An investment ‘bridge’ is built for China

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When Prime Minister Stephen Harper declared foreign governments would no longer be permitted to take over Canadian oil sands assets, it was portrayed at home as a tough new policy, made at the risk of offending the Chinese government.

But Beijing, delighted by Mr. Harper's approval of the $15.1-billion (U.S.) takeover of Calgary's Nexen Inc. by China National Offshore Oil Corp., didn't see the new rules as particularly tough or unexpected. The changes were more a predictable closing of a door that some Chinese policy makers were surprised ever existed. And a crack may remain open, since the new rules may allow for another takeover by a state-owned enterprise (or SOE) under "exceptional circumstances."

Rather than create a barrier, those involved in crafting CNOOC's takeover of Nexen say Mr. Harper has helped them build a "bridge" to the energy markets of the developed world. His moves permit the purchase to proceed and help draw up a playbook for how similar Chinese investments could be treated by other Western countries, where – as in Canada – there are lingering suspicions about the intentions of companies controlled by China's Communist Party government.

"Harper, the Prime Minister, actually made a wise balance with the deal … We now see Canada as a bridge, the best place for China to get involved in the developed world," said Xu Xiaojie, who advised both CNOOC and the Chinese cabinet on the Nexen deal and travelled to Calgary twice during the negotiations. He said he had expected the CNOOC-Nexen deal would take a long time to be approved, and that additional conditions would be added.

"Canada has provided an example of how China can work with a very developed legal and social system, an example for China of how we can make ourselves internationalized," said Mr. Xu, who is the chair of the World Energy Research Project at the Chinese Academy of Social Sciences, a government-run think tank. "I believe such a model could be emulated in other countries – maybe Australia immediately and eventually in the U.S."

Until now, China has been largely boxed out of stable energy markets by suspicious partners and an American stranglehold on supply, forced to seek oil and gas in places its Western rivals preferred to avoid, places like Angola, Iran, Iraq, Sudan and Venezuela. Beijing has proved adept at courting such regimes, but many are deeply corrupt and come with variables like whimsical leaders, civil wars and the possibility of United Nations sanctions.

Having to do deals with gunfire in the background also made China's leaders feel excluded from the big leagues, despite the country's economic rise. They wanted in, and Nexen ends a bitter string of failed attempts by Chinese state-owned firms to buy up big Western firms, including an $18.5-billion CNOOC offer for Unocal in 2005 that collapsed under opposition from U.S. lawmakers.

"The oil is obviously just oil, but the sense of national accomplishment when a Chinese firm buys up a Western one is something I think should not be overlooked, especially within that system where such things make for great political credit for the firms involved," said Scott Harold, an analyst with the Virginia-based Rand Corporation who has written about the overseas expansion plans of China's SOEs.

The deal – and the list of concessions CNOOC was willing to make, including billions in additional spending and an annual report to Industry Canada – is also proof of how much more sophisticated it and other Chinese national firms have become since the failed Unocal deal. Mr. Xu said part of the reason the Nexen transaction was successful was that China now understood it needed to provide allowances for variables like public opinion. "We finally identified the big difference between [investing in] the developing world and the developed world. We cannot simply copy our experiences from the developing world, Africa and Latin America, in dealing with the developed world."

CNOOC officials declined to be interviewed until after the deal is formally closed.

Some in Canada have fretted that the whole episode – Mr. Harper's courting of Chinese investment, followed by the public outcry against CNOOC's massive offer for Nexen and Mr. Harper's after-the-fact adjusting of the rules – may have damaged the country's reputation as a destination for Chinese investment. But there's little sense of that in Beijing.

"I don't think they dreamt in their wildest dreams that it would be open season [for state-owned enterprises] forever," said Howard Balloch, a former Canadian ambassador to China who is now chairman of Canaccord Genuity Asia, an investment bank. "I think the Chinese probably think this is really smart policy … it's the best outcome that they dared hope for."

Mr. Balloch says some Chinese officials were privately worried that Mr. Harper would not approve the deal; a step that he said would have affected the entire Canada-China trade relationship. "Of course there would have been repercussions," he said.

Canadian investors in China are instead now hoping to cash in on the warm post-Nexen vibe, which has raised hopes that Beijing will finally grant the reciprocity Ottawa has made clear it would need to be part of the quid pro quo going forward. No one expects Canadian oil firms will now be allowed to buy their Chinese counterparts, but there's optimism about a breakthrough in the financial services sector, where Canada's banks and insurers have long been pushing for greater access to the Chinese market.

"The overall situation is still going to be very good," said a Beijing-based lawyer involved in foreign mergers and acquisitions who asked not to be named. He said several deals were close to being approved that would be considered "major" in Canada, though less significant in terms of the size of the Chinese market. "The Chinese are not going to burn the bridges just because of this [no more SOE takeovers in the] oil sands thing."

Mr. Harper's new line against state-owned enterprises may also have an unplanned effect on the economic reform debate within China. If state-owned enterprises are considered unwelcome by Canada – and that precedent spreads to other Western countries where China wants to invest in oil and gas properties – it bolsters those who argue that Beijing needs to end the state's monopoly on the energy sector.

"If this policy is real, it's a bad thing for the SOEs," said Li Dongchao, a journalist with China Business News who has been covering the CNOOC-Nexen story. He said that while most Chinese were proud to see a company like CNOOC expanding abroad, there was a widespread feeling that the state-owned giants were hampered by corruption and poor management, and that few benefits from the success of CNOOC or its larger cousins, China National Petroleum Corp. and Sinopec, trickles down to the public, the companies' theoretical owners.

"People think maybe we should break up the monopoly system and allow more room for private entities," Mr. Li said.

Mr. Harper's new rule – based on what little he's said about it so far – seems to be designed to say just that: Chinese investment is welcome, just not Chinese investment directed by the Politburo. "Because of the revision of the investment policies in Canada, I believe more private companies from China will push deals with Canadian companies," said Mr. Xu, the academic and government advisor. "This deal, this bridge with Canada, is such an opportunity for China to push economic reform."

However, Mr. Xu said China had also keenly noted the provision for another oil sands takeover by a state-owned company under "exceptional circumstances." But don't expect a Chinese government enterprise to propose another deal the size of Nexen any time soon.

"I would think that an oil sands application [by an SOE], which is not ruled out, will not appear for some time," said Mr. Balloch, the former ambassador. "It would be nuts to put the Canadian government up against the wall right now and say 'this is an exceptional circumstance.' It would get turned down. That's a public reaction reality."