FROM THE ECONOMIST INTELLIGENCE UNIT
On June 24th China’s biggest oil refiner, Sinopec, announced its acquisition of Addax, a Switzerland-based energy firm, for US$7.2bn. If it goes through, the deal will be China’s biggest-ever foreign takeover, bringing state-owned Sinopec access to major oil assets in West Africa and Iraq. The deal looks expensive and could carry political risks, but it represents a success for China’s quest for foreign resources, which has recently suffered setbacks elsewhere.
For energy-hungry China, the biggest positive of the deal is its sheer volume. Addax is Europe’s second-largest independent oil producer, with average production of 137m barrels/day in 2008, primarily in Africa and the Middle East. Addax also claims to control reserves of 1.9bn barrels of oil equivalent. Another major benefit for Sinopec is the access the deal will provide to two volatile yet energy-rich regions. Having emerged on the international scene long after their Western counterparts, China’s major energy companies have long felt at a disadvantage. More recently, however, the fall in the oil price and the credit drought have made it harder for Western oil companies to finance new development work—constraints that weigh less heavily on Chinese corporations looking to build up their overseas oil and gas assets.
For Sinopec, the main disadvantage of the deal is its cost. The Chinese company will pay C$52.80 (US$45.8) per share, bringing the total cost of the acquisition to nearly 50% more than Addax’s market value before the bid was announced. Another potential worry is the political risk associated with operating in such volatile regions. For example, Addax has major stakes in two big oil projects in Iraq’s autonomous Kurdistan region, where long-running feuds over revenue-sharing between the regional and central governments have yet to be fully resolved.
Policy success
In the broader picture, the Addax deal marks a big success for a government-driven policy that has had a mixed record so far. In recent years the Chinese government, aware of the country’s growing dependence on imported supplies of oil and other raw materials, has been attempting to buy foreign resource companies and supplies of raw materials. The government believes that this will help to reduce China’s vulnerability to volatile global markets. Moreover, the sharp fall in the prices of many raw materials since the start of the financial crisis in the second half of 2008 has seemed to offer an opportunity to buy up assets at a less exorbitant price.
The most high-profile recent example of this was a US$19.5bn bid by Chinalco, a government-controlled aluminium company, to raise its stake in an Anglo-Australian mining company, Rio Tinto, from 9% to 18% (the transaction would also have included the purchase of several of Rio Tinto’s assets). Although producers are eager to attract investors amid the credit crunch and the sharp fall in commodity prices, the deal ultimately fell through. Chinese steelmakers are among the biggest consumers of iron ore from Australia, and there were concerns that they would be able to exert undue influence over pricing negotiations if Chinalco was successful in its bid for Rio Tinto. However, although political opposition played a role, the bid failed primarily because of Rio shareholders’ objections, as well as a recovery in commodity prices that lifted mining firms’ share prices and made the proposed deal look too generous.
The Chinese government is smarting from the failure of the attempted Rio Tinto purchase in part because it brought back unpleasant memories of an earlier unsuccessful attempt, by another state-owned resource company, China National Offshore Oil Corporation (CNOOC), to purchase a US-based oil company, Unocal, in 2005. That bid fell apart following security objections from the US government.
China has complained about nationalistic impediments of the kind that have hindered the bids for Unocal and Rio Tinto, amid growing unease about the country’s economic rise and how it will use its newfound influence. However, China will continue to find it hard to persuade foreign governments to allow such deals until it allows greater involvement by non-Chinese companies in its own energy industry. Moves on the part of Chinese companies to tie up oil deals in a number of countries with poor human rights records, such as Sudan, Iran and Angola, have also drawn criticism in Europe and the US.
Notwithstanding the political complications that have hampered some of China’s efforts to acquire foreign energy resources, there have also been many accomplishments. In the four years since the Unocal debacle, China’s state-owned energy companies have spent more than US$20bn to make their five biggest-ever purchases. Besides Addax, these included acquisitions by Sinopec, China National Petroleum Corporation and CNOOC of energy firms in Kazakhstan, Russia, Nigeria and Norway. Despite some setbacks, then, the overall picture is that China’s shopping spree for overseas resources is racking up substantial successes.
This trend is likely to accelerate in the next few years in line with China’s burgeoning demand for energy. Imports of oil will surge as industrial demand expands and sales of vehicles boom, boosting petroleum consumption. China’s rising dependence on foreign oil, in turn, will ensure that efforts to guarantee future supply continue. Given the controversy that China’s bids to acquire overseas resources continue to provoke—and, in the case of oil, the limited supplies of oil that can be ensured through corporate takeovers—the emphasis is likely to remain on securing long-term supply contracts. Nevertheless, as the Addax acquisition suggests, China’s state-owned energy firms have the wealth and government support to ensure that there are many more big oil deals in the pipeline.