US Oil Companies Stay Out Of China's Sights

While a mergers and acquisitions boom takes place in the energy sector globally, one trend remains noticeably absent: U.S. oil producers being targets for their cash-rich Chinese counterparts.

In the two years since Cnooc Ltd. (CEO), China's number-three oil producer in terms of assets, abandoned its audacious $18.5 billion takeover campaign for California-based Unocal Corp., China's state oil companies have been busily extending their reach in Russia, Africa and South America. But the U.S. has remained off the map - at least until now. Of the $27.3 billion worth of deals involving Chinese energy companies in 2006, none was spent on buying U.S. assets, according to analysis firm Dealogic. This inactivity was despite global M&As involving energy companies jumping to $565.9 billion last year from $372.6 billion a year earlier. Political opposition, high oil prices pushing up asset valuations, and the ease of doing government-to-government deals in other parts of the world such as Venezuela have combined to dampen China-U.S. energy M&As, experts say. Chinese oil companies, however, are shaping up for their first bid for a U.S.-listed rival since Unocal in what will test the appetite of the U.S. for further M&A activity. Cnooc and Zhenhua Oil are among companies examining bids for Transmeridian Exploration Inc. (TMY), people familiar with the situation say. Transmeridian is listed on the American Stock Exchange and owns the South Alibek oil field in Kazakhstan, which it values at just under $1 billion. "With the (U.S. presidential election) campaign season in full swing, an attempt by a Chinese major to acquire a U.S. oil company would face an uphill battle," said Trevor Houser, an energy expert at New York-based China Strategic Advisory. "While a $1-$2 billion target would certainly be easier than a Unocal-sized acquisition, a prospective Chinese bidder would still have to run the political traps to succeed." The Unocal bid was particularly bold in that Cnooc tried to go head-to-head against one of the U.S. oil giants - Chevron Corp. (CVX) - to acquire another U.S. company with a long corporate history and a lot of U.S. assets. In contrast, Transmeridian is a minnow that was only established in 2000 and has yet to turn an operating profit. But the political climate in Washington D.C. has changed since 2005, exposing foreign takeovers of U.S. companies to greater legal scrutiny than before. "I had a Chinese client looking at an acquisition in the States, and at the end of the day, it wasn't because of commercial reasons that they decided not to go ahead," Canice Chan, a partner at the Beijing office of law firm Jones Day, told Dow Jones Newswires in a recent interview. "They (the Chinese) are definitely more careful and consider more angles now, especially after Unocal." Last month, U.S. President George W. Bush signed new legislation tightening the way the U.S. government vets foreign investments into law. This was in response to Dubai Ports World, a firm owned by the United Arab Emirates, attempting to buy operations at several U.S. ports. Concern in the West is growing at the possible distortions to global markets from sovereign wealth funds, particularly as China has earmarked around $200 billion of its foreign exchange reserves for investment overseas. The new U.S. law overhauls the Committee on Foreign Investment in the U.S., or CFIUS, the government panel that reviews the security aspects of overseas deals. It requires a 45-day probe into most U.S. purchases by firms owned by foreign governments and gives lawmakers more access to decisions made by CFIUS. The law, which passed the House of Representatives by a 370-45 margin, singles out energy assets as particularly strategic and adds the Secretary of Energy to the CFIUS panel.

Negatives On Both Sides From Status Quo

Despite the rhetoric about a battle for resources among big energy consumers, both China and the U.S. have much to lose from maintaining the status quo. China's domestic crude output cannot keep pace with its oil consumption, worsening its energy insecurity and forcing it to import more foreign crude. July crude imports reached a record 14.83 million metric tons, equivalent to an average of 3.51 million barrels a day. Its policy of seeking government-to-government deals has brought disappointing returns, particularly in parts of Africa. China National Petroleum Corp. and Cnooc have either returned or relinquished rights to acquire blocks in Nigeria in the past year. The difficulty for the Chinese is that many reserves in attractive oil-producing regions, such as Angola, are already under the control of independent oil companies based in the U.S. There is a paradox in that the U.S. is more heavily invested in China in terms of energy than vice-versa, despite criticism of China's lack of transparency and the close alignment of its oil companies with the government. This year has seen ExxonMobil Corp. (XOM) commit to an integrated refinery project in South China's Fujian Province with China Petroleum & Chemical Corp. (SNP), known as Sinopec, and Saudi Arabian Oil Co., better known as Aramco. People familiar with the situation told Dow Jones last week that Chevron had won a bidding contest for the co-development of a sour gas field in the southwestern Chinese province of Sichuan with proved reserves of 58.11 billion cubic meters of natural gas. By encouraging Chinese M&A activity within its own borders, especially if deals focus on stakes in projects or individual assets rather than outright takeovers of companies, the U.S. could rebalance investment flows and protect the interests of its oil companies in China. "If a Chinese company is to acquire a U.S. company on a non-contested basis, then I think it's easier (for a deal to get political support)," Chan said. Chinese M&A activity in the U.S. would not only add to premiums on the share prices of U.S.-listed oil companies, but might also act as a catalyst for promoting change in China's energy policy. China appeared to respond to the failed Unocal bid by deciding that energy markets were unfair and stacked against its interests, forcing it to look elsewhere for reserves. In the past two years, China has strengthened its involvement in Sudan's oil sector and sought energy deals in Iran to the frustration of Washington. To get the green light in the U.S. for acquisitions of U.S. oil companies, analysts said China would need to be more pro-active in resolving a humanitarian crisis in Sudan's Darfur region. Four U.S. Representatives issued a statement on Aug. 9 opposing the proposed A-Share IPO in Shanghai by PetroChina Co. (PTR) and all investment in the Chinese company because of its parent's involvement in Sudan. Another forward step would be for China to strip its state oil firms of their political status and allow their shareholders to take a dividend - in effect making them more like independent oil companies and thereby creating a level playing field in asset auctions. Most important would be the choice of financing, Houser said, although he feels it will be years - if ever - before a Chinese oil titan makes another play for a large-cap U.S. oil company. "After the dust-up surrounding Cnooc's cost of capital in the Unocal bid, a future aspirant would be wise to look for all its external funding from a big Western bank rather than from its parent company or a Chinese state-owned lender."