EVENTS

Date:	Thursday, August 4, 2005
Time:	11:00 AM -- 12:30 PM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

August 2005

CNOOC's Bid for UNOCAL: What are the Lessons for U.S. Policymakers?

On June 22, the China National Offshore Oil Corporation (CNOOC), an oil major backed by the Chinese government, bid $18.5 billion for the UNOCAL Corporation, an American oil company. CNOOC’s bid exceeded Chevron’s by over $1 billion. Whereas some favored the CNOOC bid on economic grounds, the House of Representatives voted 398 to 15 against the proposed deal, calling it a risk to national security. Even though CNOOC dropped its bid on August 2, the episode raised important questions. In an effort to sort through the complex and interconnected economic, diplomatic, and security implications growing out of the CNOOC bid, AEI assembled a group of scholars at an August 4 conference to build upon the facts of this case in assessing the broader underlying issues.

Claude Barfield
AEI

The CNOOC bid raised two broad issues. First, as Chevron pointed out, this was not a commercial contract on a “level playing field,” as CNOOC is backed by the Chinese government. At the same time, it is not customary U.S. policy to oppose business transactions backed by foreign governments. Second, the U.S. response to CNOOC’s bid potentially challenges the current modus operandi of the Committee on Foreign Investment in the United States (CFIUS). Some propose that CFIUS expand its criteria beyond the “narrow” confines of military security to cover economic security and natural resources.

James K. Glassman
AEI

CNOOC’s decision to withdraw its bid for UNOCAL stems from ill-informed and jingoistic congressional opposition. Congress failed to look at the actual merits of the bid, particularly the fact that CNOOC’s bid exceeded Chevron’s by over $1 billion. This precedent set by Congress does not bode well for the U.S. or global economy. There are four points to consider.

First, UNOCAL is not a large company. Its annual revenue of $8 billion pales in comparison to the $1.3 trillion earned by the seven largest publicly traded oil companies each year. UNOCAL’s output accounts for just 0.5 percent of domestic consumption, and only a third of its reserves are in the United States. China’s ownership of UNOCAL would pose little to no risk to the United States.

Second, Congress’ recent interruption of trade could result in harsh retaliatory consequences, as the Chinese own billions in Treasury bonds and carry out substantial business with American firms. American companies invest in China with little government interference, and the United States has traditionally permitted government-backed companies to invest inside the country. Intervention against the CNOOC bid sets a precedent that could create further tension between the United States and China.

Third, CNOOC’s ownership of UNOCAL would not have been a national security risk. UNOCAL is small to begin with, and even if China took all the oil for itself, the United States could simply buy from someone else. The worldwide price of oil would not change. Moreover, the United States contains oil reserves in case of emergency or conflict.

Fourth, the United States should encourage Chinese investment to mitigate the consequences of the upcoming demographic imbalance. Because the ratio of retirees to workers will increase, it will be difficult to maintain the current standard of living. To compensate, the United States will want to sell assets to developing countries, particularly China. Just as the United States benefited from Japan purchasing assets like the Empire State Building and Pebble Beach, demand from Asia could keep stock prices from falling.

The main complaint against China in this matter was that the government was not dictating capital allocation on primarily economic grounds. Oftentimes, Beijing evaluates transactions on criteria such as employment levels and, in this case, a misguided view of national security. As a rule, the Chinese government needs to reduce its control over the economy. Furthermore, this was a bad deal for CNOOC stockholders, as CNOOC was prepared to buy UNOCAL at an overvalued price.

Thomas Donnelly
AEI

China was willing to pay for UNOCAL despite its small size and exorbitant price. Clearly, for the Chinese government, this was not simply an economic transaction. In attempting to purchase UNOCAL, the Chinese government aimed to increase its leverage in the immediate region and across the globe. 

Even though UNOCAL is not a large company, its assets are concentrated in East Asia and the Pacific, which is a key strategic area for China. For example, the world’s largest liquefied natural gas plant is located in Indonesia, and UNOCAL is its largest supplier. Much of the gas produced there goes to Japan, South Korea, and Taiwan. Controlling the supply of natural gas could further China’s goal of isolating Taiwan. Moreover, UNOCAL holds reserves in Azerbaijan, the most reliable ally the United States has in the Caspian region.

By bidding for UNOCAL, China was not looking to gain additional oil supplies, but rather to gain a political advantage. Proponents of the CNOOC deal cite past instances of foreign-backed companies buying American assets, such as Germany’s Deutsch Post’s purchase of FedEx, yet such analogies are inappropriate. Germany was a long-term U.S. ally, and China has yet to earn that status.   

The net outcome of this episode was good for the American political system in that it brought together different strands of thinking that must unite in order to formulate policy in regard to China. With the United States being the guarantor of a free and prosperous international order, it is crucial to take into account China’s overall political strategy, which takes precedence over China’s economic goals.

Phillip L. Swagel
AEI

The issue of foreign investment in the United States is central to the UNOCAL discussion. Due to the large current account deficit, the United States should welcome “unsophisticated” foreign investors.

The United States owns a positive differential of 300 basis points when comparing “good” U.S. investments overseas to foreign investment in the United States. This offsets two percentage points in the annual rise in the U.S. current account deficit. Therefore, if China wants to overpay for U.S. assets, the United States should welcome the business. While the United States should concern itself with “abnormal” trading behavior such as funding corrupt regimes or selling arms to Venezuela, it should not interfere with “normal” negotiations--for example, the bid for UNOCAL. The CIFIUS process works well. There is already great inclusion of economic and security interests, and the government should not do anything to tie CIFIUS’ hands.

Another possible bad consequence of this episode is that now China has an excuse to justify some of its injurious policies towards U.S. investors. Currently, China lacks open, transparent economic processes. It is difficult for the United States to conduct business in China quickly and efficiently. The United States gains from economic growth in China, and policy should focus on issues such as trade barriers, intellectual property rights, and China’s relations with Taiwan and North Korea. Energy issues such as these should be a lower priority.

Dan Blumenthal
AEI

CNOOC’s bid for UNOCAL fits the pattern of China’s “strategic supply security” policy, adopted in 1993, the year in which the country became a net importer of energy. For the past twelve years, China has been purchasing energy companies and development projects at premium prices throughout the world. The Chinese government formed CNOOC with subsidies in order to compete for overseas oil ventures. Currently, the Chinese government owns 70 percent of CNOOC stock.

The congressional vote against the proposed transaction came about after years of growing concern over China’s energy strategy. Chinese “majors” hold energy ventures in forty-four countries, many which are not U.S. allies. For instance, China has invested in countries like Iran and Sudan, and has begun importing more heavily from Venezuela. To the chagrin of U.S. lawmakers, these economic relations have caused China to lobby contrary to U.S. diplomatic intentions. China has succeeded in shielding both Iran and Sudan from tougher U.N. sanctions.

Anticipating conflict over Taiwan, China is working to find energy transport routes that bypass the Malacca Straits. China has given aid and constructed ports and highways in places like Burma, Cambodia, and Pakistan. In addition, unlike Japan and South Korea, China is not free-riding off the U.S. Navy’s protection of Asian waterways. Instead, China is investing in nuclear submarines and has ports in other countries to dock them. Congress’ reaction, therefore, is more understandable in light of China’s political and diplomatic strategy over the past fifteen years.

AEI staff assistant Dan Geary prepared this summary.