China National Offshore Oil Corporation's bid to take over Unocal is only the beginning of the country's "go out" strategy.

Get Used to It

China’s bid to take over Unocal is just the start of its plans for acquisitions

BY Jehangir Pocha

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–Demands that corporate America bolt its doors in the wake of the China National Offshore Oil Corporation’s (CNOOC’s) unsolicited offer to purchase the energy giant Unocal Corp. are being closely watched here. Many Chinese say the U.S. reaction will send an irrefutable message about whether Washington is more interested in its commitment to free trade or in containing the growing might of China, a country President Bush has labeled a “strategic competitor.”

“Right now CNOOC is only following the rules of free trade,” says Han Xiaoping, senior vice president of the Falcon Pioneer Technology Company Ltd, an energy research firm in Beijing. “If the deal is not allowed, it sends a message to Chinese companies and perhaps they might start looking for other ways, other markets to do business with.”

CNOOC’s $18.5 billion all-cash offer for the El Segundo, Calif.-based Unocal ups a friendly $16.6 billion stock bid from San Ramon, Calif.-based Chevron Corp. It is the largest international purchase any Chinese firm has undertaken to date, and marks the first time a Chinese firm has entered into an international bidding war with an American company.

CNOOC’s move comes close at the heels of Chinese computer-maker Lenovo’s $1.75 billion purchase of IBM’s PC unit and is expected to be followed by Chinese appliance maker Haier’s $2.25 billion offer for Maytag Corporation. Together, the deals reveal the determination with which Chinese companies backed by the Chinese government are following what they call a “go out” strategy–a plan to use China’s massive foreign exchange reserves of more than $650 billion to acquire leading companies and brands in several key industries.

That’s proving “unsettling and disruptive” for many U.S. leaders and corporations, says James Brock, an independent advisor to the energy industry in Beijing. “But they’d better learn to deal with this sort of thing because it is going to keep happening,” he said. “Pick any product, and the Chinese are going to change the market for it.”

Until recently, Chinese firms were seen merely as cheap manufacturers, and the Chinese government invested most of its cash in low-yielding U.S. government treasury securities. But now the best Chinese firms are moving rapidly up the value chain, and local state-owned banks are eschewing the measly 4 percent return they earn on U.S. T-bills to bankroll their dreams of global expansion.

Jing Huang, a senior fellow in Foreign Policy Studies at the Brookings Institution, says CNOOC’s bid for Unocal is part of China’s attempt to move into the global economy. “China’s ‘go out’ policy is part of the strategy to integrate it into the world,” Huang says.

But Brock says the Chinese government, which owns 70.6 percent of CNOOC, had endorsed the ambitious bid for even larger strategic interests, such as Beijing’s desire to acquire energy fields at a time of uncertain energy supplies and diminishing energy stocks.

China is now the world’s largest energy consumer after the United States, burning the equivalent of 1.5 billion tons of oil this year. Even conservative estimates expect this figure to double over the next decade. Over the next year alone, China will bring online new power plants that will produce about 80 gigawatts of electricity, more than the entire power capacity of the United Kingdom.

“If the rate of growth continues there just won’t be enough [traditional energy sources] in the world for China,” says Han.

That’s not entirely a bad thing, says Brock, because diminishing supplies and rising prices will force nations to embrace other forms of potentially cleaner fuels and renewable energies. But until that happens, Chinese companies are desperately trying “to replace the energy supplies they’ve used up with reliable sources of new reserves,” Brock says.

CNOOC executives estimate that the Unocal purchase will more than double CNOOC’s current oil and gas production, and increase its reserves by 4 billion barrels of standard oil. With more than 85 percent of these combined reserves located in China and nearby Asian countries such as Indonesia and Myanmar, the merger makes sense on a strictly commercial basis.

But the battle for the control of energy resources also has significant political dimensions. Most countries guard their energy industry from foreign or unwanted buyers. China itself does not allow foreign investors to own more than 50 percent of most oil and natural gas-related companies, though it does allow foreign firms full ownership of energy exploration ventures. In fact, it is paying for Unocal in cash instead of stock because the Chinese government does not want to dilute its own holding in CNOOC.

Voices have already been raised in the United States against allowing a state-owned Chinese entity to control Unocal, which has been closely involved with the planned construction of controversial pipelines in Afghanistan and Myanmar. House Resources Committee Chairman Richard Pombo (R-Calif.) is demanding an investigation into the deal.

To soften such critics, CNOOC, whose savvy U.S.-educated CEO Fu Chengyu has a record of successfully navigating rocky waters, has said the company will retain its entire U.S. staff and that all the existing oil and gas Unocal sells in the United States will continue to be sold there and not diverted to China. The company also stated that it would be willing to sell Unocal’s North American assets to U.S. companies, and consider “special management arrangements” for its pipeline projects.

Han says this indicates CNOOC does not want to challenge sensitive U.S. interests, and that its interest in Unocal is partly driven by China’s goal of increasing the share of natural gas in its energy mix from 3 percent to 10 percent, mostly to curb pollution.

Unocal has Asia’s largest stores of liquefied natural gas (LNG), which CNOOC needs for the new LNG terminals it is building along China’s coastline. Unocal also owns specialized deep water drilling technology that CNOOC needs to explore its own gas reserves.

“There are places in China that are like scenes out of a Mad Max movie,” Brock said, as smog obscured the normally panoramic view of Beijing from his 21st floor office. “In the short run, the move to gas is essential but in the longer run there has to be a fuller reconsideration in China, and indeed the world, of the entire energy system.”

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Jehangir Pocha is the Asia correspondent for In These Times.

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