China’s Penetration of the Canadian Energy Market

China’s relentless global search for energy supplies has taken it from Central Asia to Sudan. But China imports oil from politically unstable nations such as inflation-ravaged Venezuela; Iran, constricted by international sanctions; and violence-ridden Iraq, the Democratic Republic of Congo and South Sudan, increasing the attractiveness of politically and economically stable exporters. More than half of China’s investment in the overseas oil sector is currently in countries considered unstable.

Oil is China’s second-largest energy source after coal, accounting for 18 percent of the country’s total energy consumption. China’s crude oil imports increased about 13 percent annually from 1994 to the 2008 global economic downturn, then slowly rose by 7 percent in 2012 and 4 percent in 2013, now standing at roughly 6.2 million barrels per day. As China’s need for imports rises, it coincides with the energy policies of Canada’s Conservative Prime Minister Stephen Harper. China’s largest oil fields are mature and production has “peaked,” leading companies to invest in techniques to sustain oil flows at the mature fields, while also focusing on developing largely untapped reserves in the western interior provinces and offshore fields. As China’s domestic production is not only flat but entirely domestically consumed, imports become ever more important to feed the growing economy.

China is currently the world’s fastest-growing major economy, with annual gross domestic product growth rates averaging 10 percent for the past three decades. Energy demand in China has accelerated accordingly alongside the country’s rapid industrialization, leading it to seek energy assets worldwide. In 2013 alone, the China National Petroleum Corporation (CNPC), Sinopec and the China National Offshore Oil Corporation (CNOOC) spent $32 billion on overseas conventional oil and gas asset acquisitions, with Sinopec and CNOOC alone spending $50 billion on overseas transactions since 2008 (South China Morning Post [SCMP], August 7, 2013).

Seeking Reserves and Know-How

China is now the biggest foreign investor in Canada’s energy sector. During 2007–2013, Canada’s energy industry absorbed more than $100 billion in foreign direct investment (FDI). China accounted for 28 percent, trailed by the United States with 19 percent.

The overall total for Chinese State Owned Enterprises’ (SOEs) investments in Canadian energy assets from 2007 to the present is $119 billion (SCMP, December 16, 2013). The following is a list of Chinese energy investments in Canada worth over $C1 billion from 2008 to the present, which totals more than $C35 billion ($32 billion).

(The Financial Post, December 7, 2013)

Another factor in turning China ever more toward Canada was the Arab Spring. When Libya fell into civil war in February 2011, China had to evacuate more than 35,000 workers and lost $18 billion in investments in the process. The fracturing of Sudan into two nations, Sudan and South Sudan, in 2011, put an estimated $20 billion in Chinese investment at risk. Following the countries’ split, China has invested an additional $8 billion in South Sudan following secession. During January–October 2013, China imported nearly 14 million barrels from South Sudan, twice as much as China imports from Nigeria annually, but the renewed fighting that erupted in early 2014 again put Chinese exports at risk, making Canada ever more attractive.

An added incentive for China in buying into Canadian energy firms is access to advanced technology such as oil sands extraction and hydraulic fracturing, where North American companies have a commanding lead.

This possibility was evident when in April 2005 the state-owned CNOOC purchased a 16.69-percent stake in Calgary’s MEG Energy oil sands company for $C150 million. MEG held 100-percent ownership of oil sands leases in 52 contiguous sections, totaling 32,900 acres, in Alberta. CNOOC Chairman and CEO Fu Chengyu said, “The investment hits on our focus on long-term growth. At the same time, this move provides a good chance for us to exploit the advanced technology and expertise of oil sands development. These skills may help facilitate the exploitation of oil sands and shale in China, where large reserves of oil sands and shale were found in recent years” (CNOOC Press Release, 2005).

Unlike Canada or the United States, where shale gas is widely produced, China’s shale gas reserves remain largely untapped. Most reserves in China are in remote areas that lack access to the large quantities of water needed to extract shale gas, and China lacks contractors with advanced technology that can drill for shale gas under modern safety standards. To develop China’s own shale gas assets, Chinese companies are seeking access to Canadian firms’ management skills and technical know-how for extracting heavy oil and shale. As China has a domestic shale reserve that is larger than both U.S. and Canadian reserves combined, Chinese energy companies will greatly benefit from their investments in Canada’s advanced energy sector (The Financial Post, January 9, 2012).

Pursuing further diversification, China’s Canadian energy spending spree gathered momentum in 2012, when PetroChina bought Canadian shale natural gas assets from Encana Corp. for $1.2 billion, and a stake in Royal Dutch Shell Plc’s Groundbirch project in British Columbia.

The U.S. Energy Information Agency reports that China’s national oil companies (NOCs) anticipate that the Nexen deal and other overseas purchases will help them achieve an overall annual oil and gas production growth rate of 6-10 percent per year by 2015. The global recession is also assisting China’s purchase of global acquisitions as it uses its vast foreign exchange reserves, estimated at $3.3 trillion in 2012, to purchase equity or acquire stakes in energy companies. The CNPC Economics Technology Research Institute reports that since 2008, Chinese NOCs have purchased assets in the Middle East, North America, Latin America, Africa and Asia, and invested an estimated $34 billion in overseas oil and gas assets in 2012 alone (“China—Analysis,” U.S. Energy Information Agency, February 4).

Political Complications

There is some concern in the United States, the largest importer of Canadian oil, that Chinese companies could be buying up assets to send the oil and gas across the Pacific to fuel the nation’s growing economy, to the possible detriment of U.S. purchases. A couple of years after becoming the world’s largest energy consumer, China has also become the world’s largest importer of crude, leading some in Washington to frame China’s increasing penetration of the Canadian energy sector as a possible security risk.

However, China, now the largest foreign investor in Canadian energy, is grappling with issues that have long plagued its North American rivals, including high costs, operational challenges, aboriginal issues related to possible environmental damage and volatile bitumen prices. Despite eager support from Canada’s prime minister, these factors will limit, or at least delay, the development of natural gas exports to China.

In addition to investment, Canada has also attempted to use its energy relationship with China as a source of trade leverage in the North American market. In mid-February 2012, Canadian Prime Minister Harper, irritated with the slow progress on the Keystone XL pipeline in the United States, threatened to shift oil sands output to Asian markets, particularly China (Oilprice.com, February 21, 2012). However, the Northern Gateway pipeline needed to carry LNG from Alberta to Canada’s west coast for export has also been delayed, by mounting opposition to both the oil sands and their attendant pipelines from Canadian First Nation Indian tribes.

On October 8, 2013, the Fort McKay First Nation of the Athabasca Wood Buffalo area in northern Alberta withdrew from the federal-provincial Joint Oil Sands Monitoring (JOSM) program, established in 2012, because the First Nation’s leadership felt they were not valued in the watchdog’s consultation process, even though they were particularly interested in becoming involved in JOSM’s technical details, such as monitoring air quality and contaminants (First Nations Drum, November 14, 2013). PetroChina is consequently struggling to expand in the oil sands because of a dispute with the influential Fort McKay First Nation. While 26 First Nations out of 45 in Northern Gateway’s right of way support it and have agreed to become equity partners, a coalition of 130 First Nations has coalesced in opposition to oil sands pipelines and tankers in British Columbia’s offshore waters (The Financial Post, December 5, 2013).

Given the current lack of infrastructure, large-scale energy exports from Western Canada to China remain far in the future. China already imports natural gas via pipelines from Turkmenistan and Kazakhstan and LNG from Australia, Qatar and Yemen, which together accounted for almost a third of China’s 2013 gas consumption, an increase of 25 percent over 2012, with consumption expected to rise another 11 percent this year. Given the long lead times and substantial costs necessary to build LNG liquefaction facilities, tankers and port facilities, China will continue to import the bulk of its natural gas needs via overland pipelines for the foreseeable future.

China’s largest Canadian energy acquisition to date occurred five months after Harper’s Keystone XL diatribe, when CNOOC succeeded with a $15.1 billion (plus $2.8 billion in net debt) buyout of Nexen Inc., a Calgary oil and gas company. The purchase was China’s largest-yet overseas acquisition. In order to proceed, the contract had to be reviewed by the Canadian Parliament’s Committee on Foreign Investment in consultation with the Canadian Security Intelligence Service under the government’s Investment Canada Act, used to determine if the sale was a “net benefit” to Canada and did not pose a National Security Risk (The Financial Post, December 24, 2012). To put the acquisition in context, it was worth more than all of China’s direct investment in Africa in 2011 ($14.7 billion).

Whether the Harper administration will allow such mega-deals in the future is uncertain, as he faces political pressure both within Canada and from Washington to curtail such investment. Since Harper came to power in February 2006, the book value of foreign direct investment in Canada has increased by $237 billion. Of the ten largest Canadian takeovers by Chinese companies, nine have taken place during Harper’s administration, leading to domestic criticism. The Canadian Security Intelligence Service also expressed unease over the strategic aspects of the Nexen deal, as a large China state firm bought heavily into a major Canadian energy company. This forced Harper to declare that the rising wave of takeovers of Canadian oil sands by foreign state-owned firms had gone far enough, and would not be allowed to continue except in “exceptional” circumstances (The Star, December 7, 2012).

Conclusion

The financial benefits of buying Canadian energy assets was clearly proven on April 22, when CNOOC posted a 15.5-percent rise in 2014 first quarter output, with the rise primarily due to its purchase of Nexen (The Globe and Mail, April 22).

Barring a change of attitude in Ottawa, there is no indication that China’s spending spree on Canadian energy assets will diminish anytime soon. Strengthening the investment legislative infrastructure, in September 2012 Canada and China signed a Foreign Investment Promotion and Protection Agreement. While China’s acquiring Canadian energy assets makes perfect sense in Beijing, should such a pace continue, political pressure against further sales is likely to mount.

A further source of concern for Beijing is that while Canada is bereft of the political upheavals and terrorism infecting some of China’s other, more traditional crude suppliers such as Libya, Sudan and Iran, it is facing political risk of another kind—in addition to popular suspicion of Chinese state companies, the First Nations are turning to the courts to block what they see as wanton destruction of their environment, and have won some notable victories.

About the only certain thing about future Chinese acquisitions of Canadian energy assets is that the debates opened up during the Nexen deal will continue. When and whether significant volumes of Canadian oil and natural gas will flow to the West Coast for transshipment to China depends on a number of factors beyond Beijing’s control, including First Nations political activism and the Canadian court system.