Tuesday, January 10, 2006

Getting in on the Right Floor

After China's CNOOC failed in its effort to acquire Unocal, being initially outbid and later outmaneuvered by Chevron, it was clearly time to rethink its strategy. Buying an international oil company that was larger than itself, and taking on all the operational challenges and risks that went with it, was not just a step too far for a company that still had one foot in the world of state oil monopolies and regulated markets, it was also a poor match for China's needs. Now it has made a major acquisition in Africa, buying into a project led by France's Total. This looks like a much better move.

China's rapid economic growth has turned it from a net oil exporter into a major importer in the course of about a decade. Energy security in the Chinese context will come from reliable, geographically diverse supplies of oil and gas to fuel further growth. Unocal could have provided some of that, but it came not just at a high price per barrel, but with counterproductive political complications . Its 45% stake in the Akpo project in Nigeria will serve it better, if on a smaller scale. As CNOOC and its sister companies attempt to grow internationally, their best bet is buying into precisely this kind of project, involving the development of a previously-discovered resource.

This approach offers several advantages for CNOOC. It will still have to reconcile different cultures and management styles, but this will be on the project venture level, where CNOOC already has considerable experience working with Western companies. It is also not taking on exploration risk, which was the bane of Japan's attempt to do the same thing twenty-five years ago. Nor will it have to operate the project, relying instead on--and learning from--a major oil company with significant experience both in Africa and in deep water. Through further acquisitions like this at attractive prices (this deal is estimated to work out to under $5/barrel) CNOOC can assemble an attractive international portfolio and grow itself into a meaningful supplier of China's import needs, as well as becoming a serious player in the global market.

From the standpoint of the international majors, this strategy creates more of a mixed blessing than a successful acquisition of Unocal would have. In the near term, it provides them a cash-rich partner with whom to share development risk on the multi-billion-dollar projects they must pursue, in order to replace their depleting reserves. In the long run, however, it puts CNOOC squarely into the market from which they derive the bulk of their cash flow, and it will drive up contract terms with host countries. And CNOOC is only the thin edge of the wedge of state and former-state oil companies that are looking to break out of their national cages.

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