PetroChina Ltd. (PTR), China’s biggest oil producer, recorded only a modest growth in profit in 2007, as government controls kept the company from passing record-high crude prices on to its customers.

Beijing has kept a tight lid on fuel prices, even as oil trades between $105 and $110 a barrel, to shield its population from soaring inflation. Unfortunately, refiners struggling to keep pace with the soaring price of crude have been unable to recoup that extra cost on the consumer level.

"During the second half of 2007, international crude oil prices rocketed and as a result, domestic refineries incurred heavy losses in processing," PetroChina said in a statement.

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PetroChina grossed $118 billion in 2007, but achieved a profit of only $20.5 billion.  That’s only a 2.3% increase from 2006, despite a 21% jump in total sales. The company also said first quarter profit would be "relatively poorer" than in 2007.

The government froze gasoline and diesel prices in September to suppress inflation. It raised the price by 10% in November to curb consumer demand, but has taken no further action. As a result, PetroChina suffered a $3 billion loss in its refining process.

PetroChina’s refining business breaks even when the cost of crude oil is between $66 and $67 a barrel, Chairman Jiang Jiemin said, yesterday. But the company loses $460 million (3.24 billion yuan) for each $1 the per-barrel oil price rises above that level, Jiang said.

PetroChina was also forced to pay $2.2 billion (15.67 billion yuan) in windfall taxes in 2007, a fivefold increase from the amount it paid in 2006.

"The windfall tax, combined with downstream refining losses are big headwinds for PetroChina’s 2008 profit and free cash flow growth, all but erasing the energy giant’s earnings leverage to booming crude prices," Gordon Kwan, chief of China energy research at CLSA Ltd., said in a report.

An inability to grow profits at a time when oil is hitting all-time highs will make it much more difficult for PetroChina to keep up with rising exploration costs and meet growing demand.

Exploration and production expenses soared 30% last year, and oil and gas lifting costs jumped 15%. PetroChina said yesterday that it anticipates a 15% increase in capital spending this year.

"PetroChina is now tackling more difficult reserves as the era of easy oil is clearly over," Kwan said. "Advanced technologies must be applied to exploit the higher-hanging fruits amid a global raw materials and labor cost crunch."

Exxon Mobil Corp. (XOM), the largest U.S. oil company and the most profitable oil company in the world, said earlier this month that it would increase the amount it spends on exploration and development by more than 20% in 2008. Meanwhile the second largest U.S. oil company, Chevron Corp. (CVX), raised cost targets for seven projects by $3.8 billion.

However, neither high oil prices nor surging demand appear to be receding, and that puts PetroChina in a very precarious position. The company said 2007 sales of gasoline, diesel, and kerosene totaled 600 million barrels, but it only produced 500 million barrels. Some refiners are trying to save money by cutting production or closing down entirely, which has led to widespread fuel shortages.

If both crude prices and demand for crude remain high, something else will eventually have to give. Either Beijing will be forced to raise its cap on gas prices or shortages will intensify as refiners cut back production to save money.

"Someone has to pay if the shortage worsens, the government, the refiner or the people," an unidentified analyst with a securities firm in Shanghai told Reuters. "Of course, the people will eventually pay for it, no matter in the form of shortages or higher prices."

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One day after oil giant PetroChina Ltd. (PTR) made its debut raising $8.94 billion, Alibaba.com Ltd. yesterday (Tuesday) became the latest beneficiary of the frenzy over Chinese stocks. The business-to-business arm of China’s biggest Internet company, Alibaba saw its shares nearly triple after its initial public offering (IPO) listed its shares in Hong Kong. Shares bolted 290% from HK$13.50 to HK$39.50, giving the Hangzhou-based company a market value of $25.7 billion. When it was all said and done, the company had raised $1.5 billion, the most ever for a China-based Internet company.

The stock now trades at 155 times next year’s estimated earnings. By comparison, Google Inc.  (GOOG), whose stock has increased eightfold since its 2004 IPO, trades at 35 times its estimated earnings.

"It’s a high valuation, but if Alibaba can use its leadership position in the e-commerce market to get more Chinese businesses to pay for its services, it will justify it," Rafe Xu, an analyst at Sinopac Securities Asia Ltd., told Bloomberg News.

Alibaba allows small businesses to buy and sell products anywhere in the world. In the quarter ended June 30, Alibaba accounted for 43% of all transactions in China’s business-to-business e-commerce market. That is more than triple its nearest rival, according to estimates by Analysys International.

China Network Information Center estimated that China was home to 162 million Internet users at the end of June, second only to the United States.

"The market size is huge," David Wei, Chief Executive Officer of Alibaba, told Bloomberg.  He also said that there are more than 42 million small- and medium-sized businesses in China, all of them potential clients.

Alibaba also has a cavalcade of sister companies that include Taobao, a consumer site similar to eBay (EBAY), and Alipay, an online payment service similar to PayPal.  According to BusinessWeek, half of all online payments in China are through Alipay, which hosts approximately 50,000 users. Those users are estimated to make 780,000 transactions a day.

Alibaba also has some very powerful partners moving forward. Yahoo! Inc. (YHOO) owns a 40% stake in the company and tech giants Cisco Systems Inc. (CSCO) and Hon Hai Precision Industries Ltd. also have invested.

The company’s profit is expected to triple to 622 million yuan ($ 83.5 million) this year, Alibaba said in its listing prospectus. Goldman Sachs estimates earnings before stock-based compensation will be 1.24 billion yuan ($166 million) in 2008. Including those costs, profit is estimated to be 1.02 billion yuan ($140 million).

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PetroChina Company Ltd. (PTR) became the world’s first trillion-dollar company on Monday, when its initial public offering (IPO) soared to three times its issue price on the Shanghai market. It more than doubled the value of its Hong Kong shares. 

Moreover, the Shanghai stock market is up 160% year to date, a truly stellar performance. The only problem is that China is looking a tad overbought. And right now I prefer the "other" China, the one with a growth rate double that of the EU and U.S. markets. It’s also one that’s a screaming bargain.

Here’s what I mean …

Growth and Riches Combined

The "other" China is actually Taiwan. Although its shares are up "only" 15% in 2007, it’s a considerably better value than China at current prices. Its stock market is trading on a price-earnings ratio of less than 15. What’s more, the country is 100% democratic, with two economically sensible parties, a presidential election in December, and a congressional election in March. [As far as I can see, it doesn't really matter which side wins; they're both good].

If you want to chase performance, go ahead and run after China, but for me there’s something irresistible about a bargain.

Taiwan’s economic growth, at 5.1% over the last four quarters, looks unexciting compared with China’s 11%. But you have to remember that Taiwan is a hell of a lot richer, with per capita gross domestic product (GDP) around $30,000, just above the average for the European Union. That means it has to grow more slowly, because it already has most of the "niceties" of a modern Western civilization. It just can’t achieve an extra spurt of growth by getting them.

Nevertheless, Taiwan’s productivity growth at 4.1% per annum is more than double that in the EU, and around double that of the United States.

With productivity gains this big, Taiwanese companies are steadily becoming more competitive across the globe, as their costs decline. And that explains the country’s balance of payments surplus and international reserves of $271 billion. We’re talking about a country that’s not about to run out of money, whatever chaos erupts in the rest of the world economy.   We’re also talking a country with an immensely impressive high-tech capability.

One attractive feature of Taiwanese companies is their close connections in the Chinese economy. For example, Hon Hai Precision Industries ( HNHPF) may trade on the pink sheets in the U.S. (reducing its liquidity), but it’s also the world’s largest contract electronics manufacturer, with sales of $28 billion in 2005, six times 2001 sales, and profits of $1.3 billion.

Hon Hai’s products include Mac minis and iPods for Apple Inc. (AAPL), motherboards for Intel Corp. (INTC) and all three of the new game consoles that are battling it out in world markets. Once it figures out how to make a product, it’s highly likely production will be moved to one of its 10 manufacturing facilities in China. Hon Hai is on a price-earnings ratio of 24, but I think that’s a stone cold bargain for its growth, both past and potential.

If you’re skittish on pink-sheet stocks, you can always buy the Taiwan market as a whole, though the iShare MSCI Taiwan Index (EWT), which trades on a price-earnings ratio of 15, and yields 1.8%. [ Nine percent of that index is represented by Hon Hai, so you don't miss it altogether].

Alternatively you can go for Taiwan Semiconductor Manufacturing Co. Ltd. (TSM), one of the world’s leading semiconductor manufacturers, which is trading at a forward P/E of 13. A 3.4% yield doesn’t hurt here, either, making it pretty attractive for a tech stock. [For comparison, Intel is on 25 times earnings and a dividend yield of 1.7%].

OK, China’s the economic behemoth of 2050 and your kids are all learning Mandarin. But your money may be even happier in the "other" China – the one that’s already rich and stable.

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