This article appears in the January, 2014 issue of Oilweek
China
is an oil-producing superpower. Last year the country’s state-owned oil
companies spent $35 billion buying foreign assets. One result: the country’s
state-owned enterprises (SOEs) now produce almost as much oil outside the
country as such OPEC kingpins as Kuwait and the United Arab Emirates. These
overseas acquisitions are being operated as commercial investments, in the
sense that oil from far-flung businesses is mostly being used to supply
traditional markets. Add those volumes to China’s position as the world’s fifth
largest producer from domestic fields and the quick result is a network of
state-owned enterprises (SOEs) that are global in scope.
Since the start of 2009, Chinese national oil companies such as China
National Offshore Oil Corporation and China Petroleum & Chemical
Corporation (Sinopec) have spent more than $100 billion on overseas oil and gas
– a sum which includes CNOOC’s contentious $15.1-billion takeover of Nexen Inc.
Canada’s
response to that takeover was quite different from the US response to a Chinese
“threat” in 2005. In that year, CNOOC made a hostile $18 billion bid for
Unocal. Although CNOOC offered more for Unocal than Chevron, the Chinese firm had
to back down after American lawmakers denounced the deal as a threat to
national security.
When it made its big bid for Nexen, CNOOC had clearly learned
from the Unocal debacle. The company announced that its head office for the
Americas would be in Calgary, its shares would be listed in Toronto, its
capital investment would increase and the new firm would continue its oil sands
development. Also, the company offered a premium of more than 60% for the
shares and got approval in advance from Nexen’s board. At about the same time,
Malaysia’s Petronas acquired Calgary-based Progress Energy, paying a 77%
premium.
An
executive with a senior bitumen producer summed up the present situation thus:
“From the government policy perspective you can now do property deals all you
like, but SOEs aren’t allowed to buy companies. The problem from the industry’s
perspective is that it put a ceiling or constraint over the equity value of all
of the entities involved. That set an expectation that is no longer reflected
in the shares of other companies. The government was concerned about this, and came
in and said ‘We’re not going to allow this again.’”
The
shareholders of Nexen and Progress did well, but did Canada? No, says the
University of Calgary’s Jack Mintz – an economic thinker whose advice generally
gets a sympathetic ear in Ottawa. “Right now you’re in a situation in these
countries where they’re not interested in return on capital, but just buying
assets around the world without real consideration of value.”
An
associate dean at the University of Alberta, Edy Wong begs to differ. “The question didn’t arise when Statoil came into Canada,”
he says. “The problem is that [Canadians] don’t understand [or trust] the
Chinese regime. The government has five-year plans and they set goals. They
might want to do more investment overseas to develop better energy security.
They will then, for example, make preferable loans to SOEs to buy these assets.”
However, he continues, “The Chinese are soon going to have the biggest economy
in the world, and they are going to develop it their own way. We have to live
with that. China has 1.3 billion people, a huge economy, and they are looking
for energy security. It is the size of China that is creating the problem.”
Jack
Mintz disagrees. He notes that in a free market, takeovers play an important
and specific role in business development. “A takeover market should be an
important way of replacing bad management with better management. It creates
certain synergies that otherwise wouldn’t be available….In the normal state of affairs,
companies do buy out companies, and the result is a more efficient sector.
However in the case of a [high-premium] takeover by an SOE, that doesn’t
happen.”
Mintz
notes that in the last few decades Canada has privatized its government-owned
petroleum companies. Indeed, “countries around the world have undertaken a
whole spate of privatizations of publicly-owned companies to make them more
efficient and create a more dynamic and productive business sector. Why should
we let Chinese state-owned enterprises come in now and dominate our petroleum
sector? When you look at the performance of these companies, they historically
have not done very well. They are not efficient despite efforts by the Chinese
government.”
Once
again, Wong differs. “China has earned a lot of money by degrading their
environment and now they have to convert that money into something which
benefits them. When the Chinese buy resources to develop, it is so they can
continue to produce goods which they sell to Europe and North America. This
arrangement is in [Canada’s] interest.
Mintz
acknowledges that the Chinese are learning to be technologically advanced and
that the country has experienced remarkable growth in recent decades. However, “the
Prime Minister was extremely concerned about keeping our [petroleum] industry
competitive [and created a new policy regarding takeovers by SOEs]. The bigger
question is why only the oil companies are governed by this policy.”
Wong
again has a different take. “Let’s remember that our government went overseas
to China and almost begged for new investments. We did that in China and we did
that in India. We went to China and said ‘We want your investment.’ [Mr. Harper
and his team] then came home and said the mission was very successful. But [Canadians]
said ‘We don’t want the Chinese owning our resources,’ and they had to
backtrack.”
A Different Kind of Beast
From
Wong’s point of view, China has become “the kind of animal” that Canadians just
don’t understand. “The Chinese are now creating a new way of doing business and
we don’t know where it’s going. They call it state capitalism, and there is
more competition in China then there is in Europe or North America. The Chinese
economy is very market-oriented, but very often the competition is between
different SOEs [like CNOOC and Sinopec]. For the Chinese, industries like
aircraft manufacturing and energy are strategic. It’s just like in Canada: we won’t
let someone come into this country and buy a bank. The new policy has more to
do with political and cultural considerations than with real economics.”
Since
the announcement of the new policy a year ago, the collapse in many Asian
currencies has made Ottawa’s new policy more or less irrelevant. Japan because
of its monetary policy, but also Australia, China, India and Pakistan are now
in much weaker positions in terms of buying Canadian assets. As far as Mintz is
concerned, that makes no difference. “It’s true that the exchange rate problems
in Asia have made capital that we thought was available for the oilsands
unavailable. But investment can come from anywhere – there is a world capital
market. We don’t have to take it from SOEs. Europeans are a very significant investor
in Canada, for example. It will be interesting to see what’s going to happen as
a result of the free trade agreement between Canada and the European Union.”
An
executive with a senior bitumen producer said anonymously that the business
environment since the Nexen takeover is not good. “It certainly doesn’t help
that Western Canada Select [the Canadian heavy oil benchmark] is once again
trading at a discount of over $40 to West Texas Intermediate crude. Penn West
has light-oil assets and EnCana has loaded up on natural gas, but the
increasingly grim outlook for [bitumen sales] doesn’t help even their prospects
much.” He doesn’t expect more Asian SOEs to buy Canadian companies. “First, the
government might not let them; second, nobody wants to get into the process
that the Chinese got into over Nexen, where you make an offer and you go
through a lot of lobbying to get approval. They got approval, but only on the
basis that they were the last one through the door.”
Geoff
Hill of Deloitte agrees. A chartered accountant by background, in the interest
of full disclosure he notes that his firm is auditor for both Nexen and CNOOC,
and that he therefore can’t discuss issues related to the books. Because he
provides business advice to clients, he is deeply concerned about the clarity
of the government’s rules. They are “ambiguous,” he says, “and that has created
angst among foreign investors. They are restrictive and that too has created
angst among foreign investors. The real question when it comes down to the
specifics of any deal is how the rules will play out.”
He
wants clarity in the system. “Foreign investors still view Canada as a good
place to invest, but they have a very short claw-back time in terms of getting
their money out. They are now less certain about their investments in this
country. What always makes investors nervous is uncertainty, and other elements
of the Canadian landscape aren’t easy for foreign investors. Besides the
federal and provincial policies, there are municipal and first Nations
jurisdictions. Having so many overlapping jurisdictions can make foreign investors
nervous about working in Canada.”
The
federal government is aware of this concern. In a recent speech, the Prime
Minister acknowledged the complaints about lack of clarity, but was unabashed. “I
would put it this way,” he said. “There is margin for the government to
exercise its judgment…. In my opinion, when you are dealing with large state
investors, foreign governments as the investor, I think it would be foolish for
the Canadian government to provide absolute clarity. It is absolutely
necessary, when the investor is a foreign government, for the government of
Canada to be able to exercise its discretion and have direct conversations with
those foreign investors”
According
to Hill, “As a Canadian you can see the logic of this. But as a foreign investor,
you would be concerned. [For example], if your plans are to understand Canadian
technology and the complex geology and geoscience of Canada’s landscape and to
take some of that knowledge back to your country, you want clear rules.”
The Impact
A
key element of the policy is that it does not impose limitations with respect
to joint ventures. What SOEs can do is earn an interest in an oil sands
property by investing in its development. Unfortunately for that strategy, the market
has changed a lot in the last year – especially because of problems with market
access – and foreign partners are increasingly hard to find.
Athabasca
Oil Corp. has been looking for Chinese friends since before the new policy went
into place. Though it came close last year, that was then and this is now. Like
most bitumen producers, the company’s share price dropped in the post-Nexen
environment – in Athabasca’s case, by two-thirds from an $18 high. One of the
few analysts to tip it as a good buy is Eric Nuttall of Toronto-based Sprott
Asset Management. In his view, the company may soon ink a deal by which it will
receive $3.30/share in cash from PetroChina, for a joint venture in Canada.
That “could lead investors back to the story after a few very frustrating years,”
he says, adding that Athabasca’s asset value exceeds $10/share.
The
big decline in the company’s share price reflects new market conditions, but
more importantly it echoes the new policy environment. After all, other oil
sands companies have not seen such precipitous price drops. “Why are SOEs so
different?” Geoff Hill asks again. “At present, a lot of Canada’s resources are
controlled and produced by foreign companies, but the reserves are still owned
by Canada or the provinces. So what’s the fuss? The Canadian government should provide the
investment community and the Canadian public with an explanation of what the
rules really are.”
