Oil and Gas

Capitol Hill uproar could sink proposed Chinese takeover of Unocal Corp.

As China's demand for energy soars, a state-owned Chinese oil company is trying to buy Unocal for $18.5 billion. But members of Congress say the deal raises serious national security concerns and want the White House to intervene. Is the takeover going to happen or will the Treasury Department nix the plan? How could this affect U.S. energy supplies? And what does this controversy say about the state of relations between China and the United States? Alan Hegburg, senior fellow with the Center for Strategic and International Studies and Patrick Mulloy, a commissioner with the U.S.-China Economic and Security Review Commission, discuss the contentious proposal.


Brian Stempeck: Hello and welcome to OnPoint. I'm Brian Stempeck. Joining me right now is Alan Hegburg, senior fellow at the Center for Strategic and International Studies. Also with us is Patrick Mulloy, a commissioner with the U.S.-China Economic and Security Review Commission. Finally, last but not least, Ben Geman, reporter with Greenwire. Thank you all for being here today. Let's get the people up to speed really quickly, we have the China National Offshore Oil Corporation is offering $18.5 billion to take over Unocal. A lot of controversy going on about this right now. Congress is pretty opposed to the deal, or the members of Congress. Al, does this represent a security threat to the United States?

Alan Hegburg: I don't know if it represents a security threat. It certainly represents a political deal rather than a commercial deal and I think it's a test to see exactly how the U.S. government will react to these kinds of approaches to our major oil producers. Interestingly, it came very late in the game. I mean the deal was Chevron was almost complete when CNOOC came in with its bid, which suggests that there is something unusual about this bid from the Chinese standpoint. I don't know what that is, but it doesn't sort of resonate as an accurate commercial undertaking by them.

Brian Stempeck: Well why do you say that? Why is it not an accurate commercial undertaking? I mean this is partially a state-owned company that's probably why they don't --

Alan Hegburg: Partially a state-owned company. CNOOC is a very small company. It reminds me a bit of the hostile takeovers in the 1980s when very small companies were trying to takeover very large companies. They had no intention of taking them over of course because they couldn't run them, so they were actually taking them to break them up, sell off the assets and take charge of the main assets they were interested in. That may be CNOOC's strategy. I mean they've indicated that that is something along the lines -- and to do that they had to have outside financing. I mean CNOOC, on its own, could not finance this deal. It is much too small to do that, so it had to go to the capital markets at least in the short term and probably will have to go back into the Chinese financial markets to make the deal happen. So on the financial side it doesn't resonate as a very solid deal and it doesn't resonate, with me at least, as a serious attempt.

Brian Stempeck: Pat, what are your feelings on this? I mean the Heritage Foundation has come out and said that this kind of deal will give China access to Unocal facilities in the United States, where they have access to basically some military bases, a lot of facilities that feed the U.S. petroleum reserve, things like that. Do you think it's a security threat to the U.S.?

Patrick Mulloy: I don't want to draw the conclusion to say the outcome. This is not, I agree absolutely with Al, this is not a commercial transaction. This is not one private company buying another private company. This is a Chinese owned company using subsidized financing from the Chinese government to buy an American oil company. I was involved in writing the statute that set up the Committee on Foreign Investment in the United States.

Brian Stempeck: Right.

Patrick Mulloy: This will be subject, if it goes through and Unocal wants to accept the bid, it will be subject to a CFIUS [Committee on Foreign Investment in the United States] review and that, if you look at the statute, that makes a distinction between a government owned entity buying someone and a private sector. So obviously Congress sees a difference between government owned entities and private sector ones. This should have a very searching analysis done by that inner agency committee.

Ben Geman: If and when that review were to commence what type of outcome, Pat, would you expect?

Patrick Mulloy: Well I don't know. I can't prejudge it. I think that there's a problem with the statute. Here's the way it would work. There's a 30 day look, then if they decide they want to make a more intensive look at this, and they absolutely should in this case because it's a government owned corporation, they have a more searching view, there's very specific time frames. Then that group can make a recommendation to the president whether they want him to reject it or prove it. Along the way they can stop the process and have the company spin off things and I think, if it gets to the CFIUS that may be the way this administration will choose to deal with the deal, have them spin off on things that might be of concern.

Ben Geman: OK.

Patrick Mulloy: I think they've got to give it a very clear searching analysis. Who knows what kind of technologies Unocal has that may be important to the Chinese.

Ben Geman: Yeah, actually, based on that, I wanted to jump back into one security issue which is that Representative Joe Barton in the House has raised the claim, a couple of times now, that Unocal is likely in possession of sensitive exploration and production technologies that would have some type of dual use, military applications. Alan do you think that that's a real concern?

Alan Hegburg: I have no idea. I mean I'm not really aware of sophisticated EMP technology having dual-use capabilities, but it's perfectly possible it may happen. EMP technologies are widely dispersed in the industry and throughout the world. They tend to be developed by the service companies, not by the major equity companies. The equity companies apply it, but it's conceivable that it does, I just don't know what that might be.

Ben Geman: Given, oh I'm sorry, go on.

Patrick Mulloy: Yeah, all I know is that, again, you pick up a lot of stuff just by reading the newspapers and there have been articles that this company does have some technologies regarding undersea drilling and location of items that may be important and that may be something that our people would not want to fall into their hands.

Alan Hegburg: I would just say depending on where Unocal operates and it operates in the Gulf of Thailand and various places. It clearly has proprietary information based on its operations. Now whether that's applicable to military things or not I don't know, but clearly it has a stack of proprietary information. All companies do and they guard that very assiduously.

Ben Geman: Given some of these concerns floating around this proposed deal, how delicate a position, Pat, is the White House in here? As it decides how to vet this, assuming there's some kind of agreement.

Patrick Mulloy: Well they don't have to face up to it yet until the Unocal shareholders decide maybe to, I think there's a shareholders meeting August 10 to consider the Chevron offer. So there has to be a period of time, if they reject that, and then the company's in play and then they accept an, well then actually -- there's no requirement that they submit this. But they'll voluntarily submit it because once it goes through a CFIUS review they've got a safe harbor so it can't be unwound later. That's why it will go through a CFIUS process and I'm sure people in the administration are trying to think about and maybe even having inner agency meetings to talk about what's out there. Who's doing what? What kind of information do we have about this transaction? And start learning more while they're thinking about it, before it formally filed.

Ben Geman: One last question on sort of the process piece of this, which is there's been a resolution introduced in Congress and you've had several lawmakers critical of the deal. I believe the Wall Street Journal, in a very recent story, said that lawmakers in the U.S. represented something to the effect of the greatest threat to the deal if there were to be an agreement. So I guess my question, Alan, is does Congress have the power to block this deal? How big a threat is that?

Alan Hegburg: Well I don't know. I'm not a legal expert, and I don't do any work on the Congress, so I can't speak to law. I would defer to Pat on that. I would say one thing, there is the CFIUS process. There is also possibly another option for the administration out there and that's to actually engage the Chinese at a very senior level bilaterally and say we're aware of what you're attempting to do here in this test case. It is a situation where there's no reciprocity between the two governments. We cannot buy, our companies cannot buy your companies, but your company can come over here and buy our company. And if you want to go down this road, so we don't interrupt foreign investment in general, then we have to find some agreement between us that makes this work. Now the Chinese have been very aggressive in buying companies recently and they are insisting in the Australian FTA [Free Trade Agreement] that they have the right to buy companies in Australia, particularly in the commodities sector. So this is sort of an indication that across the board China and Chinese companies are going to pursue these kinds of options. In fact, they're pursuing them from essentially a secure position, because no one can go after them and buy them. Not to mention that in the industrial sector in China, in general, particularly in oil, there are all sorts of restrictions on foreign investors beyond this question of acquisitions. Just in the way in which they do business and how they invest and all those kinds of things. So there is no reciprocity between the two sides and it may be time to talk to the Chinese about that.

Brian Stempeck: Pat, your thoughts on that?

Patrick Mulloy: I think Al's made an excellent point. You can't have a commercial company -- say Exxon wanted to go out and buy CNOOC, that can't happen.

Brian Stempeck: Right.

Patrick Mulloy: And yet, you'll see the Chinese saying this should not be politicized. We have a statute that would govern how this should be handled and they're trying to, I think, throw gorilla dust in the air to confuse the issues here and make this seem like some kind of free trade. There are no, I heard a show last night saying there was WTO [World Trade Organization] review. There's no WTO review of this. There is no WTO rules and regulations on this kind of thing. Very narrow WTO rules on investment. So this is solely a matter United States government to decide based on statutes that Congress has put in place. Now you ask me politically, I don't expect the Congress to pass new legislation to block this. I think they want the administration to use the legislation that's on the books to do a very thorough analysis. I think the legislation that's going through the house today, I think that's what you're referring to, that doesn't require the Congress to block it.

Brian Stempeck: Right, it's --

Patrick Mulloy: It requires for CFIUS to examine the factors that are set forth by the Congress, by the House in that piece of legislature.

Brian Stempeck: This is a pretty complicated issue because basically what you have here is a company, CNOOC, which is about 70 percent state owned --

Patrick Mulloy: Correct, correct.

Brian Stempeck: -- by the Chinese, but how do you expect them, they've been making overtures around the world, the three kind of state-owned companies in China, how do you expect them to act differently than say your normal privately held oil company? I mean do they have the ability to pull these supplies off the market? Is that the fear here or what's the problem with these companies buying another privately held company?

Alan Hegburg: Well I think, in the case of China the acquisition of the three main Chinese company's overseas reserves, tends overtime, since they want to bring those reserves back to China, tends to take liquidity out of the trading market and that's a serious problem in a very tight market. The market looks like it's going to be tight for some time and then demand is going to grow substantially and a lot of that demand is going to come from China. So the ability to move supplies around the world or flexibly, the fungibility of crude oil is reduced when you have certain players who have control of the oil and actually then don't sell it anywhere except to their refining systems inside their country. That's a serious consideration. Hopefully it won't play out that way, the demand would be reduced overtime and in fact to supply system will get better into balance, but right now it's a serious question.

Patrick Mulloy: I think the real question you should ask is where did the Chinese get all this money to buy -- they're running enormous trade surpluses with the United States. So they have a big cache of dollars over there and they're going, they will go on an acquisition campaign in this country, no doubt about it. You saw it with Maytag, Lenova buying IBM, this is another one. That's why it's so important and I keep emphasizing that Congress really has to take a look at that CFIUS legislation and I think it needs to be much more transparent about how these review of these transactions is going on, because it's not transparent now. Under CFIUS, since it was put on the books, there have been about 1,500 reviews. One's been blocked. So that's not a bad, I mean you can't say that's some kind of protective device --

Brian Stempeck: Not too hard to get by that.

Ben Geman: Returning to this question of control of reserves for a second, because I think that's been on the minds of a lot of people looking at this.

Patrick Mulloy: Right.

Ben Geman: Couldn't one also make a case that even if the reserves that this company holds were to be steered in some way exclusively toward China, wouldn't that just free up oil elsewhere on the market to go to other nations? In other words, because it's a global fungible commodity, why is that such problem, even if, under that scenario that you lay out there Alan?

Alan Hegburg: That's an economic argument, and I'm arguing on the commercial side and on the commercial side, the commercial trading market is a commercial entity and it functions based on how much is available in the market place. And my point is if there's less available the economic fungibility issue is moot, because it won't take place because those supplies will be already committed and we're seeing that. If you look at Angolan crude, for example, in a couple of months in the first quarter Chinese supplies of Angolan crude were very high. They were the second largest supplier, ahead of Iran, into the China market, in part because the way the refining system is structured. Furthermore, if the Chinese don't restructure their refining system to take a wider slate of crude oil, they're going to be in the market solely for sweet crude and sweet crude is of course the one that's driving the price through the ceiling and if you have most of that going one place as opposed to into the general market prices -- you stay high. So it has a potential price impact also.

Ben Geman: OK.

Patrick Mulloy: Let me just speak to that. I wrote a paper for my LLM in international law and then got hired by the [Justice Department] antitrust division to be part of their energy team. I used to go to the IEA [International Energy Agency] meetings, in Paris, this is an agency set up so that the consuming countries don't bid against each other during periods of oil shortage. They keep the price for being escalated.

Ben Geman: Right.

Patrick Mulloy: If the Chinese get proprietary interests and seal off their supply and don't have it in the international market, then it means the rest of us are competing in cases of emergency, for a smaller share of what's available and those prices can be driven up. The Chinese really ought to -- we ought to invite the Chinese in to join the International Energy Agency and be part of a sharing mechanism so that we reduce these kinds of competitive pressures in my view.

Alan Hegburg: Can I just speak to that?

Brian Stempeck: Sure.

Alan Hegburg: Because there's two things about that, which Pat said, and one is the IEA is going through an internal process of looking at how to restructure itself and some of the work that it's done. And it has identified China and India and Brazil and Russia as potential, not members so much because they're not members of the OECD yet, but potential companies to cooperate with in a supply emergency. Because as Pat said, the IEA has agreed, among itself, that in a supply constraint it will not bid away oil prices. I mean what it will do is take its normal supply, but in fact that will allow oil out there for countries that may or may not be able to afford it. So there is already a mechanism in place to sort of calm the market and the IEA. I think Pat's point is right. I think at the end of the day the way you want China to be -- you want it to be fully integrated into the oil market in the world and that means both on the investment side, so they have an open transparent and available investment environment, and on the trading side, such that they have confidence in the trading market, that that supply market can function and they don't go out and do all of these bilateral deals. We went down this road. The French did this back in the '70s. They did bilateral deals and of course they paid a heavy price for that. So the bilateral approach, country to country approach on buying oil and locking it up, isn't very successful over time. You end up paying a lot more for oil.

Ben Geman: Nonetheless, there was recently a point made by Richard Haas, the chairman of the Council on Foreign Relations, and he basically seemed to say that this deal could be a good thing because it would further integrate China into global markets. I mean Pat, how would you respond to that?

Patrick Mulloy: Well I --

Ben Geman: Or he wasn't so worried about it I think is what he said.

Patrick Mulloy: Again, I don't want to prejudge this thing, but who knows, I think this company has a lot of natural gas reserves in Indonesia and some of these other countries in the Southeast Asia part of the world, and I think they're somewhat dependent on these natural gas reserves in those countries, are used in those countries. If a Chinese company had control of those natural gas reserves, could it use those for strategic and political purposes in squeezing governments? I don't know, but obviously these kinds of things should be looked at. We shouldn't be looking at this solely in the idea of feel good international investment is going to make everybody friends. I think we need to look after our interests here. I think the Chinese are looking after their interests and I think we have to take a very realistic look at this transaction.

Brian Stempeck: One last question for both of you because we're running out of time. Just broadly, what is this other controversy about this deal? That we're seeing so many articles in the paper about this. What does it say to you about the state of relations right now between the United States and China? I want to read to you a quote from an editorial from the Dallas Morning News. They said, "Congress, watch this dragon deal with eagle eyes." It seems very fearfully spoken. Does that reaction surprise you and are people overreacting here?

Alan Hegburg: I think there is, there's a number of opinions about China and the United States. Depending on who you talk to. I mean there are those who see China as a national security threat to us over time, military buildups, those kinds of arrangements. There are others who believe that it's essential that the U.S. and China have a very good bilateral working relationship because we have very important issues on the table, being Korea for example and others and therefore -- and going back to integrating them into the marketplace. I think that was the objective of the WTO, to bring China into the world market in a way in which that they were not disruptive and I think that's an important goal. And we think that the counter approach to the national security approach, so it depends on where you are in the foreign policy spectrum, how you look at China. I think on the national security side, at least on the military side, China doesn't represent any near term threat to us. It would take a long time for them to be able to build up a military to affect us.

Brian Stempeck: Pat, your thoughts on this?

Patrick Mulloy: I want to offer my view. I'd go back to the Godfather and say, this isn't personal. This is business. We have interests. You have interests. You're manipulating your currency. You're subsidizing your export. You're engaging merchantilish trade practices. We have to take policies that will defend our interests, because they clearly have a national economic strategy. Part of it is to draw a lot of American investment into China and have our guys help build up their R&D and industrial base and then ship the stuff back here. I don't think that's necessarily a good strategy for the United States and we ought to take that into account in how we're dealing with China. I do think -- I don't want to demonize China. They have a government that's looking after their interests. Our government's got to get on the ball and start looking after our interests.

Brian Stempeck: All right. We're out of time. We're going to stop there. I'd like to thank both of our guests today. That was Al Hegburg and Pat Mulloy. I'm Brian Stempeck. This is OnPoint. Thanks for watching.

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