Who’s afraid of CNOOC?

The $15.1-billion takeover last year of oilsands producer Nexen by state-owned China National Offshore Oil Co., or CNOOC (CEO-N), tested Canadians’ willingness to allow foreign state-controlled firms full access to the country’s energy resources.

The deal — approved by the federal government in December — raised a number of issues, including the extent to which state-owned companies are controlled by their governments; their track records for transparency and corporate authority; and whether Canadian companies would lose their commercial focus.

An early entrant in the oilsands, Nexen has become one of the crown jewels of Canada’s energy sector, with an interest in more than 300,000 acres in the Athabasca region and billions of barrels of contingent recoverable oilsands resources.

But several China watchers polled by The Northern Miner argue that Canadians have nothing to fear — at least in the short-term — of CNOOC’s ownership of Nexen, which they claim has an interest in keeping the oil producer’s operations humming along.

As evidence they point to Chinese computer giant Lenovo, which bought IBM’s entire PC division in 2004 for about $1.7 billion. By some estimates the acquisition made Lenovo the third-largest PC maker in the world.

“Lenovo has kept IBM’s PC division more or less intact because they need to sell PCs to Americans and Europeans,” notes Assif Shameen, a Singapore-based business writer and commentator on Asian affairs. “CNOOC gave a presentation to analysts after their successful bid for Nexen, in which they emphasized that it was not their objective to run Nexen as a subsidiary in Canada, but more as their international arm that could also help enhance their domestic operations and make them a global company. It wants to keep the international upstream culture of Nexen so that it can become more of a global oil multinational itself.”

The Nexen acquisition was a transformational deal for CNOOC. If Nexen is consolidated this year, Shameen calculates, it will add about 8% to the state-owned giant’s annual earnings, 20% to its total production volume and nearly 30% to its total reserves.

It is also a platform to acquire Canadian technology and move it into CNOOC’s operations worldwide. The deal helps CNOOC bring liquid natural gas and oil to China and gives it skill sets in shale gas and deepwater exploration and production, augmenting its domestic aspirations in the deep waters of the South China Sea and its large shale aspirations in onshore China.

“China may have 126 billion barrels of recoverable oil in the South China Sea and 498,000 trillion cubic feet of gas in deep water, and if they genuinely can accelerate and apply deepwater processes in their own territory, Chinese oil giants will be the next Exxons of the world — actually bigger,” Shameen says. “They can change Nexen, but that would be killing the goose that lays the golden eggs.”

John Gruetzner, Beijing-based managing director of Intercedent, an investment and business advisory firm focused on Asia, argues that it is in CNOOC’s best interests to keep Nexen unchanged — at least during the acquisition’s early years.

“In the first five years I don’t think you’ll see any significant change. I don’t think Nexen will be dramatically different as a company,” he contends. “CNOOC’s view is that they’re there to learn, and that’s one of the reasons they bought it. They bought it for a strategic position, certainly, but they also bought it for its knowledge of shale gas and deepwater drilling to apply in the South China Sea.

While CNOOC will have representatives on the board, he adds, “they are not there to tell people what to do.” The question, Gruetzner says, comes down to whether Nexen eventually gets absorbed, at which point there will be more Chinese input. But so far, he says, “there’s no sign in the short term that they’re going to integrate it.”

He says that “if management is performing, the current team will stay in place. CNOOC’s primary goal is the rate of return on its investment. Its secondary goal was to improve its reserve position, because being a public company, it had a deficit from an analyst point of view in terms of the value they were getting due to the low level of oil reserves on its books prior to this investment.”

Gruetzner also makes the point that most people outside of China don’t understand that Beijing’s goal for all of its state-owned enterprises is to divest the state’s interest by listing them overseas and on Chinese exchanges. This, he explains, will be implemented in stages to match the market’s capacity to absorb the stock. The funds from selling the state’s interest are earmarked to top-up the pension deficit and are given to the National Social Security Fund. This is important with respect to Nexen, he maintains, because the state’s long-term goal is to make CNOOC operate on the same premise that a public company on the TSX operates under.

He also points out that Canadians have far more to fear from China’s private companies taking over resource companies than state-owned enterprises (SOEs), for example China’s privately held  HD Mining, which has come under fire for importing 201 temporary workers from China, rather than hire Canadians for the jobs.

“SOEs are more compliant with labour resource laws and environmental laws than the Chinese private sector,” he argues. “You get people like HD Mining who are trying to play with the rules. The Chinese private sector is afraid of regulators while SOEs are more interested in regulations than regulators. The private sector companies see regulations in a flexible context.”

Gruetzner reasons that what Canadians should be most fearful about in foreign investment from any country is transfer pricing. The key is to make sure that companies are not shipping resources out of Canada below market rates, as this risks lowering taxable income. He argues that you want to make sure that the boards and management of companies that invest in Canada understand the law.

“What you want to impose during the approval process is Canadian counsel, Canadian directors and adherence to Canadian market practices,” he says. “You don’t need to obsess about state or private sector ownership, but you do want to make sure that companies behave properly when they operate in Canada. The government should focus on compliance, and not just on the nature of the ownership structure.”

While Canadians debate the net benefit to Canada of takeovers by foreign companies — particularly those tied to state governments — it’s unclear whether the biggest investment by a Chinese firm can yield fruit if Canada cannot build the pipelines needed to get oilsands bitumen to Asia.

“CNOOC may have overestimated Canada’s ability to get stranded Alberta crude to new markets — a situation that has put a damper on the value of Nexen’s oilsands assets,” says James Irwin, a journalist covering the oilsands for the New York-based Energy Intelligence Group. At the time of the Nexen purchase in December, Canadian oil was selling at a discount to the North American benchmark West Texas Intermediate by as much as US$40 per barrel.

Three pipeline projects from Alberta — Northern Gateway to the port of Kitimat in B.C.; the Trans Mountain expansion pipeline to Burnaby near Vancouver (f
rom 300,000 barrels a day to 890,000 barrels a day); and the Keystone XL pipeline to the U.S. Gulf Coast — all face fierce opposition from environmental groups.

“While Nexen’s oilsands assets are clearly a long-term investment,” Irwin says, “CNOOC must be wondering how it can ever exploit its new resources in booming Asian markets.”