No Reason to Block the Deal

Op-ed in the Far Eastern Economic Review

July 1, 2005

Early in July, the US House of Representatives passed a pointed resolution urging President George W. Bush to strictly review the Cnooc bid for Unocal under a US law known as the Exon-Florio provision, passed in 1988 in a bid to stem Japanese investment in the United States. This legislation enables the president to block a foreign acquisition of a US firm that "impairs or threatens to impair" US national security. More recently, congressmen also introduced a measure that would deny funds to the US Treasury (which administers the Exon-Florio authority) in the event it decided not to block the acquisition by Cnooc. In response, Cnooc has preemptively sought to reduce uncertainty by initiating the review process itself and offering to sell off Unocal's American assets should the deal go through. So how concerned should Americans be that a Chinese state-owned oil company is acquiring assets that some regard as strategic?

The short answer is that it is not in US interests to block the acquisition. While the US government could block the proposed deal either on antitrust grounds or, as noted, on national security grounds, there is no reason to do so.

With respect to antitrust considerations, the relatively small size of both Unocal and Cnooc means the merger would not have a significant effect on competition. Indeed, an acquisition of Unocal by Chevron could be of greater concern, because Chevron is one of the four largest oil firms globally. But even this latter transaction would not likely trigger major antitrust concerns.

Similarly, it is difficult to see why the acquisition of Unocal by Cnooc would pose any threat to US national security. Some members of Congress contend that Unocal holds critical dual-use technologies (ones with both military and civilian application) that could potentially give China's military some sort of advantage at the expense of the United States. However, industry specialists I've consulted doubt this, indicating that any technological expertise held by Unocal is readily available to China from many other sources.

Moreover, the interagency US government Committee on Foreign Investment in the United States, which conducts Exon-Florio reviews, has developed considerable expertise in determining the security impact of technology transfer from foreign acquisition of US firms. In past cases where such a potential impact has been identified, the committee has often recommended to the president effective remedial actions short of blocking the acquisition. Thus, even if the acquisition by Cnooc creates a security risk to the United States, most likely there are ways of mitigating this risk short of blocking the acquisition.

Overall US interest in this case, as well as the interest of other energy-importing nations, is affected largely by the acquisition's effect on overall output of oil and gas. If either acquisition were to cause global oil or gas production to rise or fall, that could have an effect on world oil prices. However, it is not clear that acquisition by Chevron or Cnooc would differentially affect output. Indeed, it could be argued that, because Chevron already holds deeper expertise in exploration and development of oil and gas fields than Cnooc, the acquisition of Unocal by Cnooc would augment Cnooc's capabilities to increase oil and gas production much more than Chevron's capabilities and eventually lead to output increases. Admittedly, this is conjectural, but at least there would seem to be no strong case that acquisition by Chevron would result in greater output than acquisition by Cnooc.

Moreover, Congress should heed a piece of Chinese wisdom: "Beware of what you seek, for you might get it." In particular, if Congress were to succeed in stymieing the acquisition of Unocal by Cnooc, the reverberations worldwide could work greatly against US interests. For example, the US government has consistently tried to convince other countries to open their oil and gas sectors to investment by US-based firms. At the moment, the United States is seeking to open access in Russia, which after Saudi Arabia, contains the world's largest economically recoverable hydrocarbon reserves. Although Russia in fact needs Western technology to open new fields in Eastern Siberia, some factions in Moscow would like to keep the Russian oil and gas sectors closed to foreign investment. American action to block Cnooc's acquisition of Unocal would only bolster arguments in Russia to close off its own oil and gas sectors to investment by US companies. This would surely create damage to American (and indeed world) interests far greater than any conceivable damage resulting from the Chinese acquisition of Unocal.

Some have put forward two additional objections to the Cnooc acquisition. First, there is a lack of reciprocity-i.e., a US investor could not make a similar acquisition in China. And second, that Cnooc will benefit from below-market financing from the Industrial Commercial Bank of China and capital infusions from its state-owned parent should the deal go through.

With respect to reciprocity, China is in fact quite open to "greenfield" foreign investment (although it does limit takeovers of existing Chinese firms). Still, some such takeovers have been allowed-e.g., Anheuser-Busch's acquisition of Harbin Breweries. Moreover, US policy toward inward foreign investment has not generally opposed foreign takeovers of US firms on reciprocity grounds. Thus, during the past 10 years or so, there have literally been hundreds of takeovers of US firms by foreign investors (and also hundreds of takeovers of non-US firms by US investors). It is not clear why takeovers from investors based in China should be treated differently than those by investors from other nations.

Furthermore, if the acquisition of Unocal by Cnooc were blocked, the United States would lose some leverage in efforts to achieve greater openness of China. Thus, if an American firm were to try to take over a Chinese firm in the future, and this were to be blocked by the Chinese government for spurious reasons, the US government might very well want to challenge the blockage on grounds that the US market for corporate control was quite open to Chinese investors. But, of course, if the acquisition of Unocal were to be blocked, this latter argument would no longer carry much weight.

The argument that the Chinese have access to cheap financing has some merit, in that it gives Cnooc an advantage relative to Chevron. This advantage, however, should not be overstated. Chevron is able to obtain financing internationally at the most favorable of market rates, and these rates remain low today by historic standards. Thus, any financial advantage to Cnooc is not great. One congressman has urged the United States to press a dispute at the World Trade Organization (WTO), arguing that this financing is in violation of the body's agreement on subsidies. But since no WTO rules seem to cover this type of subsidy-instead its rules are formulated more for limiting subsidies to exports-no violation is likely to be found. Perhaps there indeed should be international rules governing financing of transborder acquisitions, but at the Cancun meeting of the WTO, a major negotiation on investment issues under which such rules might have been lodged was effectively removed from the negotiating agenda.

Former CIA Director James Woolsey has argued that Cnooc's proposed acquisition is part of China's long-term strategy to gain military preeminence in the Pacific region and that, were China to succeed, this would be inimical to US interests. While China is undoubtedly a rising power, and the United States must accommodate itself to this fact, it seems a huge reach to argue that the Unocal acquisition is motivated primarily by military considerations. Much more reasonable is that China seeks to reduce its dependence on the Middle East for its imported oil. Such a reduction might in fact serve China's military interests in the long run. But this would be at most a collateral benefit to China. The country's economic growth has created demand for oil imports, and diversification of sources is primarily an economic, and not a strategic, reason for the proposed acquisition.

Interestingly, it could be Chinese, and not US interests, that are adversely affected by this acquisition. During the 1970s, for example, Japan learned that direct investment is actually a rather costly and inefficient way to secure sources of raw material, including petroleum. This was true in part because markets for petroleum are very efficient, such that offshore ownership of a limited amount of reserves conveys no special advantage to a nation in terms of price or availability of the resource. But mostly it is true because Japanese firms held no special advantage over international firms in terms of ability to find and efficiently develop new sources of petroleum. Whether the Japanese experience is applicable to the Chinese is, of course, not yet known. However, if Cnooc does succeed in its bid, there is some probability that economic historians will view it as a strategic error, and not the strategic triumph that Mr. Woolsey postulates.

Nothing in this article is meant to suggest that the shareholders of Unocal should accept Cnooc's bid rather than Chevron's or vice versa. Rather, the point here is that it is the shareholders who should make this decision, and not US politicians acting on emotional impulses that do not serve the national interest.