The CNOOC-Nexen deal

Aug. 6, 2012
A decision due from the Canadian government will influence the competitive framework for oil and gas investment around the world.

A decision due from the Canadian government will influence the competitive framework for oil and gas investment around the world. No matter how Ottawa rules on the proposal by CNOOC Ltd. to buy Nexen Inc. for $15.1 billion, the Chinese company and other state-owned enterprises (SOEs) will continue to invest in oil and gas projects, Canadian and otherwise. They have capital. Energy projects need capital. The two will come together. It's the interplay between an acquisitive SOE and a host-country government that bears attention.

Canadian Prime Minister Stephen Harper expressed appropriate caution when he warned Canadians not to assume his government will approve the deal, despite its earlier assurances to China that Canada is open for business. If the prospective buyer were a privately owned company from Europe, Asia, or India, the decision would be more straightforward. Because CNOOC is majority-owned by the Chinese government, however, the decision is more complicated.

'Net benefit'

The Investment Canada Act compels Ottawa to decide whether a large foreign investment proposal promises "net benefit" for all of Canada. CNOOC's bid for Nexen easily qualifies as large. And the Chinese company has been careful to offer benefits to Canadians, promising to base Nexen's North and Central American businesses in Calgary, to maintain existing management, and to list shares on Canadian exchanges. The investment will give Nexen's struggling Long Lake in situ project in the Alberta oil sands fresh life. The prospective economic benefits are clear.

When a foreign government owns the buyer, however, more is involved than the financial prospects of a single company with valuable oil sands properties and expansion of a corporate presence in Calgary. The Canadian law gives Ottawa latitude to interpret net benefit broadly. The government should avail itself of the flexibility.

The net-benefit doctrine legitimately encompasses matters of commercial diplomacy. CNOOC and other Chinese SOEs already own large interests in oil sands projects and Canadian companies. Their capital has received a warm Canadian welcome in a large industry that needs it. The Nexen takeover therefore might be construed as just a logical step along the ownership spectrum.

But is it a step that a Canadian company might as easily take in economically vibrant but still centrally managed China? No. Ottawa can't expect CNOOC's home government to restructure its business model. But it can and should ask what doors might open in China for Canadian companies if the Nexen deal proceeds. Reciprocity is fundamental to relations between governments and properly comes into play in business transactions involving SOEs.

Competitive fairness and motive should be on the Harper government's agenda, too. CNOOC enjoys the financial backing of its principal owner, which has foreign-exchange reserves of $3.3 trillion, largest in the world for a single country. The advantage in access to capital enabled CNOOC to offer a premium to Nexen's stock-market value of 61%. While this clearly benefits owners of Nexen, which is rumored to have been for sale awhile, the prevalence of knockout bids by Chinese SOEs for oil and gas properties skews competition.

This isn't just a harsh reality of international business. Aggressive Chinese investment through oil and gas SOEs is partly strategic. The government craves oil for a large and rapidly growing economy. It has the right to pursue its interests internationally, of course. But its strategically shaped investment behavior skews international competition for oil and gas properties. Ottawa and other governments have reason, even the compulsion, to question it and expect compensation.

Diplomacy required

None of this means CNOOC shouldn't be allowed to buy Nexen—or the next private company it craves, wherever that might be. It means involvement of a strategically motivated SOE raises issues only governments can address, issues requiring diplomacy.

Harper is right to want to move slowly and thoughtfully. His decision will set a precedent. CNOOC's takeover of Nexen won't be the only deal like this. And China's oil and gas companies aren't the only SOEs craving acquisitions.