The Chinese Communist leadership is not sitting around debating the timing of Peak Oil. They are being proactive, recognizing that the cost of acting early matters far less than the consequences of doing nothing. This is evident in their aggressive push to secure future energy supplies that their nascent consumer economy will need in order to mature into a more balanced, self-sustaining one. While the Chinese must continue recycling a fair amount of their export earnings into the Treasury market, they clearly have higher long-term priorities than financing a spendthrift U.S. federal government.

Interesting comparisons can be made between the incentives and strategies of private exploration and production (E&P) companies and E&P companies that are majority-owned by a government. PetroChina (PTR) and Petrobras (PBR) are two prominent companies from the latter category that are aggressively growing their reserve bases.

These companies must strike a delicate balance between free market incentives and government-mandated initiatives. So they present investors with unique opportunities and risks. Since the governments of China and Brazil are the majority owners of these companies, will they be strong-armed into profitless overexpansion or be subject to “windfall profits” taxes?

PetroChina is a major, fully integrated oil company operating across the entire chain of production. At year-end 2005, the company had independently audited proved reserves of approximately 11.5 billion barrels of crude oil and 48.1 trillion cubic feet of natural gas. Counting the gas reserves as oil on a Btu-equivalent basis (6,000 cubic feet of natural gas = 1 barrel of oil) yields 19.5 billion barrels of oil equivalent (BOE), placing the company well above ExxonMobil in size. PetroChina also owns 25 refineries, thousands of service stations, and a large pipeline network:

PetroChina has 247,000 employees in its E&P division alone, so there is undoubtedly political pressure to not abandon older fields that a 100% private company would otherwise deem “uneconomic.”

PetroChina shareholders have another reason to be concerned: the refining segment of the business. In August, the company announced impressive first-half earnings. But the report included a few discouraging details. According to the AP:

“The strong first-half earnings came despite a 10.3 billion yuan ($1.3 billion) windfall profits tax the company paid due to high crude oil prices.

“China imposed the tax of 20-40% on domestic sales of oil priced above $40 a barrel in China by companies with both onshore and offshore oil operations.

“PetroChina reported a first-half operating loss for its refining and marketing segment of 13.89 billion yuan ($1.74 billion) because of government controls on domestic oil product prices, compared with a loss of 5.95 billion yuan ($746.5 million) in the first half of 2005.”

The company may continue its impressive reserve and production growth, but there is clearly a cap on how much profit margin the Chinese government will allow in the refining business. In my view, investors should follow PetroChina for its strategy in pursuing reserves, not for its potential as an investment.

At the same time, the Chinese realize that the country’s future oil needs can only be met through expanding imports; through its controlling ownership positions, the government will continue pressuring PetroChina, Sinopec (SNP), and CNOOC Ltd. (CEO) to remain as aggressive as possible in acquiring foreign reserves. Using the tax code and regulations to make exploration and production more attractive than refining can clearly add to the pressure that originates from the government end of the boardroom table.

So is it safe to invest in a communist dominated oil company?
At this point yes because they are becoming more capitalistic everyday.
When politics change that is when you have to be careful.