China hones resource strategy: Russell

This tactic,by the world’s biggest commodities consumer,appears to be working in the sense that it allows Chinese resource companies to expand their portfolios and reserves,while at the same time avoiding the massive public scrutiny and outpourings of nationalism that tend to greet the proposed mega-deals.

It’s interesting to note that Chinese commodity companies have largely stayed away from big transactions after state-owned metals conglomerate Chinalco was rebuffed in its planned $19.5 billion investment in Anglo-Australian miner Rio Tinto.

That deal foundered after some Rio Tinto shareholders objected to what would have been the largest investment in Australian corporate history,saying management should rather raise capital from existing shareholders rather than dilute value by bringing in a new investor.

The Rio Tinto fiasco and the earlier failure of China National Offshore Oil Co. to buy U.S. oil firm Unocal for around $19 billion in 2005 underscored the rising difficulties Chinese state-owned resource giants face in securing supplies.

There was a palpable feeling in Australia during the Rio-Chinalco saga that if somebody wants to buy your milk,you don’t sell them the cow or the farm,you just sell them milk.

The Chinese appear to have taken this message on board when it comes to dealing with major companies,preferring to do joint ventures,rather than try and buy companies outright.

Of course,as the planned Daylight Energy deal shows,the Chinese aren’t scared of making a play for an entire company,but it appears they do so only if the target is relatively small,not a national champion of any kind,exists in a competitive industry and in a jurisdiction with a track record of allowing foreign investment.

The Daylight Energy deal meets these requirements nicely. It’s a small producer with heaps of competitors and under the jurisdiction of Alberta,a province that generally welcomes foreign investment.

This latest investment in similar to Sinopec’s acquisition of Canada’s Tanganyika Oil in September 2008 and CNOOC’s purchase OPTI Canada in July this year,both deals being around the $2 billion mark.

Examples of Chinese majors doing joint ventures,where concerns about resource nationalism may be higher,include PetroChina’s $3.1 billion purchase of a stake in Australia’s Arrow Energy along with Royal Dutch Shell and Sinopec’s $17.8 billion joint venture with Repsol to develop oil assets in Brazil.

PetroChina’s deal with Shell fits the template of forming joint ventures to get around potential political opposition.

Even though Shell isn’t an Australian company,it has a long history Down Under and has played a major role in developing oil and gas assets,as well as being a cornerstone investor in the nation’s biggest stand-alone producer,Woodside Petroleum Ltd.

Put bluntly,the idea of a small company such as Arrow being taken over solely by PetroChina,who would then become the main beneficiary of the liquefied natural gas produced,would have been hard to sell to the Australian public.

But add Shell to the mix and the situation changes. Then it’s easier for politicians to sell the deal,as they can point to the benefits in the form of jobs,the construction bonanza as the gas resources are developed and the LNG plant built,and of course,the royalty taxes to be paid.

China has spent some $26 billion on foreign energy and mining deals so far this year,compared with $32.3 billion in the same period last year,according to Thomson Reuters data.

Cheaper equity and commodity prices will only act as spur to further buying by the Chinese,who take a much longer term view of assets than your typical Western investor.

The dual template of making takeovers for smaller companies and joint ventures for major projects appears to be the preferred way of doing business currently,and more of these deals should be anticipated.

Clyde Russell is a market analyst. The views expressed are his own.