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
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
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
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
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