SPY EYES

Last week the Government of Canada kicked the CNOOC-Nexen can down the road for another 30 days, delaying the decision for up to a month after the statutory 45 day review period for the friendly takeover had elapsed. The government can make a decision within this 30 day extension or announce a further 30 day delay with CNOOC’s agreement. Meanwhile, Nexen shareholders overwhelmingly approved the deal, which is not surprising given the premium that state owned CNOOC is willing to pay. If this is such a good deal for Nexen’s shareholders, and will allow CNOOC to further bring its deep pockets to the Canadian oil patch, then why the delay? CNOOC’s bid poses a bit of a conundrum for Prime Minister Stephen Harper’s government. It is busydeveloping a closer relationship with China and Asia generally, and wants to make the point that Canada is open for business, especially after BHP was actively discouraged from pursuing its bid for Canada’s largest potash enterprise. At the same time, there has been a lot of negative commentary focusing on the fact that CNOOC is not just a state owned enterprise (SOE) but is a Chinese SOE. Supporters of the deal have pointed out that other SOEs are active in the Canadian oil industry, such as Norway’s StatOil, which is 67% owned by the Government of Norway, but Norway and China trigger very different reactions from Canadians. A survey earlier this year by the Asia Pacific Foundation of Canada found that a majority of Canadians would oppose deals in which state controlled companies attempted to buy a controlling stake in a Canadian company (unless it was a UK SOE, where only 39% disapproved). That number reaches 75% where companies controlled by the Chinese government are concerned. This sensitivity about the activities of Chinese companies was highlighted by the recent report of the U.S. House of Representatives Intelligence Committee accusing Huawei Technologies of being a security threat because of its close ties to the Chinese government. Almost certainly not coincidentally, a few days later the Canadian government, without naming Huawei, announced that a “national security exemption” would be applied to firms seeking to bid on a secure communications network for Canada. The Official Opposition party, the New Democrats, have come out squarely against the CNOOC-Nexen deal, but even some of Mr. Harper’s Conservative MPs have expressed reservations. As for Harper himself, he has conceded that the review raises tough policy issues, but has maintained that the decision will be made on the basis of “net benefit” to Canada. The net benefit test is one of the reasons there is so much uncertainty over the case, since it is at best subjective. As the term suggests, under the Investment Canada Act net benefit is determined by “measuring the aggregate net effect after offsetting the negative effects, if any, against the positive ones.” Factors that are taken into account include whether the non-Canadian SOE adheres to Canadian standards of corporate governance (including, commitments to transparency and disclosure, independent members of the board of directors, independent audit committees and equitable treatment of shareholders), and to Canadian laws and practices, as well as factors such as whether a Canadian business to be acquired by a non-Canadian SOE will continue to have the ability to operate on a commercial basis regarding where to export; where to process; the participation of Canadians in its operations in Canada and elsewhere; support of ongoing innovation, research and development; and the appropriate level of capital expenditures to maintain the Canadian business in a globally competitive position. There is no doubt that some hard bargaining is going on with CNOOC, and conditions will certainly be imposed. It is unlikely that the deal will be blocked but the real test will be how onerous the conditions are, and whether CNOOC will be prepared to swallow them. Ultimately China badly wants increased access to the oil sands (it already has a minority stake in the Long Lake oil sands project in partnership with Nexen), but not at any cost. However, it is prepared to make a number of concessions to secure approval, and potentially pave the way for future investments. For its part, Canada will have to impose conditions that show it has given public concerns about Chinese investment serious consideration, but not make them so onerous that they will force the Chinese to lose face and scare them off. Canada needs huge amount of new investment to continue to develop its oil sands fields, just as it needs new investment to move the product to new markets in the face of a growing glut in North America. While allowing the deal to proceed makes sense from an economic standpoint for both China and Canada, navigating the political minefields will be tricky. For both parties the stakes are high and the decision now hangs in the balance. I believe it will be approved and both sides will declare victory. We should know for sure in about a month. The Diplomat