China finds opportunities in oil price drop

This week, Cnooc announced plans to reduce capital spending as the government and large state-owned enterprises respond to the collapse in oil prices. China’s third-largest oil producer said it would cut development spending by 67 per cent and, albeit less dramatically, reduce exploration and production capital expenditure.

At the same time, the Beijing government and refiners such as Zhuhai Zhenrong have increased their purchases of crude oil to record levels. Sinopec, another big state-owned energy enterprise, opened up a tank farm for crude oil on the resort island of Hainan in November.

These apparently contradictory signals reflect changes in the sources of growth in a slowing Chinese economy and show how the government and corporate China are exploiting the collapse to reduce their longer-term vulnerability to price swings in the volatile energy market.

It is easy to understand why Cnooc is cutting back spending. The economy is growing slightly below the level the cadres have commanded and slowed to 7.1 per cent in the final quarter of 2014. Reinforcing that trend is the fact that the energy intensity of Chinese production has gone down. Chinese crude oil demand per unit of gross domestic product has been dropping by 4.3 per cent a year since 2005, according to data from JPMorgan Private Bank.

Moreover, as the sources of growth shift slowly from manufacturing to services and from exports to domestic demand, that drop will probably accelerate, making further oil capex cuts likely — and shareholders happier.

But China is also looking ahead and taking advantage of the speedy and unexpected reversal in the oil price.

The increase in demand for crude on the mainland comes because China is exploiting lower oil prices to dramatically boost its storage capacity for both commercial and strategic reasons. By doing so, it will address one of its perennial weaknesses, its reliance on imported energy, and make itself more competitive.

The move comes at a moment when pessimism about Chinese prospects generally is on the rise. That downbeat attitude reflects chronic excess capacity, an overbuilt property market and concerns about a corporate sector that has borrowed too much, whether in renminbi or appreciating US dollars.

The way China is taking advantage of the declining oil price also suggests that some of the pessimism is unwarranted. The dramatic expansion in commercial and strategic holdings of crude while the price is half of what it was just months ago is only part of the story. The government is also increasing taxes rather than pass on the full benefit of bargain fuel prices to consumers.

Those taxes will go partly to dealing with China’s monumental environmental issues, according to Miswin Mahesh, Barclays’ commodities analyst in London. That spending should be good for China and its neighbours, if the past is any guide.

Up to now, Chinese growth has been good news for the rest of the world. In 1990, China’s contribution to global GDP growth was 5 per cent. Since 2010, the figure has swelled to more than 40 per cent. Its role as a crutch for world growth has become especially important as the growth rate of other emerging markets has fallen. (Last year emerging markets as a whole grew only 4 per cent — the worst figure since 2009 — and this year may even drop slightly below that.)

China’s demand for crude is already lifting the fortunes of shippers and others. Among the biggest beneficiaries of the increase in Chinese appetite for crude is Iran, says Amrita Sen, chief oil analyst with Energy Aspects in Houston and London. Indeed, Chinese demand for oil from Iran accounts for more than India, Japan, and South Korea combined. (All these countries have received specific exemptions from US-imposed sanctions on Iran, and they may also import more than the level the waivers allow.)

Earlier on, before China received permission from the US to procure Iranian oil, the country paid for its Iranian imports in renminbi. But today, Ms Sen says, the Chinese are using dollars. That benefits both sides. Tehran finds dollars more useful than renminbi as there are still controls on what Iran can do with its Chinese currency.

At the same time, China has clearly decided it is better to obtain real assets such as oil with its dollars than to purchase paper securities. Right now, both US Treasuries and the US dollar look attractive, while oil does not. But China always takes the long view — and in the long term neither Treasury securities nor the greenback seem as attractive as they do today — at least as seen from Beijing.

Source: http://www.ft.com/intl/cms/s/0/b083f7b4-ab8d-11e4-b05a-00144feab7de.html#axzz3Qnw9Fh8K

Prada: beauty is skin-deep

Derek Zoolander learnt that "there's a lot more to life than being really, really, ridiculously good looking". Investors in Prada, a stock market darling since its debut three months ago, may soon come round to a similar way of thinking.

The basic growth strategy of the Italian fashion house is similar to that adopted by many luxury-goods companies in recent years: build out a network of directly operated stores (Dos), to reduce the share of revenues given over to wholesalers. The big difference is that Prada is currently more aggressive, looking to expand its Dos count by 75 per cent by 2014. There is evidence that the plan is bearing fruit; net revenues rose by about a fifth between the end of January and the end of July. But inventories rose by almost a third over that period. Non-current assets, mostly additions of land and buildings, also rose sharply. All that weighs on asset efficiency, or the sales Prada generates for every euro of assets. So-called "asset turns" were flat over the 12-month period, leaving the Milan-based company as one of the least impressive by that metric among peers.

According to the classic DuPont profit model, even if asset turnover remains sluggish, Prada's middling returns on equity could be improved by margin enhancement or financial leverage. The latter seems unlikely for now: one of the primary aims of relieving investors of EUR206m in the June initial public offering was to allow Prada to reduce its short-term bank debt while improving its cash balance. As for margins, Prada's falling royalties from licensing its brands suggest that it lacks the desirability of a Calvin Klein or Burberry, notes Berenberg, the private bank. Meanwhile, its relatively low level of spending on advertising looks unsustainable. However pretty those headline numbers, in short, the substance is somewhat lacking.

Source: http://www.ft.com/cms/s/3/ce966f56-e387-11e0-8f47-00144feabdc0.html?ftcamp=rss