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China's bid to fit in

The Nexen takeover shows how far Chinese companies have come on the global stage. But how should Canada deal with state-controlled firms that use their financial muscle to grab prized resources?

00:00 EDT Saturday, July 28, 2012

OTTAWA and TORONTO -- Keith Spence has had a front-row seat to the coming of age of China Inc.

When the Toronto investment banker first arrived in Beijing in the late 1990s, Chinese company and government officials were insecure about their role in the world and were looking for inbound investment to fuel the country's development.

But over the years, he has watched them conduct international business with growing confidence, with China emerging as an economic colossus courted for its own vast investment clout by western rivals. Along with that confidence, officials also showed an increasing interest in the commodity that serves as the lifeblood for the global economy - oil.

For Mr. Spence, the Chinese appetite for Canadian oil hit home two years ago during a meeting with Chinese potash executives in his Toronto office. Expecting to talk about potential potash investments, the mining financier instead found himself in a discussion about opportunities in Alberta's oil patch.

"They said, 'Listen, Keith, we are very interested in making an acquisition in oil and gas. We want an Alberta company, or a company that has some assets in Alberta, and we are looking for 'x' amount of barrels in the ground,' " said Mr. Spence, whose company, Global Mining Capital Corp., was focused more on mining at the time.

China's hunt for oil was on full display this week, when state-owned CNOOC Ltd. bid $15.1-billion (U.S.) to acquire Calgary-based Nexen Inc. If approved, the deal would represent the largest foreign takeover by a Chinese corporation.

CNOOC's proposed takeover of Nexen represents a key milestone in the country's decade-long effort to "Go Global" and become a fully fledged player in the corporate world, competing alongside private enterprises in the quest to build businesses with ambitious growth plans and attractive long-term returns.

But the deal has also raised fundamental questions about the role of aggressive state-owned enterprises (SOEs) from emerging countries.

As SOEs from countries like China, India and Brazil seek to increase their footprint in the global marketplace, western governments are facing pressure to ensure the SOEs operate under the same rules as investor-owned competitors from the developed world. Now, with CNOOC's bid for Nexen on the table, the world is watching Canada as Ottawa decides whether to approve the deal.

Skeptics worry that, in its hunger for resource capital, Ottawa is ignoring some fundamental risks associated with relying on national companies from China and other emerging markets that are controlled by regimes with little commitment to the marketplace or a level playing field in international trade and investment. Complicating Canada's decision on Nexen, Prime Minister Stephen Harper has openly wooed Chinese firms for investment during several state visits to Beijing.

Some say Canada should turn down CNOOC, arguing state-owned enterprises don't operate like western companies. Since the controlling shareholder is the government, an SOE has theoretically limitless access to capital and isn't under the same pressure for short-term results typically felt by private firms. It adds up to a government-engineered competitive advantage over public companies that must meet strict rates of return on investment, giving SOEs a leg up as resource companies around the world vie for attractive assets and companies. Critics also worry about foreign governments controlling strategic resources on Canadian soil.

"I think we need to ask the question: Do we want to see the nationalization of the business in Canada, except it's not nationalization by the Canadian government but by foreign governments," said Jack Mintz, a University of Calgary economist who serves on the board of Imperial Oil Ltd.

CNOOC and other Chinese and Asian companies are owned by their governments and - much like Air Canada or Petro-Canada from bygone days - they are seen as important vehicles for their home countries' national development, Mr. Mintz said. Canada's own development would be hampered by too heavy a reliance on inefficient, government-controlled companies, he said. He urges Ottawa to limit SOEs' acquisitions of operating companies to minority stakes.

Political reaction

CNOOC's move on Nexen has already raised red flags among some members of the Congress in the U.S. - where Nexen is one of the largest leaseholders in the deep water of the Gulf of Mexico and a partner in some of the biggest offshore discoveries. In a letter released Friday, Democratic Senator Charles Schumer urged the administration to block the deal until it could wring commitments from China to allow more U.S. investment there. While the Americans can't block the overall acquisition, they could force CNOOC to divest Nexen's lucrative Gulf of Mexico assets.

So far the CNOOC bid has not set off a political firestorm in Canada. Oil patch sources say the industry mood is nervously supportive of the deal, but officials would look less kindly on a foreign buying spree aimed at major domestic companies such as Suncor or Canadian Natural Resources Ltd.

That reaction is a reflection of the increasingly sophisticated and politically astute approach Chinese officials have taken in recent years, after some glaring missteps in previous takeover attempts.

CNOOC has carefully built an operating partnership with Nexen, won the support of the company's board with a fat premium on the offer price, and made key commitments that specifically address Ottawa's "net benefit" requirement for approving foreign takeovers.

Chinese SOEs have been pursuing global resource developments for more than a decade, at first in Africa, and then in South America, Australia and Canada, but have usually invested in undeveloped properties or minority positions as non-operating partners.

In reviewing the CNOOC deal, Ottawa will look for commitments that the company will operate in Canada in a strictly commercial fashion.

But critics suggest the Harper government has failed to erect a clear screening mechanism that would inform both Canadians and offshore investors what level of foreign acquisitions would be acceptable, and under what circumstances. And they point out the government has neglected to demand reciprocity, with the same right for Canadian companies to acquire Chinese assets as CNOOC and other SOEs have here.

CNOOC chief executive officer Li Fanrong said he's puzzled that there should be any doubt that his company's acquisition of Nexen will benefit Canada by bringing much greater financial heft to its oil sands properties, while locating CNOOC's headquarters for North and Central America in Calgary. And he vehemently rejects the view that CNOOC, like other Chinese state-owned enterprises, are agents of the Communist government in Beijing.

"Every decision we make is based on whether we can provide value to our shareholders," Mr. Li said in an interview after the deal was announced Monday. "We are purely a commercial entity."

Growing independence

CNOOC is a publicly traded subsidiary of Chinese National Offshore Oil Corp., which is wholly owned by Beijing. The parent company owns 64 per cent of the international subsidiary, whose shareholders include heavyweights like the Blackstone Group LP. (The New York-based fund has recently received $500-million (U.S.) in capital from China's foreign bank, which holds massive currency reserves.)

Mr. Li's assertion of independence is backed by a number of western analysts, including the International Energy Agency, the Paris-based advisory body to developed countries. In a report last year, the IEA concluded the three leading Chinese state oil companies - CNOOC, PetroChina and Sinopec - have gained considerable independence from the government department to which their parent companies formally report, and that their investments have been driven by commercial interests.

A series of papers released this year by the Canadian Council of Chief Executives and Canadian International Council reached similar conclusions. The leading oil companies are "profit-driven to their core," and are urged by their own government to "compete, compete, compete," wrote Margaret Cornish, a former executive director of the Canada-China Business Council and now chief representative of the Calgary-based law firm Bennett Jones LLBs in its Beijing consulting office.

Ms. Cornish said major Chinese firms market their oil wherever they can get the best price, rather than - as many critics fear - simply sending the crude to their home markets. And she said they rely on financial markets and their own balance sheets to fund acquisitions and operations.

In another paper, Georgetown University professor Theodore Moran assessed the security risks from Chinese state-owned investment, and concluded there is little concern when SOEs go after publicly traded resources companies that have little market power and no access to sensitive government information.

(As it was negotiating with CNOOC over a possible deal, Nexen met in April with Richard Fadden, director of the Canadian Security Intelligence Service. Neither side will discuss details of that meeting.)

In an interview, Prof. Moran said Chinese state ownership is not without its risks, adding that, through such firms, Beijing has been attempting to get control of the world market in rare earth metals that are critical for high-tech manufacturing. However, he said Chinese investment in the oil and gas business is generally regarded as a positive, even by the American government which is keen to see additional supply brought on to the global market.

But a U.S. congressional watchdog warns that Chinese firms remain tools of Beijing's effort to secure global resources for its growing economy.

"I don't know how anybody can look at the Chinese SOEs and believe they are normal players in a free marketplace," Carolyn Bartholomew, a commissioner with the U.S.-China Economic and Security Review Commission, said in an interview from Washington.

"The Chinese Communist Party exercises direct control over these companies, including appointing the boards and senior executives."

Ms. Bartholomew said the Chinese SOEs are deeply engaged in their government's efforts dominate the African resources sector, but conduct themselves differently - and more according to western standards - when they are operating in an OECD country.

In testimony before a congressional committee earlier this year, Ms. Bartholomew presented a scathing review of China's record of investing in resources in Africa, where its commercial interests coincide with a diplomatic effort to prevent western nations from intervening in the internal affairs of sovereign states to pursue issues of human rights, corruption, or protection of civilians in conflicts.

The commissioner said she wouldn't presume to tell Canadians how to respond to the CNOOC bid, but is hopeful the Committee on Foreign Investment in the United States - which is part of the Treasury Department - will "ask the hard questions" in reviewing its acquisition of Nexen's American assets.

Chinese firms continue to be major investors in Africa, but have shown they have their limits. China Minmetals Resources Ltd. was bested in a takeover tussle for Equinox Minerals in early 2011 by Toronto-based Barrick Gold Corp.

Australia still makes up most of China's outbound investment, but it is looking farther afield - to places like Brazil and Canada, and even the United States, as the Australian market offers few opportunities.

CNOOC had a political setback seven years ago when it attempted to take over California-based Unocal Corp., but backed away under a firestorm of adverse reaction. Minmetals had encounter a similar reaction with a similar result when it attempted to take over Noranda in 2004.

In Canada, CNOOC - like other Chinese energy and mining firms - has followed a cautious, incremental path, which was designed to increase its own confidence and the political comfort level of Canadians. It acquired a 17-per-cent interest in oil sands producer MEG Energy Corp. in 2004, followed that with a partnership with Nexen in the Gulf of Mexico, and last year, paid $2.1-billion (U.S.) for financially ailing OPTI Canada, whose sole asset was a minority stake in Nexen's Long Lake oil sands project.

For CNOOC, the Nexen deal provides numerous benefits. It gives it access to substantial market intelligence on the North Sea, whose production is critical to setting international oil prices. It also makes CNOOC the first Chinese firm to gain operational control of an energy asset in the U.S., which could be "a way for Chinese oil companies to raise their profile in the U.S.," said Erica Downs, a former CIA energy analyst who now studies China's international resource expansion for the Brookings Institution.

But perhaps the most important element is how "it's going to help them achieve their long-standing goal of not just being a national oil company, but an international energy company," Ms. Downs said.

Gaining Nexen's global scale will allow it to do that, she said, in part because it will be forced upon CNOOC. The strategies of operating in the developing world - using cheap government financing to gain leverage, using political connections and offers of infrastructure to gain access to resources - are unlikely to be viewed favourably in North America.

In fact, the way this large deal stands to transform CNOOC could be among its important elements, as Chinese firms take on an increasingly important global stature in the energy industry. It's worth recalling that a good number of the world's largest energy companies today - BP PLC and Total SA, as just two examples - started out as national oil companies.

"If you want to be an international energy company, you could market the argument that one of the best ways to get there is to go out and buy one and see what it's like," Ms. Downs said.

With files from Nathan VanderKlippe in Calgary.



Global reserves

Gross reserves (Nexen reserves before royalties, mmbbls)



Natural gas / 516

Syncrude / 324

In Situ oil sands / 319


United Kingdom / 256

United States / 122

Other / 43



natural gas / 799

Syncrude / 46

in situ oil sands / 891


United Kingdom / 139

United States / 166

Other / 39




A growing appetite overseas

Chinese overseas acquisitions in energy and natural resources by year of announcement

Value '01 to 2012 YTD

Annualized / $53.9 - b

Number '01 to 2012 YTD

Annualized / 126





In China, a history of blocked mergers

China's ambitious M&A activity abroad contrasts with the difficulty some international companies have encountered in transacting deals and other business inside its borders.

Coca-Cola: The most prominent example remains the Chinese government's rejection in March, 2009, of a $2.4-billion (U.S.) takeover bid by Coca-Cola for the country's leading juice maker, Huiyuan Juice. China blocked the takeover, which would have been the largest-ever buyout of a Chinese company by a foreign rival, arguing it would be bad for competition.

Carlyle Group: In mid-2008, the U.S. private equity firm lost a three-year struggle to buy a stake in Xugong Group Construction Machinery, the largest construction machinery manufacturer and distributor in China, amid domestic concerns the country was ceding control of key industrial assets to foreigners too cheaply. Carlyle originally proposed to buy an 85-per-cent stake in the Chinese company in 2005, and even scaled that back to 45 per cent in an effort to make a deal.

Diageo: It took the London-based maker of Smirnoff vodka and Captain Morgan nearly two years - and the involvement of British and Chinese leaders - to complete a deal in 2011 to take control of Sichuan Swellfun, China's fourth-largest premium white spirits maker by volume. The deal was considered a breakthrough after Coca-Cola's failed deal.

Google: The Web search engine is in a very public spat with the Chinese government over censorship, making it difficult to compete with the state-controlled search service.

Pav Jordan

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