzerland's Addax Petroleum Corp. for $7.2 billion, the biggest oil takeover to date by a Chinese company. The deal gave Sinopec access to fields in Iraq's Kurdistan and West Africa.

The deal values Repsol's Brazilian assets about 19% higher than the bank's valuation, marking the importance Chinese companies place on securing Brazil's oil reserves.

"Because [Sinopec] has considerations other than just economics, they will pay a premium to gain energy security for China," Laban Yu, an analyst at Macquarie, told the Financial Times.

The $7.1 billion will help develop Repsol's offshore blocks, which Sinopec expects to produce 200,000 barrels of oil equivalent per day. Brazil's offshore fields will be expensive to develop because they are thousands of meters undersea, below layers of sand, rocks and salt.

Repsol previously said producing oil from these fields could cost between $10 billion and $18 billion, and planned an initial public offering of the Brazilian unit until it received the high offer from Sinopec.

Repsol holds highly sought after offshore blocks in Brazil's Santos and Espirito Santo basins and plans to invest as much as $14 billion through 2019 to produce the reserves, boosting annual production growth by as much as 4% through 2014. The Guara and Carioca fields could hold as many as 3 billion barrels of oil.

The Santos Basin oil fields are a main target of global oil companies. Brazil's state run oil giant Petroleo Brasileiro SA (NYSE ADR: PBR) estimated in 2007 that the Santos basin Tupi field could contain as many as 8 billion barrels of oil. The company issued a $70 billion initial public offering (IPO) last month to fund exploration into fields in the Santos basin and plans to spend $224 billion over the next five years to boost production to 5.38 million barrels a day by producing oil from pre-salt regions.

Part of the stock sale included a $42.5 billion issue to Brazil's government for the rights to five billion barrels of oil. The sale boosted Petrobras to the fourth largest company in the world, according to Bloomberg, with a market value of $214 billion.

These recent billion-dollar deals have upped the price tag on future acquisitions in South America's sought after energy market.

"This puts a hefty valuation on reserves in Brazil," Peter Hitches, an analyst at Panmure Gordon & Co., told Bloomberg.

China's Changing the Energy Game

From January 2009 to April 2010, the three big China state run oil companies - China National Petroleum Corp., Sinopec and CNOOC Ltd. (NYSE ADR: CEO) - spent $29 billion on global oil and gas assets. In June the International Energy Agency said the overseas investments of China's national oil companies were on track in 2010 to significantly outpace the $18.2 billion spent in 2009.

Chinese investment in Brazil alone has hit $4.3 billion so far this year - before the Sinopec-Repsol announcement - compared to $362 million in 2009, according to data from Dealogic.

Brazil and its South American neighbors are increasingly important to China's surging energy demand. To secure oil reserves last year, the China Development Bank lent $10 billion to Petrobras when the Brazilian oil company needed to fund a $174 billion expansion plan. As part of the deal Petrobras agreed to sell Sinopec 200,000 barrels of oil per day, about one tenth of Petrobras' current oil production, from 2010 until 2019.

Money Morning Chief Investment Strategist Keith Fitz-Gerald wrote in January 2010 about China's plans to move into Brazil to satisfy the fastest growing economy's energy needs.

"Mark my words: We will see additional Chinese oil firms headed for South America, and can expect some headline-making deals," said Fitz-Gerald.

Since Fitz-Gerald's prediction, China's Sinochem Group in May bought a 40% stake in the Brazilian offshore Peregrino oil field from Statoil ASA (NYSE ADR: STO), Norway's largest oil and natural gas company, for $3.07 billion.

Sinopec confirmed it might continue its Brazilian splurge with a bid for the offshore assets of Brazil's OGX Petroleo e Gas Participacoes SA. Sinopec announced in August that it was in talks with the company.

Argentina also is attracting Chinese investment. CNOOC, China's biggest offshore oil explorer, struck a deal in March to buy a 50% stake in Argentine producer Bridas Corp. for $3.1 billion.

And with China's eager eye on global oil reserves, the deals are likely to getter bigger - leaving countries that aren't securing oil assets vulnerable to the strengthening Chinese competition.

"China has very specific long-term energy objectives that are going to result in the complete realignment of the global energy industry," said Fitz-Gerald. "Acquisitions like this will continue as long as there is growth in China."

The deal-making trend leaves the United States farther behind in the energy industry, and Fitz-Gerald sees big risks - and opportunities - coming from China's buying spree.

"At the rate China is consuming oil, they will consume at least as much or more as the United States does within 10 years," said Fitz-Gerald. "Unless someone discovers a huge amount of new oil, the energy market is going to do nothing but get more expensive and more volatile."

China's increased control over oil resources and reserves will result in sharply higher oil prices. Consumers could feel the pinch at the pump over the next five to ten years, and the United States could face negotiations with Beijing over oil supplies and pricing. Trading control over the resource will shift to the Red Dragon.

But where there are risks are always investor opportunities.

"These very same risks create unprecedented investment opportunity in the energy game," said Fitz-Gerald. "Five years from now may be too late. Energy has got to be in your portfolio because of the Chinese influence in the industry."

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