Editor’s Note:

Doctor Duarte has been at the forefront of chronicling the China dynamic. In this, the 5^th part of this ongoing series, Dr. Duarte looks behind the scenes of the highly publicized bid by Chinese oil company CNOOC of America’s ninth largest oil company Unocal. For parts 1-4 of this highly acclaimed series, see the links below.

Part 1 of The China Syndrome concluded that China is not just a power to be reckoned with in the future, but rather that China is a major player in the world now.
Part 2 of The China Syndrome set forth evidence for irregularities in the way China does business, and how the world is looking the other way.
Part 3 of The China Syndrome explores the implications of China's activities on the Asian region.
Part 4 of The China Syndrome described the key aspects of the relationship between China and the world’s other emerging potential Super Power, India.

Unocal: What‘s The Big Surprise?

China’s bid for Unocal has shaken the global economy. Why anyone is surprised is beyond us. But the repercussions are likely to reshape the world, no matter what the outcome is.

Warren Buffett, in a CNBC interview got the ball rolling. According to Yahoo Business News: “Buffett said he doesn't subscribe to the view that China is engaging in a trade war with the U.S. He said Chinese corporate takeovers, such as CNOOC Ltd's (CEO) recent bid for Unocal Corp. (UCL) were an ["inevitable"] consequence of the U.S. trade deficit. He noted that the U.S. imported far more goods from China than it sold to the nation. ["If we're going to consume more than we produce, we have to expect to give away a little bit of the country," said the "Oracle of Omaha."]”

Forbes’ Richard Lehman, who writes about fixed income added some interesting insight, when he compared China’s suddenly aggressive forays into the heartland of U.S. manufacturing. Referring to the recent purchase of IBM’s personal computer business by Lenovo, and the recent bid for Maytag, Lehman cited “previous instances of nations with huge foreign exchange reserves deciding they need to do something beside sit on them.”

First he reminded us of the 1970s, “when the Arabs didn't know what to do with their new-found wealth.” In that instance “they decided to put it on deposit with multi-national banks so they could lend it to developing countries to finance their oil imports. The end result was worldwide sovereign debt defaults.” Continuing, Lehman reminded us of the 1980s, a time when “Japan decided it couldn't just sit on its reserves and decided instead to invest in golf courses, hotel resorts and signature office properties.” Lehman correctly described Japan’s move as a “Big mistake.” When the real estate bubble burst in Japan, stocks crashed, banks eventually collapsed, and the Japanese economy has been in a recession/Depression scenario ever since.

Lehman’s thoughtful analysis notes the following. “China may have learned from the mistakes of others. They are focused on buying companies with established brand names, leading technology and distribution networks. In short, they may be focused on using their dollar reserves, earned from selling us cheap stuff, to buy our means of production.”

Continuing he added: “While this is extremely smart on their part, it has serious negative implications for the U.S. and, eventually, for the rest of the world. The current world order for international trade is a game that strongly favors the U.S. We are the engine driving the world economy through our purchase of mainly consumable goods and resources. We pay for these goods and resources with dollar-denominated paper. If our trading partners choose to sit on those dollar reserves or invest them in U.S. Treasury debt, it's a double win for us, since we have really not paid for what we received. If they choose to use those reserves to buy real estate or other hard assets, that is some improvement over holding Treasuries, but is a resource of limited potential.”

Why Does CNOOC Want Unocal?

The big picture is simple. China wants all the oil it can get from anywhere that it can get it. It has a rapidly growing economy, which is very inefficient. While the U.S. produces more with less oil, China is essentially the World’s SUV, guzzling oil, even as it delivers large amounts of cargo.

But Unocal is more than just part of China’s insatiable appetite for anything and everything being manifested. There are indeed some key strategic reasons for the Chinese interest. And much of it is geographical. According to AP “Outside of large-scale oil and gas interests in Alaska and the Gulf of Mexico, (Unocal) also has significant holdings in Azerbaijan, Myanmar, Thailand and Indonesia - many of which would be attractive to CNOOC for geographical reasons.”

Quoting Victor Shum of Texas-headquartered Purvin & Gertz in Singapor, AP continued: ["Unocal is strong in Asia, particularly in gas. Because of the geographical location of projects in places like Indonesia, Thailand and Myanmar, these assets make a very good fit for CNOOC." ]

Furthermore, China’s future energy plans call for increased usage of natural gas. “Gas usage now accounts for only 3 percent of the total Chinese energy pie, but government plans call for that proportion to double by 2010. Resources from Unocal fields in Southeast Asia would clearly expedite the process, serving as fuel for new electricity plants in fast-growing coastal areas.”

More interesting, and perhaps one of the most likely reasons for the spike in oil prices above $60, is this, also reported by AP: “On Thursday, state television reported that China will start filling its first strategic petroleum reserve in order to cushion China against possible interruptions of foreign supplies. Plans call for China to build groups of storage tanks at four locations and previous reports said Beijing plans to stockpile up to 100 million barrels of petroleum, or the equivalent of almost a month's national consumption.”

The Structure Of The Deal

There is always more, and in this case, less than meets the eye though. Although the CNOOC bid for Unocal is for a larger sum than Chevron’s bid, $18.5 billion, compared to $16.4 billion, and it is cash, compared to Chevron’s 15% cash, 75% Chevron stock bid, China, despite having hundreds of billions in foreign reserves, is only likely to put up $3 billion, while borrowing the rest.

According to Stratfor.com: “CNOOC would put up $3 billion and borrow the remaining $16 billion from Western banks, state-owned banks and its parent company, prompting a cut in CNOOC's debt rating by Moody's and Standard & Poor's. CNOOC would also have to pay Chevron a fee of $500 million. Of the $16 billion CNOOC would borrow for the proposed acquisition, $6 billion would come from the Industrial and Commercial Bank of China (a state-owned bank), $7 billion would come from CNOOC's parent company, China National Offshore Oil Corp. (in essence, a state-owned bank), and $3 billion would come from the Goldman Sachs Group and JP Morgan.”

According to the New York Times of the $16 billion CNOOC would borrow for the proposed acquisition, $6 billion would come from the Industrial and Commercial Bank of China (a state-owned bank), $7 billion would come from CNOOC's parent company, China National Offshore Oil Corp. (in essence, a state-owned bank), and $3 billion would come from the Goldman Sachs Group and JP Morgan.

According to the New York Times: CNOOC “has hired Public Strategies, a public relations firm whose vice chairman, Mark McKinnon, led President Bush's media campaign in the 2004 election.”

CNOOC is also playing the PR game as well. According to the New York Times, the company “is already trying to play down any concerns that the transaction could hurt the American oil and gas markets. It is stressing that 70 percent of Unocal's oil and gas reserves are in Asia and that its American reserves amount to only about 1 percent of America's oil consumption, with none of it now supplying the military. Unocal also has a pipeline hooked up to American strategic oil reserves, as well as a rare-earth mine, the only one in the United States. CNOOC has said it will consider selling these assets, if that is necessary to close the deal. In addition, CNOOC has promised not to take supplies from Unocal's oil and gas reserves in the United States and sell them outside the country. It also said it would retain ["substantially all"] of the American employees.”

Conclusion

The markets, Congress, and the media were shocked at the CNOOC bid for Unocal. But, in fact, CNOOC was considering a bid for Unocal before Chevron. As early as March 2005, news about a possible deal was already in the market. In fact, CNOOC’s board delayed the formal bid in order to study the matter further.

Two interesting notions come to mind about foreign oil companies owning U.S. assets.

First, BP owns much of Alaska’s oil reserves, since it bought Atlantic Richfield. And second, Venezuela owns CITGO, the refiner and marketing company we associate with 7-Eleven stores. And France’s Total, owns Fina, which is a widely available brand in the Southwest U.S.

That means that there is precedent for foreign oil companies to do business in the U.S.

BP is a U.K. company and has no trouble with its image in the U.S. And in the case of Fina and CITGO, the American public has little clue as to who owns these gas stations and refineries. And if they did, we’re not sure that it would matter much.

China, though, in the eyes of some, is a different story. China is threatening. China is expansionary. And China is Communist.

Of course, Venezuela is also threatening, since its President openly hates President Bush, and is friendly with the openly anti U.S. Cuban president Fidel Castro. And relations with the U.K. are outwardly friendly, but some polls show a great deal of dissatisfaction there with President Bush. We don’t really need to discuss French-American relations here, since we have limited space.

So why is the Unocal-China situation so touchy?

Maybe it’s because China has openly spied on the U.S. and allegedly, on a routine basis is trying to obtain high level, often classified technology from U.S. companies and key laboratory installations such as Los Alamos. China sells weapons systems and technology to countries that the U.S. is not friendly with. China is a hotbed of piracy which costs the U.S. billions of dollars per year.

China built Saddam Hussein’s fiberoptic network when the U.S. was trying to apply sanctions before the eventual attack. China has made oil deals with Sudan, whom the U.S. considers a terrorist state. China has inked oil deals with Venezuela which could lead to decreased oil exports from Venezuela to the U.S.. And China makes it a point to usually attempt to counter every move that the U.S. makes by providing a completely opposite view of what the U.S. is trying to do, in the UN Security Council and just about everywhere else that it can do so.

In other words, China is now the number one opposition to the United States in the world, and is a rising military and commercial force to be reckoned with.

To be sure, the U.S. has made significant forays into China, and continues to aggressively pursue the Chinese market.

The U.S. spies on China routinely, as we learned when China sequestered a U.S. spy plane several years ago. The U.S. explores for oil, and has massive reserves in Asia, as Unocal’s reserves prove. GE, Dell, Boeing and much of the Fortune 500 has established beachheads in Beijing and elsewhere. And Bank of America has just pledged a $3 billion foray into Chinese banking.

So what’s at stake here? Everything, including which way the spoils get divided in the world. And if we were in a position of power, we would caution those who make laws and policy to think out every single word, act, and bill that gets hatched with regards to what, according to Warren Buffett, is “inevitable.”

More than the U.S. being worried, though, we would be very concerned if we were a government in the rapidly disintegrating European Union, and the continuously stagnating Japan.

As FinancialWire recently noted: “The Chinese Are Coming.”

© 2005 Joe Duarte, M.D.
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