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 go through.
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 trade.
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 the US.
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 Nexen’s home.
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 November.
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.