Asian dragon stirring to life on resources

China takes more subtle approach in efforts to secure minerals, oil and natural gas; Canadian government rolls out welcome mat

Gary Park

For Petroleum News

Since 2006, Chinese investors have acquired almost 11,000 square miles of African farmland.

In August, China’s state-controlled Jilin Jien Nickel Industry Co. made a surprise C$148.5 million unsolicited takeover bid for Canadian Royalties, which is developing a nickel project in Quebec.

Notice anything in common?

Nothing much, unless you start rolling in a string of other deals this year that have seen China’s vast stable of government-owned resource companies embarking on a global shopping spree, chasing down the minerals and petroleum resources that are vital to its economic future.

One of the major showstoppers occurred in mid-August when ExxonMobil signed a US$41 billion agreement with PetroChina to supply 2.25 million metric tons a year of liquefied natural gas from Western Australia’s Gorgon LNG project.

“They are attempting to lock in secure supplies by buying stakes in resource companies everywhere,” said Randall Morck, a finance professor at the University of Alberta.

And backed by US$2 trillion in foreign currency reserves, compared with debt-laden, import-dependent economies, China can afford to move into real economies.

Teck share acquired this year

Until then, Canada had seen very little of the international action as China hunted down cheap assets and stakes in depressed companies.

In fact, there was an extended quiet period after late 2004, when a political firestorm scuttled a C$5 billion bid by China’s Minmetals Corp. to buy Noranda, one of Canada’s oldest mining companies, followed in 2007 when PetroChina withdrew in a huff after failing to negotiate an equity stake in Enbridge’s Northern Gateway pipeline, rebuking the Canadian government for failing to support the deal.

Those stumbles were accompanied by a decided chill in relations between Canada and China, as the administration of Prime Minister Stephen Harper took aim at China’s human rights record.

That cooling off period now seems to be over.

PetroChina financial muscle

The bold move came hot on the heels of a Chinese visit in early August by Canada’s Finance Minister Jim Flaherty, leading a delegation of financial and corporate leaders.

He urged the Chinese to consider investing in Canada’s energy sector, declaring that foreign-investment rules posed little hindrance to an expanded Chinese presence.

Flaherty said China is looking to spend its U.S. dollar reserves in the “emerging energy superpower” that is Canada, noting that neither China’s Vice Premier Li Keqiang nor Finance Minister Xie Xuren indicated any concerns that Canada’s foreign-investment regulatory framework presented an obstacle to Chinese business interests.

“China has a need for resources … and is looking for investments abroad. We are encouraging Chinese foreign direct investment in Canada. So long as there is compliance with the governance concern and other rules that we have with Investment Canada,” he said.

More investment expected

Harper, a vigorous advocate of lowering trade and investment barriers rather than resorting to protectionism during the economic recession, said his only concern is ensuring that foreign cash injections do not undermine Canada’s national interests.

Underscoring the importance of the mission, Flaherty’s team included Bank of Canada Governor Mark Carney and senior executives from Canadian banks, major insurance firms and the Toronto Stock Exchange.

While China has been making deals with energy-rich countries around the world — including a deal to buy two-thirds of Marathon Oil’s 30 percent stake in the prolific Block 32 offshore Angola for US$1.3 billion — it has made no serious inroads into Canada’s energy sector beyond two minority interests in oil sands startups.

But an official with China National Petroleum Corp. left no doubt that Canada is on Beijing’s radar screen when he called in May for a “strategic alliance” between Canada and China to create an energy corridor linking energy-rich Western Canada with energy-hungry China.

“The opportunity now exists to unite our mutual interests; to align with our respective goals and objectives; to fill China’s energy gap with Alberta oil and gas,” he told a forum attended by Alberta Premier Ed Stelmach. “The question is action. China is prepared for the future and we see the potential Sino-Canadian relationship as a tangible, long-term, mutually beneficial strategy.”

Paul Michael Wihbey, president of Washington, D.C.-based energy advisor GWEST that helped organize the Geneva event, said the speaker was making a “very serious proposal. I think it carries very significant implications at the economic, political and strategic level that could see Alberta and Western Canada emerge as an energy storehouse that sustained the well-being of the U.S. and Chinese economies.”

China’s demand up

Demand was up 2.58 percent in June over a year earlier to 33.35 million metric tons (8.12 million barrels per day) and crude throughput at Chinese refineries was 31.92 million metric tons, up 730,000 barrels from the previous record set in May.

In July, net crude oil imports climbed year-over-year by 13.47 percent to a record 19.63 million metric tons (4.65 million bpd).

The International Energy Agency has predicted China’s appetite for oil could grow to 11.3 million bpd by 2015 and 16.6 million bpd by 2030, with net imports averaging 7.7 million bpd in 2015 and 12.5 million bpd in 2030, thus hiking imports from 50.7 percent of China’s demand in 2007 to 68.1 percent in 2015 and 75.3 percent in 2030.

Regardless of government rhetoric, many Canadian interests have been reluctant to get too cozy with the Chinese, especially among Canadian oil and gas producers who believe China’s state-controlled companies are slow moving in negotiations and unwilling to pay up.

What impresses many observers is how China has also moved quickly to patch over the rift that developed in 2004 following the Noranda fiasco.

More subtle approach

It started picking up minority stakes in various holdings by Canadian-based mining companies in Peru and Mexico, side-stepping government reviews and political resistance.

The more subtle approach has also seen Chinese extend loans of US$45 billion to develop oil and gas properties in Brazil, Venezuela, Angola and Kazakhstan, which will repay the money with oil and gas production, while Chinese firms have signed a long-term gas supply deal with the Australian state of Queensland.

“We have been saying to Chinese companies that it is important to understand the environment here,” said Sarah Kutulakos, executive director of the Canada China Business Council.

And it’s far from a one-way street that benefits China alone.

Teck Chief Executive Officer Don Lindsay said China is “obviously the single most important” market for Canada’s core products “in terms of demand,” so securing a strategic Chinese investor was top of the list.

Unmentioned but not unnoticed is Teck’s continuing role as a 20 percent stakeholder in Petro-Canada’s Fort Hills oil sands project, which is stalled pending review now that Petro-Canada has been absorbed by Suncor Energy.

Describing the Chinese as a “deep-pocketed partner,” Lindsay said “they are clearly shifting out of U.S. Treasuries into hard assets.”

Concerns over government role

Ken Davies, with the investment division of the Organization for Economic Cooperation and Development, said China’s state-owned enterprises are still controlled by the government’s Assets Supervision and Administration Commission, whose mandate is to fulfill various policy aims.

Dave Kelley, a professor of Chinese studies at the University of Technology, in Sydney, Australia, said Chinese corporations have a long way to go to establish their independence from the state.

“People don’t yet trust Chinese institutions,” he said.

Analysts say building that trust needs bold steps by China to open up its politically sensitive sectors to foreign direct investment, which has totaled a mere US$1.25 billion since China joined the World Trade Organization in 2001.

Aside from adding to its portfolio in the oil sands, China’s next major move to access Canadian oil and gas production could depend on whether it returns to the bargaining table with Enbridge or establishes ties with Kinder Morgan, both of which are seeking support from producers and customers to build new or expanded pipelines to the British Columbia coast for tanker shipments to Asia.

If Canadian producers now view China as a potential outlet, they will be attracted by reports that Sinopec plans to expand its two major refineries from a current processing capacity from 13.5 million metric tons a year to almost 16 million metric tons by 2011. PetroChina is also boosting its refining capacity at one of its refineries from 10 million metric tons a year to 11.5 million metric tons in 2011. A second refinery is scheduled for a boost from 6 million metric tons to 10 million metric tons.

Moving even faster is Kitimat LNG’s plans for an LNG export terminal, that hopes to liquefy 700 million cubic feet per day of Western Canadian gas for delivery to Asia, with China an obvious market.

But, before Canada starts shipments to Asia, China wants assurances that investment in Canada won’t run afoul of the North American Free Trade Agreement, which requires that U.S. buyers of Canadian oil and gas must have equal rights to buy products that are destined for elsewhere — until now a purely hypothetical question.

China tests investment, security laws

Grabbing a 60 percent stake in fledgling oil sands projects by privately held Athabasca Oil Sands Corp. is little more than one small step.

If the deal is concluded, it gives PetroChina access to 5 billion barrels of recoverable bitumen (the oil sands have an estimated 174 billion barrels), but, according to AOSC officials, would require the Chinese giant to invest anywhere from C$9 billion to C$12 billion to bring the resources into production.

And, for now, AOSC is delicately sidestepping two key questions: If and how the production would be delivered to China and whether PetroChina might ultimately buy the remaining 40 percent of the MacKay River and Dover projects.

There were barely disguised mutterings of unease from the U.S. when PetroChina signed an agreement with Enbridge to advance plans for Enbridge’s Northern Gateway pipeline from Alberta to the deepwater port at Kitimat, British Columbia, for tanker shipment to Asian refineries, with China the obvious candidate.

But PetroChina quit the venture in a huff two years ago, lashing out at the Canadian government and producers for not backing its efforts to line-up 200,000 barrels per day of Gateway volumes and possibly take a 49 percent equity stake in the pipeline.

That also seemed to put a damper on plans by Sinopec and China National Offshore Oil Corp. to advance their minority interests in two formative oil sands projects to the commercial stage.

PetroChina changes equation

Nothing on that scale has previously been tried by a Chinese company seeking a role in the development of Canada’s natural resources.

And it’s a benchmark test for the Canadian government’s 2007 legislation to screen investments by foreign state-owned companies in Canada.

Under the Investment Canada Act, any international firm acquiring a controlling interest in a company with assets worth more than C$600 million is subject to federal review.

The vetting requires the buyer to demonstrate that there is a net benefit to Canada in the deal.

The government has also added a national security test that requires input from departments responsible for Canadian security.

That amendment allows reviews if the minister responsible “has reasonable grounds to believe an investment by a non-Canadian could be injurious to national security,” but the statute does not define what is meant by “national security.”

Guidelines introduced by the government of Prime Minister Stephen Harper will restrict investment approvals to companies that have transparent and commercially oriented corporate governance.

Harper said Sept. 1 that the PetroChina-AOSC deal is more controversial than a private sector, foreign investment in Canada would be.

“I will just say that there are laws in place to review foreign investment transactions when they meet a certain threshold and our government has strengthened those reviews by including a clause that allows officials to examine issues of national security,” he told reporters.

Heads up in Canada

He said AOSC will follow the procedures “until all the government agencies are fully satisfied and this transaction can move forward.”

Although there has been a concerted push in some U.S. political and environmental circles to join a global movement aimed at shutting down the oil sands because of their impact on land, water and air, along with wildlife and northern Alberta residents, there is a constituency concerned about the prospect of losing the United States’ exclusive access to Canada’s oil and natural gas resources.

Carolyn Batholomew, chair of the U.S.-China Economic and Security Review Commission, told the Globe and Mail that the PetroChina-AOSC deal should “Raise national security questions for both” Canada and the U.S. governments, although she did say the final decision should be Canada’s.

She said PetroChina, Sinopec and CNOOC are heading China’s drive for energy security, but none is a commercial company, raising concerns about the growing Chinese presence in the U.S. “backyard.”

“Some people believe they function a little independently, but the reality is they are controlled by the government and, for that matter, they are controlled by the Communist party, which of course controls the government,” Bartholomew said.

The commission was created by Congress in 2000 to track China’s economic expansion and measure the impact on U.S. security interests.

U.S. not expected to block investment

Gordon Giffin, a former U.S. ambassador to Canada, does not expect the Obama administration to block Chinese investment in the oil sands, suggesting that although the leases involved are substantial they are not huge.

But Giffin said the deal will draw attention to the strategic importance of the oil sands at a time when U.S. environmentalists are urging punitive measures to slow development.

He said the time is appropriate to turn U.S. attention to the “value of assets sitting in Alberta and not enough thought is given in Washington to that strategic value.”

Canada’s Environment Minister Jim Prentice is one of the leading voices in cabinet urging diversification of Canada’s oil market.

“We need transportation mechanisms to ship it to the (British Columbia) coast,” he said. “Refineries in the U.S. have limited capacity and we don’t have anywhere else to sell it. Having the capacity to ship it to the West Coast would keep everybody honest, so I think that’s good policy.”

—Gary Park