The Dragon in the Dataroom

CNOOC Ltd.'s pending acquisition of Nexen Inc. puts to the greatest test yet U.S. sentiment about Chinese E&Ps holding operated ownership of American oil and gas assets. The outcome of a decision later this year may be a win for U.S. energy producers who demand, in exchange, more access to Chinese E&P assets. And, it could be a win for U.S. E&Ps that would like another premium-paying bidder in their datarooms.

"Anybody who has assets or companies for sale these days, the first question we get is 'Will the Chinese buy us? We want to sell to the Chinese,'" says Steve Trauber, vice chairman and global head of energy investment banking for Citigroup Global Markets Inc.

The firm, along with BMO Capital Markets, represented CNOOC in its $17-billion offer for Nexen, which has received Nexen shareholder approval and awaits Canadian, U.S. and other governments' nods, including China's itself.

Trauber has been spending a great deal of time in Asia this year, as Citigroup has been the most active investment banker and advisor to the Chinese to date. "And, I will be going there again. There is tremendous appetite by the Chinese for assets," he told some 500 attendees at Hart Energy's 11th annual A&D Strategies and Opportunities conference in Dallas recently.

Steve Trauber, vice chairman and global head of energy investment banking for Citigroup Global Markets Inc., says the Chinese appetite for assets is “tremendous.”

At issue with the deal in the U.S. is that Nexen owns operated and nonoperated interests in the Gulf of Mexico—some 200 lease blocks, making it a Top 20 leaseholder. While exploration is ongoing, Nexen nets some 20,000 barrels of oil equivalent (BOE) per day from the Gulf, mostly natural gas.

The deepwater Appomattox discovery—a Norphlet play in the eastern Gulf—by Shell Oil Co. last year is 20% owned by Nexen. First oil is expected in late 2017 or in 2018, ramping up to as much as 100,000 BOE per day. It also has a position in the 2007 Vicksburg discovery and in Knotty Head. Other Norphlet-play interests include the Petersburg and Rydberg prospects about seven miles south.

Already, U.S. approval was granted to CNOOC in 2011 for nonoperated, 20% working interest in three Miocene-play Nexen prospects in the Gulf: Kakuna, which has since been deemed unsuccessful; Angel Fire; and Cypress. In that deal, CNOOC may also participate in three additional wells at 10% to 15%.

CNOOC was also cleared in 2010 and 2011 to take nonoperated joint-venture positions in Chesapeake Energy Corp.'s Eagle Ford and Niobrara leaseholds. And, Sinopec Group was approved for a nonoperated JV position in six unconventional-resource plays with Devon Energy Corp. earlier this year.

Will CNOOC now receive clearance for an operated position in U.S. oil and gas producing assets? Trauber notes that CNOOC failed in its unsolicited, cash bid for Unocal Corp. back in 2005; Chevron, a fellow California-based producer and refiner, won the integrated energy company with an all-stock offer instead. "A lot of that was due to lack of planning and regulatory discussions ahead of time. I also would say that, probably, the U.S. was not ready. Today, it's probably still not ready for a Chinese acquisition of a significant U.S. corporate entity."

In the case of Nexen, though, the company is based in Canada. Also, very few of its reserves and production—some 7% of production—is from the Gulf. "Despite a lot of noise coming out of Washington early on about this transaction, I think both Nexen and CNOOC are very hopeful that it won't be stopped by U.S. officials," Trauber says. "If for some reason it were to be stopped, I'm sure they would divest of the Gulf assets, but we don't expect that to occur."

In recent years, Chinese companies’ acquisitions of international oil and gas assets have multiplied. China has been a leader in upstream M&A.

The CFIUS step

One of the approval stops is at CFIUS (pronounced "sy-fee-us"), the Committee on Foreign Investment in the United States. Chaired by Treasury Secretary Tim Geithner, members include the departments of Justice, Homeland Security, Commerce, Defense, State and Energy.

Billy Vigdor, a Washington-based attorney with Vinson & Elkins LLP, thinks CNOOC's acquisition of the Gulf assets as part of the Nexen deal will get through CFIUS. The committee's ultimate concern is with whether foreign ownership of U.S.-based assets poses a national security risk, he notes.

"CFIUS will look at the assets being acquired, the relationship of the assets to a number of factors related to national security, the acquirer and the nationality of the acquirer and determine, given everything they have before them, whether there is a threat to national security," Vigdor says.

Within the energy sector, CFIUS would likely be more concerned with foreign ownership of U.S. energy-pipeline and power infrastructure. "Power generation and transmission grids are something CFIUS has sought to protect for a long period of time," Vigdor says.

"This is a very traditional area of CFIUS—to make sure power-generation infrastructure of the U.S. can serve the military and national defense."

American refining assets would be scrutinized to make sure they are adequately protected against a terrorist attack. "One of the questions CFIUS will ask is 'If foreign interests take control of that facility, will they be as vigorous in protecting it against terrorism as would a U.S. owner? I think CFIUS has become comfortable with the idea that companies invest significant sums on these assets and the last thing they want to see is a third party come in and destroy them.

"I think they would look at pipelines the same way—to make sure the infrastructure of the U.S. is not unduly compromised against terrorist attack."

The Nexen transaction will also need Interior Secretary Ken Salazar's approval, as title to the Gulf leases will change hands. As for anti-trust clearance, that isn't likely a problem, since CNOOC assumption of the Gulf assets doesn't diminish competition for exploration and sale of oil and gas in the Gulf region, Vigdor says.

Trade concerns

Among U.S. oil and gas producers, however, trade is a concern, they have said. In the past, they have taken issue with Chinese competition for U.S. assets because, they say, ownership of Chinese oil and gas assets—such as an American acquisition of CNOOC or Sinopec—would not be allowed.

U.S. Senator Chuck Shumer has raised that point. He is asking CFIUS to reject the Gulf portion of the CNOOC-Nexen deal, telling the media that "it is rare that we have so much leverage to exert upon China. We should not let this window of opportunity pass us by. At some point, we have to put our foot down over China's refusal to play by the rules of free trade."

In a letter to CFIUS chairman Geithner, Shumer says, "For far too long, the road toward a normalized trade and investment relationship between the U.S. and China has been a one-way street. It's time that we demand equal treatment from China…."

The trade issue likely will not measure up in front of CFIUS, though. Vigdor notes that American oil and gas companies indirectly own assets in the South China Sea. "Also, CFIUS does not use its authority as a trade tool. They base their investigation on national security."

Citing national security, however, four other U.S. senators—Oklahoma's Jim Inhofe, Texas' John Cornyn, Alabama's Richard Shelby and former North Dakota governor John Hoeven—are asking for CFIUS rejection of CNOOC's takeover of the Gulf assets.

They wrote to Geithner, "We hope, at the very least, you are viewing CNOOC as an agent of the Chinese government and are taking into consideration its capacity to act in a way that is inconsistent with the best interests of the U.S."

Billy Vigdor, a Washington-based attorney with Vinson & Elkins LLP, thinks CNOOC’s acquisition of Gulf assets as part of the Nexen deal will gain approval from the Committee on Foreign Investment in the U.S. Left, Nexen’s assets span the globe, with the U.K. holding the lion’s share of production.

On another front, U.S. Rep. Ed Markey, the ranking member of the House Natural Resources Committee, is asking Secretary Salazar to prohibit transfer of Nexen's Gulf leases to CNOOC because Nexen holds interests in four of 150 deepwater leases that carry federal royalty relief. Markey wrote to Salazar, "If CNOOC takes ownership of Nexen, these royalty-free leases could be transferred to a Chinese state-owned oil company, which would amount to a subsidy from American taxpayers to the Chinese government."

As for CFIUS, Vigdor says that several China-related deals are on its table right now and rulings on each will make its position more clear. "Watch the Nexen deal very closely. Also, watch the A123 Systems battery deal and the Hawker Beechcraft aircraft deal," he says. "These are three very different Chinese acquisitions that might give you a better sense over the next few weeks or months with respect to CFIUS' treatment of Chinese investment. "

Another matter before CFIUS is litigation involving Ralls Corp., a Georgia-based company owned by Chinese nationals, Vigdor notes. CFIUS has required that Ralls undo its acquisition of four wind-farm projects in Oregon. Representing Ralls is Paul Clement, U.S. Solicitor General from 2005-08 and now a partner with Washington-based Bancroft PLLC law firm. CFIUS claims Chinese ownership of the wind farm is a national security risk; Clement argues that it is not and that CFIUS' demands are arbitrary, capricious and draconian.

From there to here

For CNOOC, the greatest prize in buying Nexen isn't the Gulf assets, Trauber says. Instead, CNOOC gains a Canadian platform, including all of Nexen's personnel, for running its North and Central American operations. It gains production from the U.K. North Sea; oil-sands interests in Canada; Horn River Basin gas assets in western Canada that are a candidate for export as liquefied natural gas (LNG) into the Pacific Rim; West African oil production; and other upside.

Nexen's reserves are weighted to the U.K. and Canada

"What this does for CNOOC is it establishes a North American platform with 64% of its proven reserves in OECD countries, and an immediate 20% increase in production, 30% in reserves, and reserve life from 9.6 to 10.3 years."

It is a logical evolution: CNOOC and sibling Sinopec have become internally constrained. "They really needed to find corporate platforms. They found that they were able to integrate much quicker when they were picking up an entire company, so what we see today is a much more aggressive Chinese buyer—looking at platforms, not just assets."

Driving this is China's forecasted demand for 9- to 9.5 million imported barrels of oil daily by 2020, while it only produces 4.5 million daily now—and that may decline, because new offshore production isn't expected to keep up.

Also, its forecasted demand for natural gas, in particular, is to grow even faster—at a compounded 13% per annum. "This will be partially offset by growing conventional and coalbed-methane supply and the hope that shale gas will come," Trauber says. "But, we don't foresee that coming for another 10-plus years in any kind of meaningful scale."

Access to natural gas is even more important to supply-constrained China now that Japan has stepped up its bidding for LNG cargoes since the Fukushima nuclear event. Currently, China imports about 15 million tons of LNG per annum, another 30 million of capacity is under construction, another 20 million is approved and planned, and an additional 40 million is proposed, Trauber notes. "Clearly, China is becoming a Top 3 LNG buyer."

Post-Fukushima, Japan procured most of the hard, contracted LNG volumes available through 2014—more than 11 million tons per annum, "much to the frustration of the Chinese, Koreans and Indians." Other Asian buyers were forced to look out to 2015-18 for supply, further extending the current seller's market for LNG. "We expect this market to continue to be extraordinarily hot over the next several years."

Ownership of natural gas resources provides Chinese oil companies with leverage in the LNG market, Trauber explains. "There is a misperception that LNG investments are only for physical integration—in other words, that those buying into LNG projects will insist on taking the product directly back to their home countries." Instead, ownership of higher-priced, and possibly higher-risk, Middle Eastern LNG cargoes allows for swapping with less expensive tons, such as from the U.S. and Canada.

U.S. gas acquisition?

Meanwhile, money is not an issue for the Chinese as the country's trade surplus is some US$3 trillion. "This significant dollar liquidity and surplus in their respective financial systems forces them to invest back globally in U.S.-dollar-denominated assets, most notably U.S. Treasuries." In particular, China has made a national priority of investing its U.S. dollars in natural resources.

As for Chinese E&Ps having a lower cost of capital than other E&Ps, that's not so, Trauber adds. Their capital costs are lower than some because of their sheer size; for example, CNPC has a market capitalization of $190 billion. "It has nothing to do with the Chinese government itself.

"In fact, their cost of capital is very competitive with our IOCs and other NOCs. Their equity is raised in the public markets. Their long-term debt is raised in the public markets and their loans are with combinations of domestic and foreign lenders at very competitive corporate rates."

While Sinopec and CNOOC have been active deal-makers in North America, CNPC is next up, he adds. "They are the $190-billion gorilla and they are only now finding their sea legs and their appetite for acquisitions. The target they want to look at is very large and you'll see them likely make the next large acquisitions on a global scale."

It may continue to be difficult for a Chinese NOC to take an operated interest in U.S. assets, he concedes. "It doesn't mean they have any less of an appetite for assets in the U.S. In fact, their appetite for assets in the U.S. is as high as it's ever been and growing."

There is greater likelihood of a Chinese acquisition of U.S. natural gas assets, though. "It looks like we're going to be exporting natural gas anyway, so I think, if the Chinese were thinking about a natural gas acquisition in the U.S., it might be something that would get through Washington."

Meanwhile, there just aren't enough E&P asset and corporate offerings on the market to quench the Chinese NOCs' thirst, he concludes. "That's why they have such an unsatiated appetite for acquisitions. We believe the only thing limiting their M&A activity is the supply of transactions."