Financial Daily from THE HINDU group of publications
Friday, Jul 22, 2005
Corporate - Insight
CNOOC's bid for Unocal Chinese strategy that tests US ideology
On all accounts, the US is seen as the fount of stock market capitalism. Naturally, there is an expectation that the US would be more open to takeovers by foreign companies. Unfortunately, the ideology is on notice. The trouble is over the proposal of the Chinese National Offshore Oil Company (CNOOC) to take over Unocal, a California-based US energy company, through an unsolicited offer for purchase. It has turned out to be a litmus test of US' commitment to market ideology. What are the details?
In January, Wall Street Journal, citing a Financial Times report, said: "... China's third-largest oil and natural gas company is eyeing Unocal Corp., the ninth largest oil company in the US the latest sign of how China's search for oil, commodities and consumer markets is fuelling Chinese acquisitions overseas... "
It appears that CNOOC had started work on the Unocal takeover in September 2004 with detailed analysis and planning. Senior executives working on it saw a rich potential for the takeover. By February 2005, CNOOC hired J. P. Morgan Chase & Co. and Goldman Sachs Inc. to help it with the deal.
Once it had made up its mind, CNOOC decided to take the plunge, American style. It mobilised three investment banks, three law firms, a couple of media groups and a Texas lobbying firm with connections to the White House. Daily reports in the financial press suggest that CNOOC is able to match the PR efforts of Chevron, its rival.
In the US, much noise is made about CNOOC being a government-owned company and its unreliability as a business partner. It is not reckoned that except in the US and some European countries, oil companies are owned and managed by governments. Aramco is a Saudi Arabian government-owned company and holds the life support system for US supplies. Citigo, a company owned by the Venezuelan Government, operates in the US as a refiner and retailer of gas.
Though 70 per cent of CNOOC's equity is held by the Chinese Government, even critics admit that it is a professionally-run company with a number of exploration and production joint ventures off the coast of China with foreign oil companies, including Chevron. After an initial debacle, it was listed on the New York Stock Exchange in 2001.
The Economist described: "Since its floatation in 2001, CNOOC has earned a reputation as one of China's best managed firms." It is reported that when the Unocal proposal was considered by its board in March, some independent directors voiced reservations and Mr Fu Chengyu, Chairman and CEO, CNOOC, agreed to postpone the decision to give them more time for study. In hindsight, it was a costly delay as, by April, Chevron had made its offer and the Unocal board decided to accept it. It was for $18 billion on share-and-cash (including the debt).
On June 22 CNOOC made its unsolicited bid to take over Unocal on an all-cash basis. The offer is for $18.5 billion which would, in effect, be $20.6 billion, including debt and a break-up fee of $500 million. It works out to $67 per share against Chevron's offer of $62. CNOOC's board has given Mr Fu the freedom to raise it to $69.
CNOOC was well aware of the possible reactions from the US authorities and the public. From the beginning, it has been conciliatory, responsible and given necessary assurances to assuage their sentiments.
It has promised to preserve US jobs and pensionary benefits. It has assured that oil and gas from US sources would be sold within the country. It has agreed to divest all assets in the US not connected with oil. It agreed, on its own, to sit with the Committee on Foreign Investments in the US (CFIUS) and to "placing non-exploration and production assets under American management." The CFIUS has turned down CNOOC's request.
Mr Fu and CNOOC could not have anticipated the barrage of debates, controversies and vituperative attacks its offer would evoke. The most adverse ones are from the members of the Congress. Their argument is that CNOOC is an arm of the Chinese Government and the latter is engaged in strategic moves to control oil assets globally. This strategy would strengthen its military ambitions and ergo the communist government with its poor human rights record. Easily, it can be seen that all the attributes of the latter day Neocon paranoia are included in the attacks. The idea is to bind the hands of the CFIUS when the proposal reaches it.What view the Bush administration will take is not yet clear. For now, it is keen to put off a decision. In any case, it cannot enter the fray unless Unocal makes up its mind on the two offers. It cannot reach the CFIUS until then. It would reach the White House after the CFIUS takes a view. President Bush said on July 7, at the G-8 Meeting at Glendale, "There is a review process that analyses purchases and... should let the process move forward."
Will the review process be conditioned by the blinkers suggested by the Advisory Committee? As analysed by Steve Lohr in New York Times (July 13, 2005), it would be serious departure if the CIFUS departed from the criteria adopted in the past and widened the notion of national security to include oil.At the other end of the spectrum are those who wonder whether the US could afford to risk China's anger and ill will.
As one report in Financial Times said, "... Washington's paymaster, with almost $700 billon in foreign exchange reserves and holdings of Treasury bills, Beijing could inflict far greater damage on the US economy by dumping the lot" If security were the issue, perhaps China has greater concerns than the US. China became a net importer of crude oil since 1993. It is the second largest importer of energy after the US and has surpassed Japan. The exceptional rate at which it has been growing over the last three decades has increased its dependence on imports. China has signed deals worth billions of dollars around the world, purchasing energy and building pipelines. It has several pipelines planned that would automatically receive supplies from fields in Russia, Central Asia and Burma. The Shanghai Cooperation Organisation has emerged a strong alliance between Russia, China and Central Asian countries and would lead to regular arrangements for supply of gas and oil between the member countries.
Independently, China has forged closer ties with several countries and its global investments reach several billion dollars. Its investments include countries in Africa and Latin America. Its venture in Sudan created waves. I
Viewed against all these, the Unocal deal is a part of its overall strategy to diversify its resources. It is also a relatively small fraction of total Chinese investments abroad in the energy sector. It is not an attempt to seize US resources or assets. As Mr Fun repeatedly said that it was a commercial deal. In any case, Unocal's resources are in Asia and China has as much claim to them as any other unless the idea is to resuscitate the nineteenth century colonial scramble for resources.
The gains to China by taking over Unocal may really be in the longer term. Unocal's gas production is now tied to the host countries on long-term contracts and China cannot access them. China can hope to draw on the sources when the contracts expire or if there is additional production. Unocal has know-how for deep-sea operations which may be valuable to China in its China Sea operations and in other gas fields.
Interestingly, Unocal and China have worked together in dubious areas such as Myanmar, Afghanistan, and so on. The board of Unocal is said to consist of directors who are independent and unconventional in outlook. Perhaps China hopes to gain more from these connections. Judged purely by takeover tips, Unocal is a suitable gambit for CNOOC.
The price may seem high, but is necessary to tempt the hedge funds whichhold a chunk of Unocal equity. The ruling price of $60 per barrel and the hope of its rising in the future justifies it. Should the crude price drop or the price war between CNOOC and Chevron heat up as a result of the decision taken by the Unocal board on July 14, it may prove wasteful. China and CNOOC may still wish to go ahead and have a control over gas reserves in Asia, closer home. At the end, should the CIFUS or the Bush administration reject it, China may view it as an unfriendly act and the future course of US-China relations may be different. And the Bush administration may no longer claim to be the defender of faith.
(The author, a former Finance Ministry official, has experience in international, financial and trade issues.)
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