August 1, 2012

China Watch: CNOOC/Nexen

August 1

CHINA WATCH: CNOOC/NEXEN

Is the Chinese cat among the Canadian pigeons?

It is, to judge from the reaction to CNOOC’s $15.1B bid for control of Nexen Incorporated.

In contrast to the mild and limited response to last year’s $2.2B Sinopec/Daylight acquisition or CNOOC’s own $2.1B purchase of Opti, public and commentariat opinions on this latest proposal have been both noisy and seriously divided. Not surprising perhaps, given the deal’s size: the value of this transaction, if it succeeds, is said to be the largest single Chinese foreign direct investment on record.

It is as if the actions of Chinese State Owned Enterprise in Canada, even if viewed warily, are ok within the weekly range of buys and sells appearing in the Report on Business: it is another matter when something this big comes along.

The divide is between those who oppose these deals in principle (Diane Francis, hardly a left-winger: ‘…the proposed takeover of Nexen Inc. by CNOOC, or any other like it, cannot be allowed…The foreign buyout of resource, infrastructure and agricultural corporations simply has to stop…’) and those who see it as, prima facie, business as usual (Jim Prentice, hardly a right-winger: ‘the most important contextual factor is that Canada is a small country with big ambitions and a massive resource base and we need foreign capital to realize our potential’). On that point, a Conference Board study of Chinese FDI in Canada recently pointed out that 44% of the increase in Canadian inward FDI between 2008 and 2010 was attributed to Chinese investment.

The facts that more than three quarters of Nexen’s assets are abroad; that US Senator Charles Schumer calls for reciprocity if Nexen’s Gulf of Mexico assets are acquired by China; and that the SEC now suspects various players of insider trading will add yet more complexity when the Foreign Investment Canada and the Prime Minister’s Office take out their magnifying glasses and read the fine print of the proposed deal.

Surely, the back-drop to the Government’s internal deliberations will also include two significant factors: the international performance, so far, of Chinese SOEs who have made major investments abroad; and the geopolitics of permitting or rejecting the bid.

The reality is that the largest Chinese foreign investors are State Owned Enterprises. That’s the way the current Chinese system, with its national champions, works. Their Boards are populated by inside managers and, as in the case of CNOOC ‘Independent Non-executive Directors’,  there is only a pretense of independence from their owner: the Government of the PRC. All of these companies also have Party Secretaries. They variously report to the State Council, the National Development and Reform Commission, the State Assets Supervision and Administration Commission and their generic sectoral ministries. That’s the way it is.

Their corporate objectives, say, in resources and energy have evolved from insuring supply, to development of new sources, to taking equity positions to corporate control, such as has been the case with Daylight and Opti and perhaps Nexen.

Some SOEs have demonstrated – so far – good and beneficent performance. Volvo was purchased by Greely in 2010 and is apparently doing well. A Peterson Institute for International Economics study of the performance of 34 Chinese natural resource investments in Latin America concluded that ‘25 of them help to diversify and boost the competitiveness of Latin American natural resources’.

Some SOEs have been like bulls-in-a, you got it, China-shop: the Wall Street Journal has extensively reported on Sino-Iron in Australia, which has transformed what was to be a $2B investment project into a $7B plus and counting venture with no end, or production, in sight. No private Board or shareholders would put up with that.

In other words, Chinese firms will likely run the gamut of performance, whether SOE or not. Meaning that the Canadian Government will be looking closely at the CNOOC bid details regarding governance, commitment to observing Canada’s regulations on transparency, labor, environment and so forth, so that CNOOC Nexen remains in substance a Canadian company and, as they say, it brings a net benefit to Canada.

The geopolitics are equally complex: Mr. Harper’s Government and members of his Cabinet have been trooping to China, very much as their Liberal predecessors did, to give substance to the continuing objective of building a country to country, business to business, society to society relationship that is of such complexity and breadth as to be truly strategic. The Government’s energy export strategy could not be more explicit. The ‘open for business’ rhetoric could not be clearer. A privileged trade agreement is being negotiated.

And the geopolitics cut both ways. Given the size of this deal, it’s implications for future FDI relations between Canada and China, and the US dimension, one can be confident that it has received the blessings of the highest levels of the Chinese leadership, looking at the big picture.

Relevance to Canadian business: Perhaps the Government, in its deliberations, will also view things from the long term, macro perspective. The focus, structure and leadership of Canadian business – as with business everywhere – is in constant evolution, with the mix of winners, survivors and losers constantly changing. A company deemed a national asset at one given time is transformed or it has disappeared in the next. All governments – and those who comment on their decisions – should be cautious about what they think needs to be set in stone.

Most individuals and institutions who sell their shares, including those registering substantial profits, largely keep their money in circulation: few stuff it in mattresses. If Nexen is sold, the capital generated will be used in other, perhaps new businesses. That’s the way the system is supposed to work, and that is the way that, generally, it does.

Oh, and regarding the 61% premium that CNOOC has offered to Nexen shareholders, it might be useful to keep the following in mind: in 1989, Mitsubishi Real Estate bought the Rockefeller Center in New York from the Rockefellers, at what was generally viewed as a wildly inflated price. It was. Within less than a decade, do you know who owned the Rockefeller Center? David Rockefeller (with a bit of help from his friends).

Joseph Caron