Political component to Unocal bid

The attempted US$18.5 billion ($27.4 billion) acquisition of US energy giant Unocal by Hong Kong-listed China National Offshore Oil Corporation shows political considerations in such deals are not exclusive to China.

The first column of this series addressed the issue of corporate governance in China. So central is the issue that many Chinese-related business stories come back to it, just as National Offshore's does.

To recap: Managers of the listed company have a fiduciary duty of care to the interests and assets of the listed company.

The fact that in this case the listed company National Offshore is majority owned by the parent company (itself Government owned) does not give the parent company the right to interfere in the running of the listed unit.

The issue for this deal is especially prickly for China because it involves energy, raising the probability that the Government will overstep the mark by using listed companies such as National Offshore to attain strategic security goals.

This is essentially unfair to investors who have bought National Offshore shares in Hong Kong under the assumption that the company would focus on maximising its profitability only.

Yet the Government's anxiety is understandable.

China's energy security is low. Its greatest future geo-strategic rival, the US, has a stranglehold on many of the world's richest oil and gas reserves, from Middle Eastern oil in Iraq and Saudi Arabia to the gas reserves in Central Asia.

China, although it has some domestic oil stocks, has been a net oil importer for the past 12 years. China's need for energy is compounded by its lack of a strategic reserve, raising the country's vulnerability to a decrease in its supplies of oil.

China's vulnerability to oil is balanced by its vast coal fields, but even these are showing signs of scarcity.

The country also has gas reserves; however these reserves are far away in the west, and only amount to 3 per cent of China's energy mix.

The gas pipeline running from the west of the country to Shanghai is expensive to build and operate (transporting gas is six times as expensive as transporting oil) and is only being used at half capacity due to decreasing gas supplies. That makes it more difficult for the Chinese Government to switch consumption away from coal, which is a heavy pollutant, to gas.

Some analysts say it's precisely because of these negatives that the current bid for Unocal is about securing on gas.

Many of these assets are conveniently located in Indonesia and complement National Offshore's predominantly oil-based assets.

They would also help to diversity energy supplies away from the Australia-China gas pipeline.

National Offshore's offer price of over US$18.5 billion cash is huge and far more attractive than a rival US$2 billion lower cash and shares offer from US oil giant Chevron.

The obvious reason a company buys another company is because it permits it to grow faster than through its own efforts.

Focusing on growing a company bit by bit through retained earnings is steady, but slow.

Speed is important when energy assets are becoming increasingly valuable because of the suspicion that traditional, carbon-based fuel sources are running out.

While the price seems high, National Offshore is financing the acquisition via conveniently soft and unsecured loans from its parent. This is not against stock exchange listing rules. Loans at commercial rates or lower are advantageous to the listed company and do not represent an abuse of corporate governance.

These loans mean that the company does not have to carry out a rights issue.

On the other hand, part of the loans will eventually be converted into shares, which will dilute minority shareholders. A rights issue would have given them the choice of taking up the new shares on offer, and maintaining their percentage ownership.

Converting the loans into shares does not give them this choice, so minority shareholders will face dilution in the future.

US critics also say that the National Offshore is buttressed by unlimited cheap capital from the parent (state-owned) and from Chinese banks (also state-owned), enabling it to pay over the odds for the company - and outbid Chevron.

To free marketers, this is a serious charge. In practice, so many trade disputes revolve around the issue of Government subsidies that one can really only shrug one's shoulders.

Boeing stands accused by Airbus of getting Government subsidies through its US Government defence contracts, for example.

Nor is it certain that National Offshore's offer, despite being considerably higher than Chevron's, is excessive.

If you have few strategic reserves, came to exploration game late, do not possess the best technology, and believe oil is moving towards US$100 a barrel, then National Offshore could well feel justified in paying a premium to Chevron's offer.

Unlike Chevron, National Offshore has little experience of the peaks and troughs of oil. For the past 20 years of the company's existence, oil prices have done nothing but go up.

The American accusation that the deal is too political sounds all the more odd given this is actually the first genuinely commercial attempt by National Offshore for energy assets.

Previous efforts by the company, for example in the Sudan, were far more political, with the Sudanese Government intent on obtaining arms from China.

In effect, commercial and political motives are both compelling in the current case.

Given sufficient evidence for the commercial component, the deal should surely be approved.

* The writer remains anonymous to protect his position in China.