It’s a Big Deal – China’s $18.5 Billion Bid for Oil
CNOOC Ltd., a unit of China National Offshore oil Corporation, has made an unsolicited bid of $18.5 billion to acquire Unocal Corporation. China National Offshore oil is a state-owned Chinese company, while Unocal is one of the largest US-based independent oil and gas exploration and production companies. The offer, part of an ongoing Chinese quest for resources, has set off a wave of discussions over US and Chinese trade policies. The deal is further complicated by the fact that Unocal recently accepted a takeover offer from Chevron Corporation.
CNOOC stated that its cash offer represents a premium of about $1.5 billion over the Chevron offer after accounting for the Chevron deal’s $500 million breakup fee. Unocal has said that it would consider the CNOOC offer but its current recommendation of the Chevron deal remains in effect. Unocal is highly active in Asia. The company has assets in Thailand, Indonesia, Myanmar, and Vietnam that account for more than half its worldwide reserves. The deal, which would be China’s largest overseas acquisition, would more than double CNOOC’s production.
China’s Quest for Resources
Energy deal making has dominated China’s foreign policy over the last two years. Energy resources are important to China’s continuing development. The country is trying to modernize its economy and secure the fuel that a modern industrial nation requires. As the country’s energy needs grow, it comes into competition with other world powers, including the US, for resources.
A decade ago, China exported more oil than it imported. In 2004, the country became the world’s second-largest importer, after the United States. Due to inefficiencies in China’s economic structure, the nation consumes three times as much energy per dollar of output than the world average. China is developing superhighways and large modem cities, increasing the nation’s fuel demands. China is wary of becoming heavily dependent on imports while it does not control major international oil reserves.
It is easy to see CNOOC’s bid for Unocal as driven by the Chinese government’s desire to build global enterprises with international resource holdings. The fact that CNOOC is a state-controlled entity invites political analysis of the deal. It is also possible, however, that the deal is primarily motivated by business factors. Wang Zhen, dean of the business school at the China University of Petroleum, has described the deal as being more about CNOOC’s commercial interests than national energy security. According to Professor Wang, the energy security question is a long-term issue that will not be solved by the acquisition of a few oil fields.
The $18.5 billion offer is clearly receiving support from the Chinese state. As part of the financing for the deal, CNOOC is being allowed to borrow $7 billion from its state-owned parent corporation at below-market rates. China National Offshore oil is providing a 30- year $4.5 billion loan at a rate of 3.5 percent nd an interest-free bridge loan of $2.5 billion. Current 30-year US treasury bonds have a rate of 4.2 percent.
“It’s like the government giving it a subsidy,” claims Michael Cuggino, the president of investment management firm Pacific Heights Asset Management LLC. Yang Hua, the Chief Financial Officer of CNOOC, sees it differently. “I don’t agree that the bid is a government-backed pursuit,” Yang stated. “We got great support from the parent company financially and the deal is also in line with its interests.”
US Policy
US economic relations with China are currently a big issue. In the US, CNOOC’s bid for Unocal is being seen as a sign of China’s emerging ambitions as a global economic power. The unsolicited offer comes at a time when oil prices are reaching $60 per barrel, energy reserves are in high demand, and the United States is concerned about its own oil and gas resources. Congress is also currently considering legislation to respond to alleged Chinese intellectual property violations and illegal export subsidies.
If Unocal enters an agreement with CNOOC, the deal would be subject to review by the Committee on Foreign Investments in the United States. The Committee is a federal multiagency group with the authority to prevent foreign investments on the grounds of national security. Unocal is in the difficult position of weighing the higher monetary value of CNOOC’s bid against the risk that the deal may be blocked in Washington DC.
In the past, the US government has exercised its power to place restrictions on the extent of foreign ownership in a variety of US industries including airlines, media, and military contractors. These restrictions have primarily affected developed countries like Japan and the United Kingdom. Unlike Japan and many European nations, China does not have a strategic alliance with the US. As a result, Washington is likely to perceive China as a growing global power that the US might come into conflict with in the future.
Two Republican congressmen wrote a letter to President Bush, stating that the acquisition raised concerns about US jobs and energy security. “We fear that American companies will find it increasingly difficult to compete against China’s state-owned and/ or controlled energy companies, given their mandate to supply China’s ever-growing demand for energy, which will increasingly need to come from foreign sources,” the letter stated.
On June 30, 2005 the House of Representatives approved a resolution to seek a review of the offer. The resolution described the CNOOC offer has heavily subsidised by China’s state-owned banks.
Blocking the deal could also have consequences. Federal Reserve Chairman Alan Greenspan and Treasury secretary John W. Snow warned the Senate Finance Committee against taking punitive action against the Unocal transaction, stating that it could trigger a trade war with China that would ultimately harm the US economy. “Resorting to isolationist trade policies would be ineffective, disruptive to markets, and damaging to America’s special role as the world’s leading advocate for open markets,” Snow said.
Another possible consequence of blocking the deal is that China is likely to seek other international sources for oil reserves. It would likely court major oil producers in Africa and Latin America that have in the past sold their oil mainly in the US market. It might also turn to oil producing nations that are less favored by the US government, such as Iran and the Sudan.
In an effort to gain political acceptance of the Unocal bid, Fu Chengyu, the chief executive of China National Offshore oil, gave his endorsement for a US national security review of the deal that has been requested by 41 members of Congress. “We know that this bid is historic for both companies and will be closely scrutinized by everyone involved,” Fu stated in a letter to American lawmakers. “I want you to know that we encourage that review and welcome the opportunity to participate.”
CNOOC has also argued that since the majority of Unocal’s operating assets are in Asia, and its products are already sold in Asian markets, that the acquisition of Unocal is no threat to the United States.
Although CNOOC has presented a friendly and cooperative face to the deal, the Chinese government has been more demanding. The Chinese Foreign Ministry sent a statement to Congress describing the CNOOC deal as “a normal commercial activity between enterprises” and demanding that the US Congress not provide political interference to the deal.
Chevron’s Position
Chevron does not appear worried by the competing bid for Unocal. Chevron’s vice chairman Peter Robinson stated that his company is satisfied with its bid for Unocal and confident that it will receive shareholder approval. He noted that CNOOC faces a much more difficult process to complete an acquisition of Unocal and stated that if the time value of the money is taken into account, Chevron’s offer is comparable with CNOOC’s.
On June 23, Chevron granted Unocal a waiver to their deal agreement that allows Unocal to negotiate directly with CNOOC Ltd. The waiver gives Unocal improved communications with CNOOC, but also benefits Chevron. If Chevron had not granted the waiver, it could potentially have been accused of attempting to obstruct Unocal from pursuing the best option for its shareholders.
It is difficult to predict the outcome of the two competing bids for Unocal. Fu Chengyu was right to describe his company’s offer as historic. Whether the deal is blocked or allowed to proceed, whether is succeeds or fails, CNOOC’s bid will impact trade relations and the global energy marketplace.
Sources: Bloomberg News, Los Angeles Times, MarketWatch, New York Times, Wall Street Journal, Washington Post
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Copyright NVST, Inc. Jul 11, 2005