Why Nexen is Different: The Politics of Supply

China National Offshore Oil Corporation

China National Offshore Oil Corporation (Photo credit: Wikipedia)

Earlier this week, CNOOC Ltd. (NYSE:CEO), China’s largest offshore oil and natural gas explorer, announced that it had agreed to pay $15.1 billion in cash to acquire Canada’s Nexen Inc. (NYSE:NXY) in the biggest overseas takeover by a Chinese company. The price tag that CNOOC put on Nexen represented a 61 percent premium over the company’s stock market value the day before the offer. Nexen’s board recommended the deal to its shareholders, but the deal is still subject to regulatory approval.

CNOOC’s announcement immediately brought to mind the company’s failed $19 billion bid for Unocal Corp. in 2005 that was blocked by strong political opposition in the United States, as well as the more recent failure of a $40 billion hostile takeover bid by Australia’s BHP Billiton Ltd. (NYSE:BHP) for control of Potash Corp. of Saskatchewan Inc. (NYSE:POT). In 2010, Canada’s Prime Minister Stephen Harper rejected BHP’s bid, saying it didn’t provide a net benefit to the country. It was only the second rejection of a foreign takeover in Canada in 25 years.

Clearly, CNOOC has learned a great deal since Unocal. In the Unocal transaction, CNOOC was competing with Chevron Corporation (NYSE:CVX), a U.S. company, for control of Unocal, while the bid for Nexen is a negotiated deal that is uncontested and has the full support of the company’s board of directors. Also, CNOOC has gone out of its way to reassure management and the Canadian government that Nexen will remain a Canadian company. CNOOC said it will list its stock in Toronto, keep Nexen’s employees and make Calgary its North American headquarters. The latter should help deal with the wild card of provincial politics in Canada.

Apart from these rather significant differences with the Unocal transaction, though, CNOOC’s bid for Nexen has a more fundamental difference that also distinguishes it from the proposed takeover of Potash. The Nexen transaction involves a company from a “consuming” country (China), purchasing a company from a “supplier” country (Canada). By way of contrast, Unocal involved a company from a consuming country (China), purchasing a company in another consuming country, in this case the United States. Similarly, the Potash transaction involved a company from a supplier country (Australia) trying to take over a company from another supplier country (Canada).

In Nexen, the interests of the two countries involved can easily be seen to be aligned, while it’s much more difficult to see alignment in either Unocal or Potash. In Unocal, the countries represented by the companies involved are in head to head competition for oil, while in Potash, the countries involved are competing for markets.

The respective leaders of large consuming nations such as the United States and China are understandably concerned about their country’s ability to have continued access to the natural resources needed to keep their economies growing. That’s why America’s dependence on imported oil is a constant theme in political campaigns.

It’s also why China, as the biggest energy consumer in the world and the second-biggest consumer of oil, has been snapping up resource assets across the globe.

However, supplier countries like Canada and Australia that have large stores of natural resources, but relatively smaller populations and economies, are most concerned about finding long-term, stable markets for their products. Developing and selling more of their natural resources is their path to prosperity.

Canada has the world’s third-largest oil reserves — more than 170 billion barrels — after Saudi Arabia and Venezuela. Daily production of 1.5 million barrels from the country’s oil sands is expected to increase to 3.7 million by 2025. Finding a reliable market for this output is one of Canada’s key concerns, and developing China as a long-term customer is a prime objective.

Moreover, CNOOC has an incentive, as well as the financial wherewithal, to accelerate development of the oil sands as well as Nexen’s Canadian shale gas prospects, boosting investment and tax revenues in the country. In this context, it’s easy to understand why the Nexen deal is likely to receive regulatory approval.

Canada’s essential problem is that the United States market currently absorbs approximately 97 percent of the country’s oil exports. As any businessman will agree, having one large, important customer can be a big asset for any company. It also represents a key vulnerability, as Canada saw first-hand when the Obama Administration rejected the Keystone XL pipeline, which would have taken oil from Alberta to the Texas Gulf Coast. Harper remains determined to build a pipeline to Canada’s Pacific Coast where tankers can then be filled to supply needs in China and Asia.

It’s no coincidence, therefore, that Harper visited China to discuss oil sales and other economic ties shortly after U.S. rejection of the Keystone pipeline. In February, Harper headed a delegation of 40 Canadian business leaders to China. While in Beijing, Harper met with President Hu Jintao, Premier Wen Jiabao and other top Chinese officials.

Harper’s visit to China highlighted Canada’s determination to diversify its energy sales. Chinese state-owned companies have invested more than $16 billion in Canadian energy over the past two years, and Chinese state-controlled Sinopec has a stake in a proposed Canadian pipeline to the Pacific Ocean that would substantially boost Chinese investment in Alberta oil sands. Overall, trade between China and Canada surged to almost $50 billion in 2011.

If anything, the failed bid for Unocal in 2005 taught CNOOC not to “fight the tape.” Deals for critical natural resources such as oil will come much easier if they are done with companies in countries whose interests are more naturally aligned with those of China.

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