UNDER Canadian law, China National Offshore Petroleum
Corporation’s (CNOOC) proposed $15.1 billion
($15.4 billion) takeover of Nexen must pass a net benefit test
to determine whether it is in Canada’s public
interest. There are plenty of reasons to expect the deal will
Most of Nexen’s operations lie outside Canada:
in the UK North Sea, the Gulf of Mexico and Africa. Those in
Canada account for a quarter of Nexen’s portfolio
and are not considered vital national interests.
Throwing Nexen to the wind is a small price to pay to
cultivate a closer trading relationship with China to offset
Canada’s overwhelming reliance on the US, which
buys about 99% of the country’s oil and gas
exports and accounts for more than 80% of its overall
In light of the US administration’s delays to
critical pipeline projects like Keystone XL, Canada is
determined to send the message to Americans that if they
don’t buy oil-sands crude, China surely will.
On every other count, though, it’s hard to see
how the deal passes the net benefit test.
If the goal is to sell high and allow the Chinese into
paying premium prices for sub-par assets, then it surely fits
the bill. But if the public interest is determined on capital
discipline, a free flow of commerce and efficient development
of Canada’s oil-sands resource, the deal
doesn’t meet the grade.
This is not about nationalist politics on either side of the
Pacific Rim. Independent economic analysis increasingly shows
that CNOOC is bringing little in the way of technology, access
to Chinese markets or any kind of operational expertise to
Canada’s oil-sands table.
In an examination of the deal, Toronto-based Dominion Bond
Rating Service (DBRS) said there is no reason to sell Nexen
– apart from the 60% premium CNOOC seems more than
willing to pay for the company’s chronic
underperformance on North American stock exchanges in Toronto
and New York.
Despite a sagging share price, DBRS notes that Nexen has no
trouble accessing credit and equity markets; that it generates
sufficient cash flow to fund future development projects and
meet capital spending obligations.
In fact, allowing the deal to proceed may not meet the net
benefit test because it distorts the fair value of the assets
being acquired to the detriment of domestic players. Allowing
CNOOC to over-capitalise Nexen’s oil sands will
inevitably lead to higher cost inflation and operational
inefficiency, compounding chronic shortages of manpower and
materials in Canada’s energy sector.
It’s true CNOOC may be a publicly traded
westernised corporation, but its willingness to pay such a
hefty premium for Nexen seems to run counter to any
conventional business rationale used by western firms. If Nexen
is such a prize, why hasn’t a western major like
Total or Shell made a counter-offer?
That’s because CNOOC’s government
backing – either real or perceived – gives it
a cheaper cost of capital and other competitive advantages not
enjoyed by its western peers.
Critics have also raised the issue of reciprocity: would
China let Nexen take over CNOOC? Probably not.
But according to DBRS, it’s not clear why the
shoe shouldn’t be on the other foot. The credit
rating agency seems to suggest that Nexen has more than enough
financial resources, technological and operational expertise to
control CNOOC, not the other way around.
"This transaction is not necessary, as Nexen remains a
strong operator with good access to capital markets. Moreover,
foreign investment could add greater value if it was directed
towards smaller companies, which may have limited access to
funds, higher operating costs due to lack of economies of
scale, operate in riskier areas, and reduced access to
technology and research and development."
So the deal only makes sense from a political perspective.
Canada’s government wants to be seen as open for
business and is keen to expand trade ties with China.
Since 2007, about $28 billion has been spent to acquire
Canadian oil-sands assets; the Nexen deal would push that
number to $47 billion. National oil companies have funded more
than half of that investment, and only 30% has come from
domestic firms. The rest comes from outside Canada, mostly from
Nexen has as much as 6 billion barrels of contingent
oil-sands resources spread across 300,000 acres in northeastern
Alberta and is already a partner with CNOOC in the Long Lake in
situ project, which produced 30,000 barrels per day (b/d) in
the second quarter.
Given that most of Nexen’s operations are
self-funding – as are those of most other large
oil-sands players – it’s not clear why
outside foreign investment benefits Canada in this case.
There are growing signs that others in Canada agree. A
recent survey of Canadian corporate executives by polling firm
C-Suite found that 50% oppose the deal without special
conditions. Not surprising, support is strongest in the oil
industry itself and especially in Calgary,
Canada’s oil patch capital and
The high level of uncertainty is reflected in
Nexen’s shares, which are trading 10% below
CNOOC’s offer price of C$27.50. On 12 October,
they closed at $25.30 on the New York Stock Exchange.
This represents the scepticism among investors that Canada
will let the deal go through. The fears were compounded on 11
October after Canada’s industry ministry extended
the mandatory review period by an additional 30 days, until 11
Little wonder CNOOC is making promises to locate its North
American headquarters in Calgary, alongside promises not to cut
staffing levels for five years. These are conditions that test
the notion of free markets on the part of the Canadian
government – no western firm would willingly agree to
such onerous terms without some other non-financial motive.
Is it to secure oil supplies and repatriate them to the
Chinese mainland? For now, there is no way to export oil from
Canada to China without a pipeline to the west coast.
Opposition to allowing oil tankers in Canada’s
coastal waterways makes it unlikely that such a pipeline will
be built this decade, if at all.
For the Chinese, Nexen is all about expanding its footprint
in North America and abroad. Nexen is a relatively small and
weak player, albeit a global one. China is hoping it is the
least controversial entry point to gaining credibility in the
world market, after its disastrous attempt to buy Unocal in
2005. Nexen will be its largest foreign takeover to date.
Canada has committed to engagement with China, and it is in
the national interest to expand trade ties.
That’s why the deal will proceed. But not
without a lot of hand wringing and soul searching between now
and 11 November.