Thursday, December 26, 2013

Life after CNOOC’s Nexen deal

Life after CNOOC’s Nexen deal: Is China’s honeymoon with Canada’s oil patch over?

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After spending roughly $30-billion on Canadian oil and natural gas assets over the last six years, making it the largest foreign investor in Canadian energy, China is grappling with issues that have long plagued its North American rivals, including high costs, operational challenges, aboriginal issues and volatile bitumen prices.
Handout/NexenAfter spending roughly $30-billion on Canadian oil and natural gas assets over the last six years, making it the largest foreign investor in Canadian energy, China is grappling with issues that have long plagued its North American rivals, including high costs, operational challenges, aboriginal issues and volatile bitumen prices.

At a recent conference at Beijing’s Four Seasons Hotel, one of many featuring trade missions from Canada promoting energy-related investment, Feng Zhiqiang wondered aloud about the next blockbuster Chinese energy deal in Alberta’s oil patch.

A worthy fight for First Nations: Choosing to become partners in Canada’s energy vision

With the release Thursday of Douglas Eyford’s roadmap to address aboriginal concerns over energy projects in Alberta and British Columbia, First Nations have come to a fork in the road.
They can choose the way opened wide by Canada’s Prime Minister, to whom Mr. Eyford reports, along with provincial governments, industry and scores of Canadians, and become partners in Canada’s great energy vision.
Continue reading.
“If Sinopec decides to do its own Nexen, what would Canada do?” the chief executive and chairman of Sinopec Daylight Energy Ltd. asked.
The question was put to Canadian political and energy powerbrokers, including Joe Oliver, Canada’s natural resources minister, Rich Coleman, B.C.’s natural gas minister, Alberta energy minister Ken Hughes and David Collyer, the head of the Calgary-based oil industry association.
“The room virtually went silent,” recalled Wenran Jiang, director of the Canada-China Energy and Environment Forum and an advisor to the Alberta government on China, who organized the event that day. “Nobody was able to answer that question.”
Variations of the question have ricocheted around Calgary’s office towers and in federal political circles since Ottawa approved the acquisition of Nexen Inc. by China’s CNOOC Ltd. exactly one year ago. While China’s biggest purchase ever in a market economy was allowed, Prime Minister Stephen Harper sent an unequivocal message that investments by state-owned enterprises for controlling interests in oil sands companies would no longer be allowed, other than in exceptional circumstances.
“To be blunt, Canadians have not spent years reducing the ownership of sectors of the economy by our own governments only to see them bought and controlled by foreign governments instead,” Mr. Harper said on Dec. 7, 2012. “When we say Canada is open for business, we do not mean that Canada is for sale to foreign governments.”
To some, it was a masterful political stroke that put to rest Canadian concerns about the country’s resources falling under the sway of a powerful foreign government. To dealmakers, it marked the beginning of a big slowdown in Chinese investment in Canadian oil assets.
But a competing theory suggests China’s newfound thrift reflects a deeper anxiety about doing business in the world’s No. 3 crude deposit. After spending roughly $30-billion on Canadian oil and natural gas assets over the last six years, making it the largest foreign investor in Canadian energy, China is grappling with issues that have long plagued its North American rivals, including high costs, operational challenges, aboriginal issues and volatile bitumen prices.
“They’re not doing great, so I think a period of pause and reflection might be in place,” Mr. Jiang said.
The growing pains have raised questions about whether big premiums paid for struggling assets were justified.
The big three state-run Chinese companies — CNOOC, PetroChina and Sinopec — are showing mixed results. Exact numbers are hard to come by, executives shun public interviews and progress reports are rare and often opaque — a low profile cultivated partly as a result of not wanting to create waves. But interviews with bankers, industry insiders, lawyers and government officials suggest the companies are on a steep learning curve.
Investments in publicly traded entities paint a similar picture. CNOOC-backed MEG Energy Corp. is down 1.8% this year. PennWest Petroleum Ltd., another CNOOC investment, is off roughly 15%. Miner Teck Resources Ltd, backed by China Investment Corp., and a partner in the Fort Hills oil sands project with Suncor Energy Inc. and Total S.A., has declined by 30.1%.
It wasn’t supposed to be this way. With its vast cash reserves, China was seen as having the capital and the market to support Canada’s emergence as an energy superpower, just as American capital and political support for new pipelines dried up. For China, Canada represented an attractive entry into a market-driven economy after its US$18.5-billion bid for California’s Unocal Corp. unraveled amid a backlash in Washington.
“I don’t think anybody’s hitting it out of the park,” said a high-ranking Canadian government official. “But like everybody else in the business, they are producing oil and coming to terms with the challenging operations and challenging geology.”

TEH ENG KOON/AFP/Getty Images
TEH ENG KOON/AFP/Getty ImagesSinopec, which lost its Canadian CEO following allegations of insider trading, has mused about partnerships to develop shale gas properties purchased from Daylight Energy.
 
Big mergers usually result in abrupt strategy changes, leadership renewal and sales of non-core assets. But CNOOC-owned Nexen has been slow to adapt to its new status as a wholly owned subsidiary. PetroChina is struggling to expand in the oil sands because of a dispute with the influential Fort McKay band in northern Alberta. And Sinopec, which lost its Canadian CEO following allegations of insider trading, has mused about partnerships to develop shale gas properties purchased from Daylight Energy.
The moves have unfolded against a backdrop of deteriorating bitumen prices and heated controversy over export pipelines. Western Canada Select, the heavy oil marker in Alberta, has been whipsawed by refinery outages and pipeline constraints. This week it traded at more than $30 under the main North American oil price, according to broker Net Energy Inc., and the National Energy Board is predicting discounts of between US$30 and US$40 this winter. Canadian natural gas is under pressure in the U.S. market, and prices in Alberta are expected to stay in the low range of $2.90 to $3.40 per gigajoule, the board said.
The conditions are frustrating the state-run companies, which are under pressure to show profits, while acquiring experience running a company in a developed economy, a Chinese diplomat said. Like their North American peers, the Chinese giants are taking a hard look at the cost structure of extracting oil from Alberta’s bitumen deposits. They are “troubled” by the big salaries in Calgary, a former top banker said, and considering building giant processing modules in Montana to bring down costs. “They never read the doing-business-in Canada manual,” said one energy lawyer.
One lesson PetroChina is learning the hard way is aboriginal relations. The company is a partner in the Brion oil sands project with Athabasca, whose development is being threatened by demands for a buffer zone between the project and aboriginal lands. Hanging in the balance is a $1.3-billion payment to Athabasca, which would give PetroChina full control of the project. PetroChina has said it would honour the commitment once the dispute is sorted out. But the episode, combined with fierce First Nations’ resistance to major pipelines, has fed anxiety about Canada’s regulatory regime and long timelines required for approvals.
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The $15.1-billion takeover of Nexen was the high watermark of China’s buying spree in Canada. Over the past year, Nexen has been transformed from an enterprising Canadian company with assets throughout the world into a “pet on a leash,” the Canadian government official said. Unlike typical takeovers that involve a big company swallowing another company, Nexen is operating in much the same way and most of its staff and executive team have remained.
However, Americans have been nervous about Chinese control and forced the company to erect a wall between its Calgary office and U.S. staff. “We do have very stringent rules about the way we communicate with them,” Regis Drevet, manager, conventional and global exploration, said at an industry conference this fall. “Right now you have to view them as a very independent structure.” U.S. authorities, he said, “tell us how we can communicate with them and on what subjects,” which are limited to strategy, operational issues and financial reporting.
About 65 CNOOC employees have joined Nexen since the take over, spokeswoman Patti Lewis said in an email. In November, CNOOC named Kevin Lynch, a former Bank of Canada economist and current vice-chair of BMO Financial Group, to its board as a non-executive independent director. “We’ve established an excellent sense of team work and collaboration as we work to unify the two companies,” Ms. Lewis said.
But the message from Beijing is no more acquisitions, Mr. Drevet said at the Calgary Global Exploration Forum in October.
Nelson Ching/Bloomberg
Nelson Ching/BloombergCNOOC-owned Nexen has been slow to adapt to its new status as a wholly owned subsidiary. 
 
Indeed, Chinese companies across the board now seem focused on boosting cash flow. They are also accelerating investment in natural gas. PetroChina has committed between $500-million and $600-million with Encana Corp. next year to develop Alberta’s Duvernay shale. Nexen said capital spending in its Liard shale gas play on the northern edge of British Columbia could top $200-million this year. The company recently applied for an export license as part of plans to build a massive LNG terminal at Grassy Point, B.C. Rival Sinopec is eyeing a stake in another export scheme led by U.S. oil major Chevron Corp., according to reports.
“To say that they’re not investing is not accurate, because they have acquired a tremendous amount of assets in this country,” said Janice Buckingham, a partner in the Calgary office of Osler, Hoskin & Harcourt LLP who handles asset deals involving SOEs.
Even so, the days of fat acquisition premiums and big sticker prices appear to be over. The Canadian government has made no secret that large, strategic companies are off limits to national oil companies. Changes to the Investment Canada Act made by Ottawa put constraints on control of oil sands assets, but the tweaks ultimately went much further, alienating investors. An analysis by Osler lawyers said the rule changes introduced in last year’s federal budget give Ottawa more discretion over even minority purchases of energy assets by SOEs.
The caravan has moved on to other places
Many deals that were in the works evaporated with the changes, and Chinese investors moved on to other jurisdictions willing to “roll out the red carpet,” said Adam Waterous, head of global investment banking at Scotiabank. “There can be a little bit of a perception within Canada that we have the resources, therefore the world will beat a path to our door,” Mr. Waterous said in an interview from Korea. “That is a big mistake, and it has been proven. The caravan has moved on to other places.”
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Mr. Oliver insists changes to the Investment Canada Act are not discouraging investment. During a recent trip to China and Korea, the minister said he solicited feedback and no one suggested the SOE thresholds had dampened enthusiasm for Canada. “From the [Chinese] president down, they have a keen interest in Canada, and its resources and the investment opportunities. Of that there is no doubt,” the minister said.
Politically, however, the new rules appear to have quieted the raging debate over Chinese investment in Canadian resources, which Gordon Houlden, director of the China Institute at the University of Alberta, said was the biggest public policy issue in 2012.
Support for Chinese investment in the energy sector in Alberta has dropped off compared to a year ago, according to an October poll of 1,200 Albertans by the institute. Mr. Houlden, a former diplomat who served in China, said Canadians oppose selling domestic resources to foreign entities, period. But they favour building pipelines to the West Coast and trading with China, he said.
A decision from the federal panel assessing Enbridge Inc.’s Northern Gateway project to send Alberta crude to the Pacific coast is due this month, capping more than a decade of planning and review. Such timelines baffle the Chinese, who are backing the plan. “They just don’t get it,” said one observer. “They don’t understand the levels of appeal and how long it takes and that the government can’t just rubber stamp something and say, off you go. And that’s intimidating.”

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