China's gas guzzler

Face value

Jun 23rd 2005
From The Economist print edition

Fu Chengyu must balance China's thirst for energy with its desire for corporate respectability
FOR a man about to make the biggest decision of his career—one that could trigger a huge political backlash in America—Fu Chengyu seemed remarkably relaxed earlier this week. Sitting in a stately meeting room in his Beijing offices, the blunt, English-speaking 54-year-old chairman and chief executive of China National Offshore Oil Corporation (CNOOC) joked that the outcome could “make me a hero or a martyr”. On June 23rd Mr Fu took the plunge, making an offer of $18.5 billion (excluding debt) for Unocal, a California-based oil and gas company.

This is the largest foreign takeover yet attempted by a Chinese firm—and a contested one, to boot. On April 4th, Unocal agreed to be acquired by Chevron, the second-biggest American oil firm, in a deal worth $17 billion (excluding debt). With Sino-American relations already strained, the prospect of a state-owned Chinese company buying a big American energy firm is causing ructions in Washington, DC, ostensibly over potential national-security risks, and may also do so elsewhere in Asia, where most of Unocal's gas reserves are located.

Mainland China's top companies are becoming increasingly ambitious and aggressive in their pursuit of foreign assets, their competitiveness boosted by ready access to (effectively free) state cash. Last month, computer-maker Lenovo completed its $1.75 billion acquisition of IBM's personal-computer operations. On June 20th, Haier, China's leading white-goods maker, launched a $1.3 billion cash offer for Maytag, an ailing American rival, trumping Ripplewood, a private-equity firm. But the Unocal deal is something new, not only because it is much bigger and more politically sensitive, but also because CNOOC has, until now, behaved like a commercial, western firm in the bidding process, rather than as an arm of the Chinese government.

Since its flotation in 2001, CNOOC has earned a reputation as one of China's best managed firms. Its shares trade at a premium over those of its larger listed rivals, PetroChina and Sinopec. Mr Fu's market-friendly rhetoric, reflecting his experience of western business (he got a masters degree in California and worked for Phillips, an American oil firm), has contributed to its reputation. “Transparency makes shareholders love you,” he says. So does having four respected non-executive directors, including two non-Chinese: Evert Henkes, a former Shell executive, and Kenneth Courtis, vice-chairman of Goldman Sachs in Asia.

Buying Unocal could threaten this hard-won credibility. Analysts and minority investors, who own 30% of the stock, are concerned. CNOOC is offering 9% more than Chevron. Then there are integration and political risks and a big pile of fresh debt. The Chinese offer is in cash—the shares even of a well-run Chinese firm are not yet acceptable as takeover currency.

It is no surprise that China wants Unocal. The country is thirsty for energy to fuel its booming economy. China is already the world's second-largest oil importer, after America. More even than oil, China wants gas, of which Unocal has lots, but which currently accounts for only 3% of China's energy use.

To correct that imbalance, CNOOC's state-owned, unlisted parent company—which still owns 70.6% of the listed CNOOC—is building up to ten giant liquefied-natural-gas terminals along China's east coast. All that it needs now is the gas. Three-quarters of Unocal's gas reserves (and a quarter of its oil) are in Asia (mostly Indonesia, Thailand and Bangladesh) and may be double previous estimates. This, and the American firm's expertise in deep-water oil-drilling, is what CNOOC, or rather China, wants. Price, therefore, does not matter much. Chevron may raise the stakes by upping its bid, but, ultimately, “if the People's Republic of China wishes to acquire Unocal, it will,” says David Hurd of Deutsche Bank in Hong Kong.

Mr Fu is caught between two imperatives. On the one hand, he is a western-trained manager fighting for the interests of all shareholders. On the other, he is president of CNOOC's state-owned parent and ultimately beholden to Beijing. Pulling off the deal would bring huge political influence and secure his future.

Caught between yin and yang

Hence CNOOC's initial ambivalence towards Unocal. After a tentative first approach last December, the Chinese company almost bid this April, only for Mr Fu to pull back in deference to the concerns of his non-executives. The independent directors then hired their own team of advisers, led by N.M. Rothschild, an investment bank, to judge whether a bid was in the interest of all of the firm's shareholders. Mr Fu insists that it is: “China needs gas. Unocal will allow us to sell more gas to China and grow our company for shareholders.” He plays down the political risks, saying that Unocal's production is equal to less than 1% of American consumption and that, unlike Chevron, CNOOC will preserve local jobs. To maintain financial prudence—Mr Fu's mantra in the past—CNOOC's parent will provide $7 billion in cash, easing the strain of the bid on the listed firm's balance sheet.

While the parent's role raises doubts about the deal's commercial logic, it should protect CNOOC's minority investors. The bulk of the transaction will take place through the listed firm, not (as is common practice in China) its opaque, unaccountable parent. “If our parent buys Unocal, America will think the Chinese government wants it,” says Mr Fu. But “this transparent, commercial way, based on international practice, should be less sensitive for the US government.” Will that really reassure American politicians, given that CNOOC is state-controlled? Mr Fu says that, although his firm is like a state company in ownership, “in management and operations we are commercial.” Perhaps. But with oil and gas prices at record levels, Mr Hu's expensive deal puts the extent to which CNOOC is really a commercially driven firm, with corporate governance able to protect all its shareholders from Chinese political pressure, to the severest of tests.

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