We often highlight articles that would be interesting and relevant to the Firmex community. We hope you enjoy this in-depth article by Yuen Pau of the Asia Pacific Foundation of Canada, on the impending CNOOC-Nexen deal in the oil and gas sector.
While the political and economic views expressed in this article don’t necessarily reflect that of Firmex, we felt that it provided a succinct overview of major considerations at play in this deal, and should serve as a good starting point for those interested in exploring the topic further.
With the Canadian government expected to make a decision by mid-October on the $15.1 billion CNOOC-Nexen acqusition, at least one thing has become clear: critics on the left are in rare alignment with critics on the right in their uniform opposition to the deal.
The arguments are of course different: While economic nationalists call for government to block the sale of a private asset; free market champions oppose the deal precisely because the acquirer is a government-linked entity.
In other words, those who traditionally favour a larger role for the state in the economy oppose a state-owned entity from buying this asset, and those who traditionally resist intervention in the marketplace support a government decision to block the sale.
At the heart of this puzzle is the fact that CNOOC is a state-owned company from a country that has an economic system that is described confusingly as “market socialism”. The Chinese economic model may not be everyone’s cup of tea, but it is the chosen model in China and there is little likelihood that SOEs will be dismantled in the foreseeable future.
It so happens that when it comes to the oil and gas sector, China’s preference for state ownership is not unique. State-controlled companies account for nearly 80 percent of the world’s oil and gas reserves. Many of them are already operating in Canada, for example Statoil, Japan Oil, Gas and Metals National Corporation (JOGMEC), Korea Gas Corporation (KOGAS), the Korean National Oil Corporation (KNOC), Petronas, and PTT Exploration and Production Public Company Ltd. (PTTEP).
Canada chose a different route 21 years ago with the privatization of Petro-Canada. Many in this country who fought so hard for the divestment of government from industry now see the threat of foreign SOE investment in Canada as a kind of back-door nationalization. The concern is on two fronts: That foreign SOEs have a lower cost of capital and hence can outbid private firms for assets in Canada; and that state-run companies underperform private firms in the long run.
If CNOOC was a Canadian state-owned company, the public might be unhappy about Canadian tax dollars subsidizing their perhaps too-rich offer to buy Nexen. Chinese citizens may well be upset about the deal, but that is for the Chinese government to worry about. If CNOOC is indeed paying too much for Nexen, hooray for Nexen shareholders. As for whether or not CNOOC has outbid another buyer through its unfair use of government subsidies, there are two points to consider: a) Nexen has been the subject of acquisition rumours for a long time, including a failed deal with Total of France in 2009; b) many other potential buyers would have been state-owned companies as well, given their domination of the oil and gas industry.
It may be true that state-owned companies in general underperform private firms, but research on National Oil Companies has found very wide variation in their performance, depending in part on the nature of their assets, governance, quality of human resources, and the degree of political interference that they are subject to. There is similar variation in the performance of private companies, even if the question of political interference is not usually a factor. Indeed, Nexen has long been seen as a performance laggard in the industry. Should we be relieved that a state-owned company has picked up this underperforming asset or alarmed that the new owner will do an even worse job of running the company?
The answer to this question should be the same as if the acquiring company was a private enterprise: It is for shareholders to decide, not the government.
In coming to this conclusion, this article does not argue that state-owned enterprises are identical to private firms. By the very nature of their ownership and control, state-owned companies have the potential to behave in ways that are motivated by “non-commercial” concerns. It would be naive to think otherwise. This is fundamentally why Canada chose to keep government out of business (for the most part), and went through a wave of privatizations starting in the 80s. But this is not the choice taken (so far) by many other countries, and particularly not so in the oil and gas industry.
In accepting that SOEs may not behave like private firms, the important question is to ask what these deviations might be and what recourse is available to the government of Canada.
There is already a suite of domestic laws on unfair competition, labour and environmental practices, consumer safety etc. that govern business practice in Canada. There are not many examples of a situation where an undesirable practice would not or could not be addressed by domestic laws. These laws of course apply equally to foreign state-owned and private firms operating in Canada, which underscores the basic point of non-discrimination between these two categories of foreign investor. Perhaps there are extreme scenarios where prevention is better than redress, but even in these situations, one could sooner apply the “national security” filter in the investment review process than to make a hard distinction between foreign state-owned firms and private ones.
We should reject the notion that by accepting investment from foreign SOEs, Canada is in effect adopting a statist model of economic development and allowing the “nationalization” of industry. This is a spurious argument not only because of the extremely small share of foreign SOEs in Canada, but also because the market framework governing industry is more important that the fact of foreign state ownership in that industry. However they might behave in other parts of the world, SOEs in Canada have to play by Canadian market rules.
Canada is not alone in its anxiety over foreign state-owned investment, and there is similarly muddled thinking on this issue in the United States, Australia, and in the EU. Across the west, a combination of discomfort with SOEs and fear/distrust of China is encouraging policymakers to put up investment barriers. Which is why Canada has an opportunity to stake a unique position by being the most open of industrialised countries to all forms of foreign investment.
By rejecting false dichotomies between state-owned and private foreign investors and conflated arguments about foreign SOEs leading to nationalization, the Canadian government can claim a unique space for its investment regime – one that is committed to market forces, underpinned by strong domestic regulation, and which does not single out state-owned companies for special scrutiny.
Content courtesy of Asia Pacific Foundation of Canada. The views expressed in this article do not necessarily reflect those of Firmex.