“If you don’t review this one, that law is meaningless,” Democratic senator Ron Wyden told then US treasury secretary, John Snow in 2005. He was talking about legislation designed to veto foreign takeovers that threatened American interests. “I don’t think being a free trader is synonymous with being a sucker and a patsy,” added the elected representative from Oregon.
That pretty much set the tone for Chinese oil major CNOOC’s battle to buy California’s UNOCAL. Opponents lined up to warn against the bid as an energy grab detrimental to US interests. Shocked by the “regrettable and unjustified” reaction, CNOOC withdrew.
Five years on and CNOOC is preparing again to take a stake in the US oil and gas industry. This time the deal is valued at a much more modest $1.1 billion (versus $18 billion for UNOCAL) for a third of Chesapeake Energy’s shale project at Eagle Ford, Texas. CNOOC has also agreed to finance another $1.1 billion in drilling costs. Chesapeake’s reserves in Eagle Ford are mostly oil, though it expects to make 20% of its revenue from natural gas.
The deal represents another bet by state-run CNOOC on the price of oil. Chesapeake specialises in ‘unconventional’ deposits trapped in shale rock formations – shale oil can cost anywhere from $50 to $110 a barrel to produce (versus just $2 a barrel in Saudi Arabia). Crude oil is currently trading around $83.
It’s hard to imagine CNOOC Chairman Fu Chengyu would be going ahead with the deal unless he was confident of it being approved by US regulators. The memory of the failed UNOCAL bid five years ago must still touch a nerve, even for a hardy oilman.
“The climate is much more hospitable now,” energy consultant Juli MacDonald-Wimbush told the Houston Chronicle, “[Chinese firms] have the cash, and energy companies in the US are looking for [capital] to develop these reserves.”
Politics could still get in the way of the deal. Congressional elections are coming up next month, and campaigning season means that the rhetoric on China’s role in the current economic malaise in the US is cranking up (see page 6).
Some observers think that CNOOC might be overpaying. But oil isn’t the only thing it’s hoping to get from the deal. Also important is the chance to gain experience in the latest technologies for extracting oil and gas from shale. “I call it legalised industrial espionage,” energy analyst Fadel Gheit told MSNBC.
“From the Chinese perspective, this is a golden opportunity,” explained Ken Medlock, economics professor at Rice University, “They have identified shale resources in China, but they don’t have the knowledge or technical expertise to go after those resources.”
China’s own shale deposits are thought to have as much as 918 trillion cubic feet of natural gas (for comparison, China consumed 3.1 trillion cubic feet of natural gas last year) and 16 billion barrels of oil.
Right now, Chinese companies break down the rock the old fashioned way – by mining it. That means stripping away a huge amount of earth, before sending the uncovered rock off to be broken apart and then treated to get the hydrocarbons out. Adopting the methods used by Western oil companies could significantly reduce costs.
The only companies using the newer technology in China (for now) are foreign ones. The process, called hydraulic fracturing, involves drilling horizontally and then driving a mixture of water, sand and chemicals into the rock at high pressure. The Chesapeake deal might just give CNOOC a way to learn the ropes too. Then again, it remains an expensive way to extract oil, and is likely to put more pressure on China’s dwindling water supplies (see WiC81). The technology has also started to attract controversy in the US, with claims that the chemicals involved in ‘fracturing’ the rock have leached into the groundwater in areas surrounding the wells.
That’s not likely to deter CNOOC, which seems committed to building up its expertise.
“We expect them to expand their footprint in the Canadian [tar] sands and also in Brazil’s deep water,” predicts Gordon Kwan at Mirae Asset Securities.
© ChinTell Ltd. All rights reserved.
Sponsored by HSBC.
The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.