The Nexen Deal: Chinese Imperialism or Plain Old Oil Patch Economics?

The tie-up has exposed the nationalistic sensibilities that always seem to bubble under the surface of Canada’s resource sector. Foreign companies are seen as rapacious vultures sweeping in to expropriate Canada’s mineral and petroleum riches. Rarely are they seen as stable surfeits of capital necessary for ensuring the competitiveness of an industry that is extremely cost-heavy and run by a few major multinationals with very deep pockets.

We saw it when BHP Billiton (NYSE:BHP,ASX:BHP,LSE:BLT) tried to swallow up PotashCorp (NYSE:POT,TSX:POT) back in 2010, when Sinopec last year closed a $2.2 billion deal with Daylight Energy (TSX:DAY), and we’ll see it again, without a doubt, as more of these mega-resource deals are struck.

China moves from stakeholder to acquirer

Anyone who understands the history of the Canadian oil industry will know that foreign ownership of the resource is nothing new. As Peter Tertzakian points out in a recent Globe and Mail article, China is really just replacing the United States as Canada’s most important oil industry benefactor in the latest “Great Scramble” for oil:

“U.S. companies were quick to recognize the potential of Western Canada 60 years ago, and were instrumental in providing the capital to invest in and develop our resources. In return, the tacit deal was for Canada to be the dominant supplier of foreign oil and gas to the U.S.,” he writes.

Companies like Exxon Mobil (NYSE:XOM), Royal Dutch Shell (LSE:RDSB), Chevron (NYSE:CVX), and BP (LSE:BP,NYSE:BP) set up shop, followed by Canadian oil sands anchors Suncor Energy (NYSE:SU,TSX:SU) and Canadian Natural Resources (NYSE:CNQ,TSX:CNQ), among others. But now, these familiar players are being forced to share the field with developed-nation newcomers like CNOOC (NYSE:CEO,HKEX:0883) and China National Petroleum. These state-backed companies are driven to secure more oil resources for China, which since 2002 has been a net importer of the oil it requires to fuel double-digit economic growth. It is no surprise that they are looking to Canada because like the United States it is one of the few remaining safe, democratic countries with accessible oil. What’s more, around 75 percent of the world’s oil supply is owned by state-run enterprises, meaning it’s not for sale, and Canada is estimated to contain half of the remaining oil reserves that are free and open for competitive bidding.

For decades the United States was the foremost customer for Canadian oil, but that is beginning to change for two reasons. First, the US is becoming more self-sufficient and less reliant on Canada for its oil as big oil plays like the Bakken bring more and more barrels to the domestic market. Second, the drawbacks of having a single buyer, the United States, have become evident lately, as was clearly demonstrated by the US government’s rejection of the proposed Keystone XL pipeline. Landlocked Canadian crude, which sells at a discount to the US West Texas Intermediate benchmark, needs pipelines to relieve the supply glut pushing down the price, and the Canadian government, which backs the pipelines despite environmental opposition, has begun to see the advantages of diversifying its oil customer base. China knows this, and is an important reason why overtures by Chinese companies for Canadian oil plays are not being turned away by politicians in the national and provincial capitals.

Notable about the bid for Nexen is that compared to previous incursions by Chinese companies, China is no longer content to be a bit player in Canada’s oil sands. The offer by CNOOC, which stands for China National Offshore Oil Company, is a 61 percent premium to Nexen’s $27.50 share price, which is a good indication of how badly China, and its proxy CNOOC, wants to control the company and its share of oil production. Indeed, CNOOC is already a 35 percent partner in Nexen’s Long Lake oil sands project, which uses the steam-assisted gravity drainage method to pump out up to 72,000 barrels of bitumen per day.

Jeff Rubin, Canadian resource economist and author, points out that the deal indicates “how far the goal posts have moved” because even a few years ago it was “unthinkable” that a Chinese corporation could lock up a Canadian oil company like Calgary-based Nexen, which actually only produces 30 percent of its oil domestically (the rest is sourced from the North Sea, West Africa, and the Gulf of Mexico). Today, “that’s all changed,” Rubin writes, citing a number of recent foreign transactions in the Canadian energy sector, including:

• a $5.5-billion bid for Progress Energy Resources’ (TSX:PRQ) natural gas reserves in BC by Malaysian energy giant PETRONAS;
• PetroChina’s deal earlier this year that allowed it to snap up Athabasca Oil Sands for $2.5 billion — the first time a Chinese company has made an outright Canadian oil company acquisition;
• the $4.65 billion paid in 2010 by Chinese state-owned Sinopec for a 9 percent stake in Syncrude Canada.

“As the Nexen deal shows, Calgary’s economic compass, which used to point south to Houston, is now being drawn east to Beijing,” Rubin states.

The Americans push back

Perhaps surprisingly, considering that Nexen is Canadian and the deal has to be approved by the Canadian government, the greater push back is occurring south of the border. Last Monday, senior Democrat Edward Markey, a key congressional leader, urged the Obama administration to block the deal because it includes leases on just over a million acres in the US-controlled Gulf of Mexico.

“I believe this merger could lead to a massive transfer of wealth from the American people to the Chinese government,” Markey wrote in a letter to the US Treasury secretary. In the letter, quoted by the Toronto Star, Markey argues for a renegotiation of offshore oil royalties and for Nexen and CNOOC to relinquish ownership of the leases.

It’s not the first time CNOOC has clashed with the US government. Seven years ago the company tried to take control of California-based Unocal, but received a hostile reception from Washington. The United States does not have the power to block the current deal but could force CNOOC to divest itself of it Gulf of Mexico assets, which would prove costly to the new corporate entity.

Good corporate citizen?

Back in Canada, questions are being asked about what kind of corporate citizen CNOOC is likely to become when given free reign to operate in a foreign (Canadian) jurisdiction. China’s involvement in Zambia is not an act that CNOOC would want to follow. As reported in The Guardian, a Zambian textile factory financed by Chinese money has been shut down, throwing over a thousand people out of work, while employees at Chinese-owned copper mines in Zambia have gone on strike to demand higher pay and better working conditions.

Critics of the Nexen deal argue that state-owned enterprises like CNOOC do not operate like western companies since they are controlled by the Chinese government, which has an endless supply of capital through a tax base. They are also concerned about foreign entities controlling a strategic resource like oil. However, recent reports, including one by the Paris-based International Energy Agency (IEA), speak to the growing independence of Chinese companies from their government paymaster. The IEA’s report states that China’s national oil companies “operate with a high degree of independence from the Chinese government” and that ” far from puppet companies operating under control of the Chinese government, as many have assumed … [t]heir investments in recent years have been driven by a strong commercial interest, not the whim of the state.”

Last weekend, CNOOC chief executive Li Fanrong was reported by The Globe and Mail as saying that he is “puzzled” that there are doubts that the acquisition will be a net benefit to Canada. He commented, “[e]very decision we make is based on whether we can provide value to our shareholders. We are purely a commercial entity.” The company is publicly traded and its shareholders include The Blackstone Group (NYSE:BX).

Richard Dixon, a University of Alberta business professor and commentator on the Canadian energy industry, said CNOOC made a sly strategic move in promising as part of the deal to move the company’s headquarters to Calgary. Dixon explained that with the hollowing out of the number of head offices in Canada — including Shell Canada — basing CNOOC in Calgary would be looked on favorably by the Canadian government, since corporate head offices confer a number of advantages, including research and development. “It would certainly help the deal,” said Dixon.

Dixon said one of the biggest questions is whether a foreign company like CNOOC is going to push back against environmental regulations as some American companies have.

“They’ve got to live up to our expectations of a good corporate citizen. And for me, one of the measures is pushing back against polluter pays principle … that runs to the heart of Canadian environmental law.”

As to the argument that state-owned companies have an unfair competitive advantage, Dixon disagrees, saying that Canadian industry players have deep pockets too.

“I think the issue with deep pockets is how do our energy services sectors benefit from that, and as long as it’s open competition, then we will benefit.”

Securities Disclosure: I, Andrew Topf, hold stock in Canadian Natural Resources.