CNOOC’s Nexen Bid Doesn’t Pass the ‘Net Benefit’ Smell Test

China National Offshore Oil Company bid 15.1 Billion dollars last week for Canada’s eight largest oil producer Nexen. The friendly bid offers a 60% premium on Nexen’s pre-offer stock price and was further sweetened with assurances of a new head office for the Chinese company’s North and Central American divisions in Toronto as well as an eventual listing of the company on the Toronto Stock Exchange.

Much of the talk surrounding the deal has had to do with the possibility that the deal may be blocked under the Canada Investment Act, which states that all foreign investment over 300 million must pass a ‘net benefit’ test before being approved. Such discretionary government powers have only been used twice to block deals in the past. MacDonal Dettwiler and Associates, a Canadian satellite-imaging firm, was the first firm to be saved from takeover based on national security concerns. BHP Billiton’s hostile takeover bid for Potash Corp of Saskatchewan was blocked by what can only be described as economic nationalism.

After an initial outcry from both Potash Corp’s management and the public in Saskatchewan BHP sweetened it’s then 39 Billion dollar offer by promising to continue any pre-existing community investments and reneging any potential tax breaks it would be eligible for following the takeover. That wasn’t enough to convince the political establishment in Regina.  For some reason the public outcry against the CNOOC bid is much more tame this time around.

Maybe the facts that Nexen is only the eight largest Canadian oil producer and that half its producing assets are foreign makes the pill easier to swallow for corporate nationalists. Also, assurances of heightened employment levels thanks to the new head office might endear CNOOC to Canada’s corporate and political elite. This time however Canadian corporate cheerleaders may actually have something tangible to worry about.

BHP Billiton is a commercially focused enterprise bent on squeezing out profit from all its assets. With BHP already building the world’s largest potash mine in Saskatchewan, any corporate or engineering synergies the company could have squeezed out of the takeover would simply have led to more labour productivity gains in the short run and more corporate profits to tax in the long run. The profit motive and BHP’s long track record in commercial ventures assured Canada both the those benefits. CNOOC’s bid for Nexen insures neither.

CNOOC has no efficiencies or productivity gains to offer, as it has never operated a steam assisted gravity drainage mine in the oil sands before. As a matter of fact we have no assurances that the company is a commercially minded institution as the Chinese have a longer track record of promoting its political interests than its commercial interests. A small example for the record is China’s financing of a new National Stadium in Costa Rica for no other reason but to make buddy buddy with the political class there. No one in Canada really understands what motivates the Politburo in Beijing, and since CNOOC is controlled by that same Politburo, why should Canada trust such sensitive and strategic assets such as the oil sands to them? As another example of the shadiness of China’s intentions, it is reported by Canadian security services that there may be as many as a thousand Chinese corporate spies passing on industrial secrets from Canada to China. China’s aggressive self-centeredness doesn’t stop there.

China has long had a policy of trying to secure energy assets to help feed its industrial base back home. In almost every commodity market China is one of the largest players, ever attempting to ratchet up the best deal so that its manufacturing base can wipe out the international competition. As far as we are concerned China may yet be willing to operate natural resource companies at a loss in order to bump up its local industries profitability. This has long been the case of the Chinese steel sector operating at a loss to bolster Chinese manufacturing competitiveness.

With such a history and the potential for direct trade in oil between China and the oil sands should Enbridge’s Northern Gateway get approval, it isn’t far fetched to imagine Chinese energy traders attempting to manipulate prices so as to reduce profits from their Canadian divisions, thus contributing less taxes to Canada and more profits to China. While this scenario is speculative many industry insiders wouldn’t be surprised to hear it.

There also remains the issue of environmental record. Chinese companies aren’t especially well known for green track records. Canada’s environment is prized by its citizens, and it is doubtful that Canadians would really trust a government backed company from the worst polluting country in the world.

Whether it be for national security reasons, environmental concerns, Canada’s commercial and economic interests, it would seem that everything points towards the necessity of prohibiting foreign government backed companies from buying up our strategic national assets. Canada did a great disservice to itself when it refused BHP Billiton’s bid for Potash Corp. We let our petty corporate nationalism get in the way of a deal that would have attracted financial and human capital to our country. We smudged our image as a trading nation open for business. Today for the sake of protecting that image we have spoiled, we are readying ourselves to accept a bid that is short on benefits and long on potential risks.

Canada already looks like the scared kid unwilling to dip more than a toe in the swimming pool of big business, and we may look it more so after blocking CNOOC. If the reasons for such a use of the ‘net benefits’ test are properly articulated and China is called out for its only half hearted adoption of capitalism, everyone outside of Beijing will understand and accept such a decision.

British-Columbians Without Leadership on Northern Gateway

There used to be an unwritten golden rule for Provinces in Canadian politics; if you are going to do some beggar thy neighbour monetary demanding or demonizing make sure it’s against the feds. Provinces typically demand funds from flush federal government coffers, or when they need a scapegoat for this or that local problem they can always trash the federal government for their ills. They usually abide by a set of rules of solidarity to put pressure on Canadian federal governments. With Stephen Harper immovably tightening the federal purse’s strings, it would seem that hard-pressed Premiers need new scapegoats for populist speeches and monetary extortions.

 This new reality was on full display this week as British-Columbia’s Liberal Premier Christy Clark put down her conditions for the approval of Enbridge’s Northern Gateway oil pipeline joining Bruderheim, Alt and Kitimat in BC. Clark put down five conditions for her approval of the project the most important of which were world-class environmental emergency response plans, for Enbridge to go beyond the minimum legal requirements with respect to First Nations relations and for BC to get its ‘fair share’ of tax revenue from the oil to flow through Northern Gateway.

 The Premier from Alberta Alison Redford responded to Christy Clark today by saying that BC won’t get a looney’s worth of tax money it is not already entitled to from the pipeline. Stating that resource management is the purview of individual Provinces exclusively, Ms. Redford objected to Ms. Clark’s policy of nitpicking projects and subjecting them to targeted political scrutiny.

 Ms. Clark’s approach to Northern Gateway however deserves much more scrutiny than Alberta’s Premier has so far leveled against it. Let us start by examining BC’s request for world-class environmental disaster response plans. That such regulation wasn’t already the norm in BC should be news to British-Columbians. Since environmental regulation is as much a provincial responsibility as a federal one, why is BC home of Canada’s most ardent environmentalists not already the most protected and best regulated in the world? Does this mean that other energy projects aren’t going to be subject to such environmental scrutiny? Why single out Enbridge when it comes to protecting Canada’s Pacific coast?

 Moving on to the provincial Liberals’ demand that Enbridge go above and beyond legal requirements in dealing with First Nations. Enbridge states that it already has 60% of concerned Native bands signed on to Northern Gateway. If so many First Nation’s have already of their own volition accepted Enbridge’s proposals one might assume that the company has already gone beyond legal requires in enrolling Native support. Why go into the media playing the ‘white man guilt’ card against Enbridge? This looks like an almost Orwellian display of government interference in private affairs. Governments should not ever, be in the business of telling private citizens or corporations how they should think and behave. Ms Clark shames the name of her party with such private affairs meddling.

 That Ms Clark should go after private enterprises in trying to boost her pre-electoral profile seems to fit with the times but for her to go after another Province for revenue is a relatively new development in Canadian political history. Ms Clark has asked for a ‘fair share’ of tax revenue from Alberta.

 A report by Calgary firm Wright Mansell estimated that BC would only be getting a paltry 6.7 billion dollars worth of tax revenue from the pipeline over 30 years from a total pie of 80 billion. Ms Clark pointed out that BC would be shouldering 100% of the maritime environmental risks and over 50% of the land based risk. With such false assertion the BC Premier is effectively spitting in Albertans and Canadians faces. The environmental risks don’t start at Bruderheim, they start near Athabasca Lake where the extraction occurs and where Alberta will cover 100% of the risk. Let’s face it, the oil sands represent the largest oil related environmental risk worth monitoring, Northern Gateway is a sideshow. The oil must flow through pipelines all the way down to Bruderheim first where again Alberta is responsible for all leak risks. In any case the monetary responsibility of cleanup falls squarely on Enbridge so what kind of risk is the Province assuming exactly? With proper regulation, which BC is entitled to implement, risks can be minimized if not eradicated so why demonize Alberta?

 Ms Clark further added injury to insult when she said, “This project is good for Canada. It’s great for Alberta and at the moment it’s not very good for British Columbia”. It would seem that 60% of concerned First Nations disagree. Such blatant ‘not in my backyard’ styled blackmail is unbecoming of a Canadian Premier. What would Canada look like today if it weren’t for generations of Ontarian and now Albertan uncompromising funding of equalization? Such inter-provincial self-centeredness hasn’t been seen since the Lower Churchill Falls deal where Quebec unceremoniously screwed over Newfoundlanders.

 If political leadership is bringing out the best out of one’s constituents, BC’s Liberals have succeeded in wrestling the crown of leadership deficiency from Quebec. It was bad enough when Obama blocked Keystone XL for electoral purposes to the detriment of America’s economy and North American relations, that such demagoguery and populism should have crossed the 49^th parallel is a new low in the history Canadian Confederation.

(First published on The Prince Arthur Herald website)

***Apologies to all readers, this post has somewhat strayed from the more economic level headed commenting this blog was started for. None the less this was worth posting enjoy.

Another Spill Another Outrage

Oil spill on Red Deer River, Alta

Another spill another excuse for environmentalists to block the Keystone XL and Northern Gateways of this World. Alberta suffered its third significant oil spill of 2012 near Elk Point 200 km northeast of Edmonton, as Enbridge’s Athabasca pipeline spilled some 1450 barrels of oil onto farmland. This comes as environmental crews are still cleaning up two larger oil spills in Alberta near Red Deer in Alberta’s deep north.

One can now expect to see the Pembina Institute, Greenpeace et al. descending on Alberta with renewed fervour to oppose the Oil Sands development. Likewise, south of the border, environmental groups will use these spills as further proof that Keystone XL and other pipeline projects must be stopped. Industry insiders and astute observes might come to a different conclusion based on these spills.

It is well know in the industry that the leading cause of pipeline rupture is third party related. That is to say I pipeline is most likely to be ruptured when a construction crew doesn’t do its land surveying due diligence. In the rest of incidences, the leading cause for ruptures or spills are corrosion and excess pressure.

Now both these causes have their own causes and those are the ones environmentalists should be worrying about.

Corrosion occurs most often when the interior coating of a pipeline isn’t adequately maintained and is exposed for long periods of time to acidity. Heavy Crude oil can be highly viscous and must be diluted with various sorts of acids and chemicals to help ease the flow in a pipeline. Such additives may corrode a pipeline over time when coating isn’t sufficiently or regularly applied. In Germany for example most of the pipeline infrastructure dates from the post war recovery, and thanks to consistent coating, the industry there reports some of the lowest incident records.

Excess pressure is a problem due to mismatching of the pressure pumped through a pipeline and its design pressure capacity. With time the structural integrity of a pipeline tends to diminish somewhat, which means that pressure needs to be corrected downward as a pipeline ages. With the ramp up of production in the Bakken oil fields of North-Dakota and Oil Sands in Alberta’s Athabasca Region, expectation is that pipeline operators will be pushed to capacity, increasing pressure flow to its limits and playing catch up on pressure capacity assessment.

In both cases monitoring is key to safety. Nobody argues that industry norms need to be updated regularly if not imposed through regulation. What can be argued is that in both cases there is a common variable. Time. A Canadian study by the Energy Board of Canada said that non third party related spills were time dependent. On average the first spill in a pipeline system occurred after 28 years of operation. After adequate monitoring of pressure and coating adequacy quality control, the most important contributor to pipeline spill prevention is keeping pipeline systems young. In other transportation industries such as airlines, shipping and railroads the norm is to limit the age of fleets as well as do proper maintenance.

So what do Keystone XL and Northern Gateway have to do with all this. These pipelines would both do three things. One, they would reduce average pressure throughout the North American pipeline system by increasing flow capacity for a predetermined amount of oil and gas production. Secondly, modes of oil transportation with even worst safety records wouldn’t be used. Trains and trucks tend to derail or get into highway accidents, causing injuries or fatalities as well as spills that wouldn’t occur in pipelines; today without XL and Northern Gateway trucks and trains are increasingly being used to transport large amounts of oil. The third effect of building Keystone and Northern Gateway would be to decrease the average age of the pipeline system, as they’d be new.

All in all these pipeline mega projects would serve to increase the safety of the North American energy industry and reduce ecologically destructive oil and gas spills. Environmentalists should ask themselves whose side they’re on: the anti-oil lobby side, or the environment’s.

Also published in the Prince Arthur Herald here. 

Could Carney Be Wrong

Mark Carney the Bank of Canada’s Governor has been one of the most vocal central bankers Canada has yet seen. He intervenes in the media often and repeatedly about some of his worries concerning the health of the Canadian economy. His chief worries revolve around three subjects broadly vassal to the theme of international competitiveness. The first of his worries is that Canadian manufacturers aren’t using the combination of low interest rates and high Canadian dollar to invest in cheap foreign capital goods. His second ”keep me up at night” issue is that of Canadian businesses’ low exposure to rapidly developing countries and over exposure to stagnant markets. His third problem and dilemma is that of rapidly escalating household debt load. While not explicitly saying so, Carney’s fear is that Canada will increasingly ressemble the pre-crisis US; a debt saddled and internationally uncompetitive economy. Commentators have been doing a fair bit of wall painting by noting that Canadian Households are second in indebtedness in the G7+BRIC category. Economic nationalists regularly plaster business newspapers with doomsday scenarios foreshadowed by Canada’s perennially lagging productivity. Alright, let’s breath… wait a minute and think about this.

It is a little funny that Carney’s most recent musings about Canadian manufacturers and business came less than a week after the latest numbers of the Canadian Survey of Business Investments . The survey’s data reveals that new capital expenditure (read fixed capital formation) is expected to run at the fourth highest clip in over two decades, only failing to surpass the dotcom bubble fueled investment mania at the turn of the millennium. One would have thought that the BoC Governor would have taken note of such a survey. It seems that manufacturers were just waiting for the Goldilocks’s moment of low interest rates, easy lending conditions and better international sales prospects to start investing. A traditional Canadian conservative way of doing business, one that served Canada’s financial sector well during the crisis. In any case with Chairmen Bernanke of the Fed’s pledge to keep interest rates near zero through 2014, Canadian manufacturers probably expect their low rates + high currency combo to persist a while longer, so what’s the big rush to invest? As noted above business investment isn’t our central bankers only preoccupation. Our aversion to developing nations export markets tick’s him off as well.

When it comes to Canadian exporters’ choice of export markets, I propose that bureaucrats who have never managed anything other than a hyped up economic think tank (say a central bank) or sovereign debt investment bank department (say at Goldman Sach’s), stay out of real businessmen’s head. When Mark Carney proposes exporters start doing business with emerging markets, which ones is he talking about? Is he talking about Russia? a country where ex-KGB mafia is indistinguishable from the oligarchical business class and where the contracts you sign are only as good as the prevailing mood of the Kremlin? Is he talking about Brazil? Brazil a country where if your company spills a drop of oil in the ocean your executives risk loosing their passports and being prosecuted by only thinly-veiled xenophobia infected local prosecutors. Maybe, he meant China? That very same country that will toss Rio Tinto executives in jail just to squeeze a better deal out of those executives’ native country and supposed business ally Australia. International business is a tough business in itself, why don’t we let those entrepreneurs that have first hand experience decide when they want to abandon the largest markets of the World (Japan, US and Europe) for some of the riskiest markets on Earth.

We’re left to examine the remaining entry on the Carney sin list. Our profligacy and lack of thriftiness. So Canadian household debt levels have jumped to never before seen heights. With interest rates at a historic low this is to be expected. The number however only gives an incomplete picture of Canadian households’ health. Household average debt says nothing about the distribution of that debt. In the US, the subprime crisis became a crisis because debtors were at or not far away from the bottom of the income distribution. In Canada most of the ongoing issuance of debt is for mortgages, and less than 9% of Canadians have less than 10% equity in their homes. If we add the two together it says that on average wealthy Canadians are the one’s increasing their average debt load, since homeowners that own a decent amount of home equity are generally well off. Something which makes sense as most wealthy Canadians do not need to indebt themselves to live, whether they choose to invest when their financing costs go through the floor is a whole other ball game. Maybe commentators want to come out with more data on the distribution of indebtedness in Canada before alarming national rate strategist.

The accusation that Canada is uncompetitive however is rooted in other numbers than simply those on indebtedness or exposure to this or that foreign market; it is rooted in the fact that on an aggregate level more Canadian workers working longer hours have not been producing as much. The US has seen its per worker productivity increase faster than Canada’s for much of the last few decades. Something that we should all be worried about in normal circumstances. Canada is not living in normal circumstances. Canada is in the midst of reallocating some of its labour and capital resources to a sector where it actually holds a comparative advantage. For the last few years Canada’s workers, corporations, entrepreneurs and capital markets have been investing time and effort in developing its valuable natural resources. There are very long lags between payoff and investment for some of Canada largest most capital intensive projects. The Business Investment Survey forecasts fixed capital formation in the resource extraction industries will beat the record set last year by $13 Billion dollars. For now this money creates little revenue, profits or exports but 3, 5, 10 years down the line expect to see GDP jump. Building Oil Sands steam assisted gravity drainage mines takes years, likewise BHP Billiton’s Jansen potash mine wont be operational for years. The Canadian mining landscape is only now starting to bubble, when it starts to boil those productivity numbers we spend so much time worrying about will become jokes. All in all Canada is shifting. The economic landscape we now see will not be the same. Mr Carney rest easy, Canada’s households and entrepreneurs have got this one under control.

Potash vs. Oil Sands, a policy dichotomy

With news of PetroChina International Investment Co. readying itself to be the sole owner of the undeveloped Mackay River in-situ project ~40 km Ouest of Fort McMurray, the question of Canada’s foreign takeover review scheme merits further attention than it’s been getting of late. The deal triggered by Athabasca Oil Sands Corp. owner of the remaining 40% stake not owned by PetoChina will lead to the latter buying the stake for an estimated $680 M Canadian dollars.

Now for those not aware, the Mackay river flows into the Athabasca river which itself flows into Athabasca Lake which outflows through Slave river and through a few national parks until the water system reaches its final destination in the North Arctic Sea. All that to say that the in-situ development finds itself in quite the environmentally sensitive region. Now, a foreign state owned company will be an environmental guarantor of the region. Why am I kicking up a fuss about this exemple of foreign Oil Sands ownership and not say, Statoil’s not far off operations. Is it maybe because Norwegians are something of green nuts while China is competing with Russia for most pollutated country in the World, maybe. Is it because Statoil is known for trying to maximize the return on Norwegian taxpayer dollar while PetroChina and other chinese primary ressource companies are known for attempting to distort markets for the gain of the motherland, probably.

The reason I raise this issue is because I personally disagreed with the Canadian federal government’s decision to oppose the BHP Billiton bid for Potash Corp of Saskatchewan, while I opposed the federal governments regulatory decision to allow PetroChina’s majority ownership and operating of Canadian natural ressource exploitations. So who between the Conservative government of Canada and myself is wrong while both hold seemingly inconsistent and paradoxical opinions? I’ll let you answer that once I’ve finished exposing my case.

Let’s start by raising a point that would seem to show inconsistency on behalf of the Government. The regulatory approval of PetroChina’s deal with Athabasca raised the feds no problem because it could only increase competition for the supply of Canadian Oil and increase the competition for demand in Canadian labour, win-win right? The decision to oppose the purchasing of Potash Corp. was one of opposing increased supply of Canadian potash (one of the worlds most popular agricultural fertilizers). Sudden policy shift or backtrack? Not really, here is a situation of two weights, two measures. Both ressources are considered ‘Strategic Ressources’ in Canada. However one is treated as a free market good while the other one is considered as legitimate producer collusion product, a.k.a. a cartel worthy product. In light of the Governments recent abolition of the Canadian Wheat Board monopoly, their previous decision to protect the Saskatchewan potash cartel seems strange. Or maybe it doesn’t after all Alberta (where most of the Oil Sands are) is traditionally pro-market whereas Saskatchewan is traditionally left-leaning. Does lobbying by Provincial governments really explain a difference in policies. The real difference lies behind the fact that Oil production is extremely geographically atomized, thus it’s trade is quite competitive, potash on the other hand can only be found in a few regions of the World. One of the regions richest in potash is western Canada. Essentially the difference is that Canadians can get away with cartel-esque behaviour in potash but not in oil.

This demonstrates that if the conservatives in Canada are not consistent in their policies it is not for lack of reflection of pragmatic economic solutions, simply inconsistent and un-ideological ones. So we actually have two very different decisions made for pragmatic reasons. That just means I will have to raise two different objections!

Regarding the BHP Billiton takeover of Potash Corp. blocking. The main reason for blocking the takeover was because of the aforementioned cartel in potash. In Saskatchewan the export of potash outside of NAFTA is undertaken by a corporation called Canpotex (short for Canadian Potash Exporters), which effectively operates as a cartel controlling over 30% of the worlds potash production. BHP would have broken up the cartel in order to produce at capacity and sell freely. The Provincial governments belief was that it would have lost royalty revenue from the drop in per unit profit. Whether the government would have actually registered a drop in revenues following the decision is aside from the point. It represents a stark intervention into markets which should be unacceptable in a modern democracy. A short list of consequences include, higher fertilizer prices for such poor farmers as those found in India or Africa, damaged Aussie-Canadian relations, reduced attractiveness of Canada as an investment destination and countless other immeasurable and unimaginable damages to Canada and the World.

Unfortunately one bad decision tends to follow another in politics, let’s now turn our attention to the regulatory decision that paved the way for a foreign power’s state owned corporation buying up ressources in Canada. As a fervent classical-liberal and staunch internationalist, I am all in favour for increasing developing nations and less than democratic nations participation in Global trade. I think there is no better way to improve their economic and socio-political prospects, than permitting them to join the WTO and partake in international trade. Although these beliefs push me to reflexively accept international takeovers, I believe there are a few caveats needed to smooth things out. First problem is the lack of reciprocity. Chinese companies benefit from industrialized nations legal systems when investing in the West. Western multinationals do not benefit from such property protection when doing business in China. Let’s help China, let’s show them some tough love by telling them they can buy our ressources when our companies will get some respect in China. An important issue is that state owned corporations do not necessarily seek to maximize profits as much as maximize socio-economic and political priorities of their governments, whereas public companies always seek to maximize profit for their shareholders. From the economic literature I believe it is most evident to all that maximizing profit in a competitive environment is the key to increasing global welfare.

It is hence my view that the Government’s Foreign Takeover Review process should be aimed at differentiating between those companies who will seek to maximize profit through increased productivity, the real key to increased wealth, and those companies who may have alternate motives such as shifting wealth from one geography to another (like state owned corporations). Blocking foreign State’s proxies from buying our ressources and encouraging public companies to invest is good policy. Let’s hope that when the Canadian federal government finishes its review of the takeover process that will be the ensuing conclusion.