Overcoming Political Risk in Cross-Border Transactions

Essay

Overcoming Political Risk in Cross-Border Transactions:
China's CNOOC Invests in Chesapeake Energy
Cross-border transactions often are subject to considerable political risk. In emerging countries, this may reflect the potential for expropriation of property or disruption of commerce due to a breakdown in civil order. However, as Chinese efforts to secure energy supplies in recent years have shown, foreign firms have to be highly sensitive to political and cultural issues in any host country, developed or otherwise.
In addition to a desire to satisfy future energy needs, the Chinese government has been under pressure to tap its domestic shale gas deposits due to the clean burning nature of such fuels to reduce its dependence on coal, the nation's primary source of power. However, China does not currently have the technology for recovering gas and oil from shale. In an effort to gain access to the needed technology and to U.S. shale gas and oil reserves, China National Offshore Oil Corporation Ltd. in October 2010 agreed to invest up to $2.16 billion in selected reserves of U.S. oil and gas producer Chesapeake Energy Corp. Chesapeake is a leader in shale extraction technologies and an owner of substantial oil and gas shale reserves, principally in the southwestern United States.
The deal grants CNOOC the option of buying up to a third of any other fields Chesapeake acquires in the general proximity of the fields the firm currently owns. The terms of the deal call for CNOOC to pay Chesapeake $1.08 billion for a one-third stake in a South Texas oil and gas field. CNOOC could spend an additional $1.08 billion to cover 75 percent of the costs of developing the 600,000 acres included in this field. Chesapeake will be the operator of the JV project in Texas, handling all leasing and drilling operations, as well as selling the oil and gas production. The project is expected to produce as much as 500,000 barrels of oil daily within the next decade, about 2.5 percent of the current U.S. daily oil consumption.
Having been forced in 2005 to withdraw what appeared to be a winning bid for U.S. oil company Unocal, CNOOC stayed out of the U.S. energy market until 2010. The firm's new strategy includes becoming a significant partner in joint ventures to develop largely untapped reserves. The investment had significant appeal to U.S. interests because it represented an opportunity to develop nontraditional sources of energy while creating thousands of domestic jobs and millions of dollars in tax revenue. This investment was particularly well timed, as it coincided with a nearly double-digit U.S. jobless rate; yawning federal, state, and local budget deficits; and an ongoing national desire for energy independence. The deal makes sense for debt-laden Chesapeake, since it lacked the financial resources to develop its shale reserves.
In contrast to the Chesapeake transaction, CNNOC tried to take control of Unocal, triggering what may be the most politicized takeover battle in U.S. history. Chevron, a large U.S. oil and gas firm, had made an all-stock $16 billion offer (subsequently raised to $16.5 billion) for Unocal, which was later trumped by an all-cash $18.5 billion bid by CNOOC. About three-fourths of CNOOC's all-cash offer was financed through below-market-rate loans provided by its primary shareholder: the Chinese government.
CNOOC's all-cash offer sparked instant opposition from members of Congress, who demanded a lengthy review and introduced legislation to place even more hurdles in CNOOC's way. Hoping to allay fears, CNOOC offered to sell Unocal's U.S. assets and promised to retain all of Unocal's workers, something Chevron was not prone to do. U.S. lawmakers expressed concern that Unocal's oil drilling technology might have military applications and CNOOC's ownership structure (i.e., 70 percent owned by the Chinese government) would enable the firm to secure low-cost financing that was unavailable to Chevron. The final blow to CNOOC's bid was an amendment to an energy bill passed in July requiring the Departments of Energy, Defense, and Homeland Security to spend four months studying the proposed takeover before granting federal approval.
Perhaps somewhat naively, the Chinese government viewed the low-cost loans as a way to "recycle" a portion of the huge accumulation of dollars it was experiencing. While the Chinese remained largely silent through the political maelstrom, CNOOC's management appeared to be greatly surprised and embarrassed by the public criticism in the United States about the proposed takeover of a major U.S. company. Up to that point, the only other major U.S. firm acquired by a Chinese firm was the 2004 acquisition of IBM's personal computer business by Lenovo, the largest PC manufacturer in China.
Many foreign firms desirous of learning how to tap shale deposits from U.S. firms like Chesapeake and to gain access to such reserves have invested in U.S. projects, providing a much-needed cash infusion. In mid-2010, Indian conglomerate Reliance Industries acquired a 45 percent stake in Pioneer Natural Resources Company's Texas natural gas assets and has negotiated deals totaling $2 billion for minority stakes in projects in the eastern United States. Norwegian oil producer Statoil announced in late 2010 that it would team up with Norwegian oil producer Talisman Energy to buy $1.3 billion worth of assets in the Eagle Ford fields, the same shale deposit being developed by Chesapeake and CNOOC.
-Do you believe that countries should permit foreign ownership of vital scarce natural resources? Explain your answer.