China Petroleum & Chemical Corp. (600028), Asia's largest refiner, and rival PetroChina Co. (857) are poised to seek assets overseas to diversify as domestic earnings are depressed by state-controlled prices for processed fuels.

Refining losses resulted in China Petroleum, known as Sinopec, reporting a 41 percent decline in first-half net income to 24.5 billion yuan ($3.9 billion) yesterday. PetroChina, the nation's biggest oil and gas producer, last week said first-half profit declined 6 percent to 62 billion yuan.

Chinese refiners, which sell gasoline and diesel below cost because the government caps retail prices to contain inflation, aren't waiting for the controls to be relaxed. PetroChina said it plans to generate more than half its oil and gas output from overseas projects by 2020 to offset refining losses, while China Petrochemical Corp., Sinopec's state-owned parent, said it would more than double its foreign production by 2015.

"Every dollar spent on domestic refining projects would be a waste of a dollar, since it generates absolutely no return," said Simon Powell, the Hong Kong-based head of Asian oil and gas research at CLSA Ltd. "Overseas acquisition is a short cut to balance refining losses, but it's a gradual process and takes a long time because of political scrutiny and availability of assets globally."

China's state oil companies have spent more than $100 billion on assets over the past decade to supply the world's largest energy importer. Sinopec lost 12 percent in Hong Kong trading this year to Aug. 24, while PetroChina fell 0.2 percent and the MSCI Far East Energy Index (MXMF0EN) dropped 1.8 percent. Sinopec climbed 1 percent to HK$7.24 and PetroChina slipped 1.1 percent to HK$9.54 at 10:23 a.m. in Hong Kong.

Cnooc Deal
Cnooc Ltd. (883), China's biggest offshore oil and natural gas maker with no refining operations, has proposed the nation's biggest overseas acquisition, offering $15.1 billion for Canada's Nexen Inc. (NXY) Canadian and U.S. regulators are reviewing the takeover.

"If the Cnooc deal is approved, we can expect more Chinese energy investment in those countries almost right away," said CLSA's Powell.

Sinopec lost 18.5 billion yuan after processing 811 million barrels of oil in the first half compared with PetroChina's loss of 23.3 billion yuan from refining 489.7 million barrels.

"The loss came purely from the government's policy of capping retail fuel prices," said Laban Yu, head of Asia oil & gas equity research at Jefferies Hong Kong Ltd. "There is not much Sinopec can do. We believe current low inflation will allow higher refiner margins in the second half and quite possibly a change in the fuel-pricing mechanism."

Price Controls
Gasoline and diesel prices are set by the National Development and Reform Commission, China's economic planner, under a system that tracks the 22-day moving average of a basket of crudes, including Brent, Dubai and Indonesia's Cinta. The cycle may be shortened to 10 days, China Petrochemical said March 28.

NDRC has indicated it may relax price controls on natural gas and fuels in the second half, PetroChina President Zhou Jiping said at a post-earnings briefing on Aug. 23.

The fuel pricing reform may not materialize in the second half, especially after the government has made and missed similar commitments in the past, said Shi Yan, a Shanghai-based energy analyst at Uob-Kay Hian Ltd.

"I believe both Sinopec and PetroChina understand the situation well and both of them are determined to expand in upstream quickly with or without the pricing reform being finally implemented," she said.

Overseas Targets
PetroChina wants half its oil and gas output to come from overseas by the end of the decade, Chairman Jiang Jiemin said in March. Production abroad rose 0.9 percent to the equivalent of 62.5 million barrels, accounting for 9.4 percent of the company's output in the first half.

Chinese companies can sell oil and gas from overseas assets at market prices.

President Zhou said in Hong Kong on Aug. 23 the explorer is looking closely at assets in Central Asia, east Africa, Australia and Canada. Zhou said he's "completely confident" of achieving the 2020 goal.

China Petrochemical, Sinopec's parent, aims to produce 50 million metric tons of crude a year overseas by 2015. Last year, foreign production was 22.9 million tons. Sinopec said it boosted first-half crude output 4.3 percent to 163.09 million barrels and overseas production jumped 82 percent to 11.13 million barrels.

Shale Assets
Sinopec has held talks with Oklahoma-based Chesapeake Energy Corp. (CHK) and others about investing in shale assets, Chairman Fu Chengyu said after the company's annual shareholder meeting in May.

"We've always been talking to and cooperating with U.S. and Canadian companies on unconventional and shale gas and oil," said Fu, who became chairman in April 2011. "Not just Chesapeake."

Fu has already announced at least $12 billion in deals at Sinopec and its parent since he was appointed, data compiled by Bloomberg show. That includes a $1.5 billion agreement for a 49 percent stake in Talisman Energy Inc. (TLM)'s U.K. unit on July 23 and the acquisition of a 30 percent stake in Galp Energia SGPS SA (GALP)'s Brazilian unit in November.

Cnooc cut the interim dividend by 40 percent to 15 Hong Kong cents a share on Aug. 21 in order to fund its acquisition of Nexen, a Calgary-based company that operates in the U.S. portion of the Gulf of Mexico, and other potential overseas deals and future production growth. Cnooc posted a 19 percent profit decline after a spill closed its largest offshore oilfield, Penglai 19-3, in China's Bohai Bay.

Regulatory Approvals
The Nexen acquisition needs approval from regulators in Canada, and the U.S., where the Committee on Foreign Investment in the United States examines whether foreign purchases of U.S. assets raise security risks.

Nexen's oil and gas assets include production platforms in the North Sea, the Gulf of Mexico and Nigeria, as well as oil- sands reserves at Long Lake, Alberta, where it already produces crude in a joint venture with Cnooc.

Sinopec and PetroChina would probably wait until the outcome of the Nexen regulatory screenings before announcing new deals, said Uob-Kay's Shi.

Up Tempo
"They certainly want to push the tempo but they also understand acquisition is a game of patience and timing," Shi said. "Takeovers are only going to happen over a long period of time, not something that can be achieved in days or months."

PetroChina will spend at least "over 10 billion yuan" in developing unconventional natural gas in the next couple of years, President Zhou said last week in Hong Kong.

Sinopec is one of the two winners of China's first shale gas parcel auction last June and plans to accelerate the exploration of the fuel by teaming up with domestic and international shale gas explorers, Chairman Fu said in March.

In the second half, Sinopec will "step up efforts in exploration and development of unconventional resources," including building production capacity in the Fuling continental shale gas project and preparing for coal-bed-methane production in the southern part of Yanchuan, it said in a statement to Hong Kong's stock exchange yesterday.