Canada mulls China’s massive oil takeover bid

Posted on August 15, 2012


China is looking to convert more of its $3.1tn in foreign reserves into hard assets, including western oil firms [Reuters]

Backed by a massive trade surplus and bulging overseas currency reserves, and fuelled by a voracious appetite for commodities, China has launched one of its largest foreign takeover bids to date, aiming to control a Canadian oil giant.

China National Offshore Oil Corporation (CNOOC) wants to buy Calgary-based Nexen for $15.1bn, a premium 60 per cent above the company’s listed value, in a deal analysts say Canadian regulators are likely to approve, despite opposition from some US politicians.

James Inhofe, a Republican from Oklahoma, has “serious national security concerns” over the bid, while Charles Schumer, a Democrat from New York, said China’s “blatant disregard for US intellectual property rights makes this transaction even more concerning”.

Canada is the largest foreign supplier of oil to the US and Nexen has operations in the Alberta tar sands, one of the world’s largest petroleum deposits, along with international investments in Africa, the Gulf of Mexico, the North Sea and the Middle East.

Regulators from the Canadian government, led by Prime Minister Stephen Harper, a Conservative who hails from Alberta and has close ties to the oil industry, are currently mulling whether the takeover deal represents a “net benefit” to Canada. It is unclear when exactly a decision will be announced.

In search of stability

China is the world’s second largest oil consumer, according to the CIA, burning about 9.4 million barrels per day in 2011.

“Over the past couple of years, the boom in unconventional extraction has made North America the centre of the mergers and acquisitions world,” Erica Downs, a former CIA energy analyst, now with the Brookings Institute, told Al Jazeera. “Canada and the US are increasingly where these companies want to be.”

In the short-term, China needs energy – and Nexen, one of Canada’s ten largest oil companies, has an ample supply, producing some 213,000 barrels of oil equivalent per day. The deal would increase CNOOC’s reserves by 30 per cent, company officials told the Reuters news agency when the takeover plan was announced in late July.

Nexen’s Canadian assets in the tar sands, where oil is often mined rather than pumped, are far more expensive to access than conventional crude. But companies such as CNOCC are willing to pay an extra premium for energy which comes from a politically stable western country such as Canada.

“It’s no secret that geostrategic instability affects most oil exporters,” Gordon Houlden, director of the University of Alberta’s China Institute, told Al Jazeera. “The Chinese got burned in Libya [after rebels ousted Gaddafi’s government and the Chinese lost their contracts].”

“They got badly burned in Sudan with the break-up of the country [most of the oil is in South Sudan while China had signed deals with the former government in the north] and there are questions over Iranian production because of sanctions and the risks of war,” he said. “The premium for security is reasonable.”

With 175 billion barrels of recoverable crude, Canada has the world’s third largest proven oil reserves, behind Saudi Arabia and Venezuela, according to the CIA. Producing oil from Canada’s tar sands requires an oil price of more than $50 per barrel to be profitable, according to Shell and other energy companies.

Extracting one barrel of oil from the tar sands produces three times more greenhouse gas emissions than conventional crude, leading conservationists to oppose the China takeover plan, as it is likely to mean increased production and investment in one of the world’s most environmentally harmful fuel sources.

“A Chinese owned company is going to want pipelines [to the Pacific coast],” said Gordon Laxer, director of the Parkland Institute, a left-leaning think-tank in Edmonton. “I don’t think Canada should be increasing tar sands production, we should be capping and phasing it out,” he told Al Jazeera.

Two controversial pipeline proposals – the Northern Gateway spearheaded by the energy giant Enbridge and the Kinder Morgan pipeline – are hoping to bring Canadian oil to Asia, but environmentalists and some indigenous groups are battling to stop them.

“As a world power, much like the Americans, the Chinese want diversity in their energy sources,” Laxer said.

China’s ocean ambitions

Over the longer term, some analysts believe Beijing is eyeing Nexen’s deep water drilling technology in order to cement its claims to prospective offshore oil deposits in the disputed South China Sea.

The region could contain as much as 213 billion barrels of oil, according to Chinese studies, making it a geopolitical prize comparable with Saudi Arabia. Most of this potential for oil is deep under water.

In May, China’s first deep-water drilling rig, CNOOC 981, began operations in the South China Sea. It can operate at a maximum water depth of 3,000 metres, which is a significant improvement over past Chinese technology, but still less than the capacity of major western energy firms.

“The deep sea component is one of many attractive components of Nexen to CNOOC,” Houlden said, calling the acquisition “one of the ways” for the Chinese to add to their capacity.

The US government will review if China’s ownership of Nexen’s offshore assets in the Gulf of Mexico – accounting for 14,000 barrels of oil per day, or 6.6 per cent of the company’s production – poses a national security risk.

Above and beyond any particular concerns about technology, some politicians are worried about firms backed by the Chinese state going after hard assets.

US debt conundrum

China controls more than $3.1tn in official currency reserves, an “unprecedented amount for any country” The Financial Times reported earlier this year. With a trade surplus of $160bn in 2011, the country has money to spend.

Previously, this money had been invested in US treasury bonds – buying US government debt – but Chinese officials have repeatedly warned that increasing US debt levels and political paralysis in Washington are making debt investments less appealing.

But China cannot sell its investments in US Treasury Bonds without causing the value to drop. As the biggest holder of the asset, any moves away from US debt would hurt China, which would be left holding a bag of worthless paper. “Just a few words from China that they wished to divest or even to stop purcashing T-Bills would hurt them [both China and the US] very much,” Houlden said. For the time being, China is likely to keep buying US debt, while attempting to slowly shift reserves into other properties.

Trying to convert investments in treasury bills into hard assets in western countries hasn’t always been easy. Canadian officials blocked a takeover attempt by a Chinese firm on mining giant Potash Co last year, saying it would not be beneficial to Canadians. In 2005, CNOOC attempted to buy the US oil company Unocal for $18.5bn, but regulators blocked it on national security grounds.

State and corporate power

CNOOC’s operating structure is considered murky by some analysts. Its divisions are traded on international stock markets and the company has pledged to keep Nexen listed on the Toronto Stock Exchange (TSX). The firm traded on the TSX is apparently a subsidiary of a bigger corporation which is owned largely by China’s government, allowing the company to secure financing with low interest rates often unavailable to its competitors.

“Chinese companies have a lower cost of capital and a lower cost of inputs,” Downs, the former CIA analyst, said. “Secondly, they do not pay anywhere near the same amount of money in terms of dividends to shareholders as western publicly traded companies.”

With Chinese state firms, it is often unclear where national interests end and corporate interests begin, worrying some western capitalists.

“In the past 10-15 years we have seen these companies emerge as increasingly powerful actors vis-à-vis the Chinese government,” Downs said. “There has been a devolution of power away from the state to these powerful firms,” she said, adding that top executives in major companies are still appointed by the Chinese state.

The majority of the world’s oil and gas reserves, some 75 per cent of total global production, are controlled by state owned companies. The big names of the oil game: Shell, Exxon, BP and Total are small players compared with Saudi Aramco, Russia’s Gazprom and Petroleos de Venezuela. Canada and the US are some of the only places where foreign firms can directly buy upstream petroleum access.

“There are lots of state owned companies operating in the tar sands,” Laxer said. “None of them are Canadian.” If anything, the power of Chinese state capitalism should give Canadian policy makers pause in how they govern their own oil sector, where critics say finite and highly polluting resources are not managed for the public good.

Chris Arsenault

Could the World Drown in a Chinese Perfect Storm?

We all know that Europe may be ineluctably sinking financially, and the U.S. is barely staying afloat. Now, potentially even more seriously, comes last week’sconfirmation that China, long considered the life raft of the global economy, may also be taking on water.

Unfortunately, that’s not the only sobering news from China of late. You likely picked up on the news last month that China,through CNOOC (NYSE: CEO  ) , its biggest offshore oil and gas producer, aims to spend more than $15 billion to buyNexen, a big Canadian operator. But you may not have noticed that the world’s most populous nation has been rattling sabers in both the South China Sea and the East China Sea, causing consternation among its neighbors in both areas. Add to those events an obviously destabilized internal political situation, and you just might have a figurative perfect storm that could endanger the entire planet.

Worse than we thought?
My primary focus is normally on oil, gas, and other natural resources, and it will be here as well. But before examining China’s potential effect on those commodities, let’s take a glance at the country’s economic and political malaise. For instance, you may already have noted that China’s banks provided a relatively minuscule 540.1 billion yuan (that’s $85.1 billion) in July loans. That’s down a whopping 41% from June. Further, the country’s exports grew a paltry 1% year-over-year, and slid meaningfully from the 11.3% rate just a month earlier.

I could continue to recite all manner of slowing statistics, but the real key is that China’s economy may be far worse off than we’d realized. After all, the nation’s numbers are the product of home cooking, and it’s been noted that they may have been sweetened to mask reality. Indeed, it wouldn’t constitute a voice in the wilderness for one to classify China as teetering on the edge of a recession.

Preparing for a changing of the guard
Then there’s the murky — and lately more unpredictable — internal political milieu. As Martin Feldstein, a Harvard professor and erstwhile chairman of the Council of Economic Advisors under President Ronald Reagan, told Wall Street Journal readers after recently discussing China’s softening economy, “The political problems are even more difficult. Corruption, income inequality, and party governance are at the top of the list of domestic issues.”

After delving more into the specifics of the corruption and other issues, Feldstein concluded that, “The new Chinese leaders who will begin their 10-year terms this fall have much to do at home and abroad if they want their country to continue its successful and peaceful rise in the global economy.”

More acquisitive in the West
Obviously, “much to do … abroad” refers in part to the steady Chinese movement into the world of Western oil and gas. The proposed CNOOC-Nexen combination — which Sen. Charles Schumer, D-N.Y., has vowed to contest — is the biggest, but hardly the first, of China’s forays into the acquisition of North American energy assets.

Chinese giant Sinopec (NYSE: SHI  ) earlier this year coughed up $2.2 billion for a stake in Oklahoma-based Devon Energy (NYSE: DVN  ) , and the Chinese company is currently reported to be sniffing around Texas. Earlier, CNOOC had hooked up with Chesapeake(NYSE: CHK  ) in Eagle Ford and Niobrara partnerships.

But are Beijing and its corporate minions due for a breather from Western energy purchases? Probably not. If the U.S. continues to stiff-arm TransCanada‘s (NYSE: TRP  ) efforts to build the Keystone XL pipeline from northern Alberta to Texas, it will almost certainly encourage a more acquisitive China, which in turn would rile Sen. Schumer — who, by the way, has opposed Keystone — and his colleagues.

A newly nasty neighbor?
Closer to its home — in both the South China and East China seas — China has become significantly more bellicose with its neighbors. To the south, it’s used the aforementioned CNOOC as its proverbial front man and its actions there could threaten the Nexen purchase.

As the Journal observed earlier this month, China’s decision to establish an island military outpost in South China Sea waters to which China, Vietnam, the Philippines, Malaysia, and others claim at least partial ownership has “renewed U.S.-China tensions over the sea (and) threatens … to complicate a push into North America by CNOOC Ltd.” Along with its numerous international trade routes, the South China Sea is believed to contain significant reserves of oil and gas.

But if China’s intent to fortify a group of relatively uninhabited South China Sea islands is making waves, its leering at Japan’s Ryukyu Islands in the East China Sea could be even more upsetting. The Ryukyus include Okinawa, which the U.S. returned to Japan in 1972 after capturing it in the final major battle of World War II. Encroachment vis-a-vis Okinawa appears to stem from a three-way dispute involving China, Taiwan, and Japan over five islands and three barren rocks, the Senkakus, also in the East China Sea.

China now claims a flimsy historic justification for its right to help itself to Okinawa, a sizable island dotted with U.S. military bases. Having once been ensconced in one of the U.S. Marine Corps’ less sumptuous “resorts” on the island, I’m not sure why anyone would become especially belligerent over ownership of “the rock.” Nevertheless, were China to press its claims to Okinawa, it obviously would set off a conflagration that would pit it against Japan, the U.S., and probably others.

The Foolish bottom line
So, without even delving into China’s role in supporting Syria’s besieged President Bashar al-Assad, along with Russia and Iran, it’s clear that Hu Jintao’s country is proverbially kicking up its heels on several fronts. Where all this will eventuate is hard to forecast, but it’s less difficult to see how the potential contretemps could render global crude prices far less stable than they might appear to be.

In any event, I’d strongly urge Foolish investors to, at the very least, add CNOOC to My Watchlist. The company is in the middle of lots of action, some merely interesting and some potentially catastrophic.

David Lee Smith