The China Syndrome
Vol. 9 Issue 5 - June 2005

by James Stevenson

Wild speculation about where and how China would make its triumphant entrance into northern Alberta’s oilsands became a popular oilpatch pastime over the past year. Nearly every major energy company confirmed that they had held at least cursory talks with one or more of the large, state-owned Chinese firms. It was no longer a question of whether the Chinese would come – it was just a matter of when.

The most likely takeover target of resource-hungry Chinese heavyweights like PetroChina International Co. Ltd. was Husky Energy Inc., the fourth largest oil and gas company in Alberta. With more than 70% of the company controlled by the family of Hong Kong billionaire Li Ka-shing, Husky’s Asian connections are evident. And so are its ties to one of China’s largest state-owned oil and gas companies, China National Offshore Oil Corp. (CNOOC). Last year, Husky signed its seventh exploration contract with CNOOC to drill in the Wenchang oilfield, increasing its exploration activities in Asia.

Critical to speculation that Husky would be the first Alberta company to ink a deal giving the Chinese a stake in Alberta’s oil reserves is its aggressive oilsands plans. Husky has taken huge strides to move ahead with its $500-million Tucker thermal oilsands project, which is expected to produce 30,000 barrels of oil per day. Its second project, the $10-billion Sunrise Thermal Project, is scheduled to be built in three phases and increase production by more than 100,000
barrels per day.

Despite Husky’s strategic maneuvering, however, the first Chinese foray into the oilsands was not a multi-billion dollar takeout of Husky, but a minority investment in a tiny company that few had ever heard of.  In mid April, CNOOC paid $150 million for one-sixth of MEG Energy Corp., a private Calgary-based firm with large land holdings in northeastern Alberta. But because MEG doesn’t  even have a pilot project yet, nor any guaranteed barrels, the deal appears strategic in nature – a pure equity investment by CNOOC to access advanced oilsands extraction technology that can be transplanted to oilsands and shale projects back home.

Industry watchers didn’t even have a chance to wonder if China’s oilsands interest had been greatly overblown before another deal was announced two days later. That same week, Enbridge Inc., operator of the world’s longest crude oil pipeline system, unveiled a preliminary deal with PetroChina to earmark half of the oil flowing through its proposed $2.5 billion Gateway Pipeline. When completed, the project is expected to move 400,000 barrels of oil per day from Edmonton to a deep-water port on the west coast where the crude oil can be shipped to China, other Asia-Pacific markets and California. Because oilsands production is estimated to at least double to two million barrels per day by the end of the de­cade, filling most of the existing markets in the American midwest and east coast, Enbridge hopes to open up west coast and Asian markets with Gateway in place by 2010.

Enbridge expects that three-quarters or 300,000 barrels per day of oilsands crude from its pipeline will head to Asian markets, with the remaining 100,000 daily barrels destined south to California. With the Chinese tentatively filling half the capacity, the rest is likely to be taken up by smaller contracts.

Out west, Enbridge isn’t the only company with plans to ship large quantities of oilsands crude to tankers bound for Asia. In direct competition is Vancouver-based Terasen Inc., which has already announced a $570-million expansion of its Trans Mountain pipeline to add 75,000 barrels per day on its line from Alberta into Burnaby in B.C.’s Lower Mainland by 2008. Further plans also call for a new line into Prince Rupert or Kitimat, but Enbridge’s preliminary deal with PetroChina puts Terasen significantly behind in the race to build a new west coast line.

Greg Stringham, vice president of markets for the Canadian Association of Petroleum Producers, says he wasn’t surprised at all by CNOOC’s cautious first investment. “That’s where I thought they would start. I have been meeting with them for almost 20 years, and most of the time they come over, they’re looking around and they’re seeing what’s going
on – they’re kicking the tires.”

On a visit to Calgary last year, the Chinese delegation displayed a sophisticated understanding of the global oil market and was asking all the right questions. “To them, it was, ‘We’re just looking for a good investment for some of our capital and we see this as a long-term supply.’ The direct connection to the coast was appealing, but it wasn’t a necessity,” Stringham says. “They understood that if the oil came on here and got sold to the U.S. and that backed out some oil from elsewhere, they could then pick that up. It is a global market. And they can financially move it around just as easily as having a direct connection.”

The recent deals, proof positive of China’s interest in getting its hands on oilsands barrels, raise important questions about how a growing Canada-China partnership will be viewed south of the 49th parallel. Will the Americans take kindly to sharing Canada’s energy exports at a time when their conventional supplies continue to wane? And how will state-owned Chinese oil and gas companies operate in Alberta’s free market economy?

China’s interest in Alberta’s energy reserves is a pressing matter as the world’s fastest growing country struggles to fuel an economy that continues to grow at a pace not foreseen even just a few years ago. Its GDP growth, 9.4% in 2004, has put strains on the country’s ability to meet its energy needs. It is well known that several state-owned companies have been scouring the globe to secure resources. Canada’s oilsands, the world’s second-largest energy reserves behind Saudi Arabia, have become an appealing target.

Usually tight-lipped about business, Chinese oil executives have been rela­­tively candid about their interest in Alberta’s oilsands. In April, executives from a third Chinese company, China Petroleum & Chemical Corp. (Sinopec), made it clear that they too are interested in “profitable” oilsands projects. An official with the company told Calgary reporters that the MEG announcement was likely to be followed by other deals – each one larger in size and significance. The oilsands are, as one Sinopec vice-president told a Toronto business crowd last December, “remarkable resources and we are currently investigating them.”

China’s intentions are apparent, but what is not so obvious are the geopolitical ramifications. How do the Americans view the strengthening China-Canada relationship? BMO Nesbitt Burns global economic strategist Sherry Cooper points to number of concerns in a recent report. “Firstly, do we want to sell our resource companies to the Chinese or just sell the products produced by Canadian companies?” she asks. “And secondly, what will it mean for our relationship with our largest customer, the U.S.? No doubt, Washington is taking note of the Chinese-Canadian courtship.”

Depending on who you talk to, the American reaction to Chinese oilsands investment  veers from one extreme to another– there are those who feel there is nothing to worry about and those who fear China’s motives. “If you believe in free trade, then you should have no objection to Chinese companies acting like American or Canadian companies, making investments where they see opportunities,” says Michael Klare, a professor of peace and world security studies at Hampshire University in Massachusetts. “So there’s really nothing to say except that if you’re an American company, you have to compete in a capitalistic fashion with the Chinese.

“On the other hand,” he continues, “if you speak to neo-conservative analysts and more traditional conservatives in the U.S. who view oil as a strategic rather than a purely commercial product, then there’s a great deal of anxiety about this.... Oil is different from everything else in the eyes of some, including people in the U.S. government.”

According to Klare, the author of Blood and Oil: The Dangers and Consequences of America’s Growing Dependency on Imported Petroleum, conservative think-tanks believe the U.S. and China are destined to clash and view oil as a critical factor in the inevitable feud, regardless of Canada’s relationship with China. Any Chinese investment in the Canadian oilpatch would be seen as poaching in America’s backyard, diverting oil that should be flowing to the U.S. and fueling the tension between the two countries.

Frankly the Americans should be less worried about China, adds Klare, and more concerned about pinning too much hope on the oilsands, which in Klare’s opinion isn’t enough oil to solve America’s energy problems anyway. He warns that Americans have a false impression that the Canadian oilsands are going to save the U.S. from diminishing conventional oil sources, making it easier to reduce ties to Saudi Arabia and other unsavory regimes in the Middle East.

Years of continental energy markets – pipelines transporting thousands of barrels of Canadian crude and natural gas southwards to the U.S. each day – has fuelled America’s feeling of entitlement to Canada’s energy exports. Canada may be the largest energy supplier to the U.S, but the majority of Canadian oilsands players are pleased with the idea of a major new pipeline opening up international markets. Deals like the recent one between Enbridge and PetroChina are beneficial to Canada, say some producers.

“More market access is a good thing for this industry – it’s a good thing for Canada as well,” says Suncor Energy CEO Rick George. “You only have to think about softwood lumber or beef to say, ‘Listen, having only one customer is not necessarily the best position for this country.’ We certainly support expansion of pipelines to the west coast.”
While oilpatch deals are the purview of the marketplace and economics, the Alberta government believes more can be done on the inter-governmental and regulatory level to help move along large proposals. Alberta Energy Minister Greg Melchin says it’s time for the province to make sure heavy oil upgrading and other value-added opportunities are done here in the province rather than exporting raw bitumen for refining elsewhere in the world. “If we start shipping large amounts of the oilsands in bitumen form to China, I would say that’s not in Alberta’s interest,” he says. “We need to help facilitate the supply of more finished products rather than being just hewers of wood.” In April, Melchin and Canadian oilpatch executives travelled to Washington to talk with senators, congressmen and senior officials in the American administration. The message that the Chinese are investing in Canada’s oilsands is increasingly met with “curiosity, more than alarm.”

The Alberta government, says Melchin, still views the U.S. as its “most valuable and strongest relationship, as well as our friend and neighbour.” But that doesn’t mean that they can’t use a good wake-up call. “Sometimes we get taken for granted as a Canadian customer,” says the energy minister. “I think the awareness work is really important so they understand. Go ask any American who is their largest trading partner globally and many times they don’t even list Canada. If you ask them who provides them their oil and natural gas, Canada isn’t listed in the top and we are their largest supplier of those products.”

Another lingering question is whether it’s in Alberta’s best interest to have state-owned companies that take their orders from China’s communist government operating in Alberta. How will this wash in a province that puts so much stake in its entrepreneurial spirit? Loren Brandt, an economics professor at the University of Toronto and specialist on Chinese trade, says fears about Chinese business are outdated. Many of the barriers that once existed have come down, especially since China’s entrance into the World Trade Organization several years ago. “China is a reasonably open economy and most people don’t realize how open it is.”

Fear surrounding different business cultures and views on human rights tend to be grossly overblown in regards to modern Chinese companies. “If I was working for them, all I’d care about is that they’re a well-run company,” says Brandt. “I don’t get too hung up on nationality these days.”

 Potential Chinese ownership is not an issue found solely in the oilpatch. Chinese companies are combing the world for acquisition targets, as demonstrated by last December’s $1.75 billion US takeover of IBM’s personal computer business by Lenovo Group, one of the world’s largest manufacturers of PCs. Canadian resource companies are also on their radar screen, proven by last fall’s attempted $6-billion takeover of mining giant Noranda Inc. by China’s state-owned Minmetals, which eventually collapsed without a deal.

If there are no hang ups about two ideologically-opposed economic systems clashing, then why haven’t there been more Chinese deals? Part of the answer lies in the fact that established oilsands producers are less than welcoming to prospective suitors, especially in an environment of near-record oil prices and sky-high valuations for all energy companies. Marcel Coutu, CEO of Canadian Oil Sands Trust, the largest shareholder in the Syncrude Canada joint venture, admits to having early discussions with Chinese companies but nothing more. “Frankly, no, we don’t entertain a lot of discussions on that front,” says Coutu. “We don’t need the capital, we are focused on our operations and they’re looking for something else. They’re looking for developing projects or they’re looking to buy crude oil like the U.S. If they want to buy our crude oil, that’ll be fine. They can bid alongside everybody else.”

Richard Bird, the Enbridge vice-president who put together the preliminary agreement with PetroChina to anchor its proposed Gateway pipeline, says getting a final deal on pipeline commitments later this year would be much easier if the Chinese companies had barrels of their own earmarked for export, rather than trying to buy them from oilsands producers. “I get a sense that all of the Chinese companies are interested in acquiring equity barrels,” he says, “actually having an ownership position in the production and having the ability or right to take their share in kind and transport it to their home market.”

At the same time as Enbridge was trumpeting the PetroChina memorandum, Bird cautioned that lots of work needed to be done before this pipeline could be built.One of the first big issues is finding a pricing mechanism that’s agreeable to both parties. Refiners in Asia-Pacific countries tend to use benchmark products that come out of the Middle East, while Canadian companies use a North American standard. The Chinese are just as befuddled by a Hardisty posting as the Canadians are to Arabian heavy as a pricing reference point. “So that’s one area where there has to be a bridge,” says Bird. “Either one has to accept the pricing mechanisms of the other, or there has to be some mixture or composite that both are prepared to accept.”

With the initial Chinese investments behind us, Alberta may have to pick its battles carefully with its new friends. But oil and gas producers seem ready for the struggles that lie ahead and the intricacies of international politics. Everyone in Alberta – industry, governments and investors alike – are all awaiting China’s next big step.