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    China Business
     Sep 20, 2011


China's cash floods into Canadian energy sector
By Wenran Jiang

As China has become the world's second-largest economy, its demand for energy has caused it to become the world's biggest comprehensive energy consumer. Accompanying this process has been a sharp upward trend in Chinese foreign direct investment (FDI) focused on energy and other resources.

Canada has become the latest addition to Beijing's FDI investment priority list with C$15 billion (US$15.2 billion) worth of Chinese capital pouring into the energy-rich province of Alberta in 2010. [1]

These fast-paced investment activities have occurred against the backdrop of a sustained high energy demand forecast from China in the coming years and sluggish prospects for economic recovery in the United States. Additionally, there has been

 
intensified protest from environmental groups against the import of Canadian oil sands products to the United States, for example, against the controversial Keystone XL crude oil pipeline from Alberta to the southern United States.

A closer look at the China's leap into the Canadian energy sector, however, may reveal some surprising characteristics that are not associated with conventional assessments of China's much talked-about ''Go Out'' strategy.

China's renewed interest in investing in Canada
Since the end of 2009, China National Petroleum Corporation (CNPC), China Petroleum & Chemical Corporation (Sinopec) and China National Offshore Oil Corporation (CNOOC) all have made substantial investments in the Canadian energy sector with a particular focus on the Alberta oil sands development. The China Investment Corporation - a $300 billion sovereign wealth fund - opened its first overseas office in Canada early this year and chose Canada for its only energy sector equity investment.



The proposed PetroChina-EnCana shale gas deal in British Columbia, worth $5.4 billion has failed to materialize. Therefore, so far the largest single Chinese investment in the Canadian energy sector is the $4.65 billion takeover of ConocoPhillips' shares by Sinopec in Syncrude Canada Ltd. The Syncrude Group is Canada's largest oil sands production consortium with most of its production exporting to the US market.

The Sinopec-Syncrude deal was followed closely by the successful purchase of 60% of Athabasca Oil Sands Corporation's MacKay and Dover oil sands projects by PetroChina (a CNPC subsidiary) worth $1.9 billion. China also has invested in Canada's mining sector since 2009 - notably the $1.7 billion equity investment by the China Investment Corporation in Teck Resources, a Vancouver-based company with both energy and mining assets in North America. In its latest move, CNOOC, the third-largest Chinese national oil company (NOC), acquired the struggling oil sands producer Opti Canada Inc, buying a 35% stake in the joint Nexen-Opti oil sands project in Long Lake, Alberta.

A number of factors have contributed to China's renewed interest in Canadian investments.

First, the recent Chinese re-entry into Canada is more than a reflection of basic market movements. Chinese energy and resource needs have been driving China's foreign investment in these areas over recent years. A better-than-expected recovery from the recession in China also has fueled demand energy and resources. Such demand however did not translate into a steady inflow of Chinese investment in Canada's energy sector, as in other resource rich countries.

In 2005, the three top Chinese national oil companies made investments in Canada, including a $2 billion memorandum of understanding between PetroChina and Enbridge to support building the Gateway pipeline system from Edmonton, Alberta, to Kitimat, British Columbia. [2] This momentum, however, did not continue. During the pre-crisis boom years from late 2005 to early 2009, Chinese firms made almost no major investment in Canada's energy sector.

In fact, the absence of major Chinese investment coincided with a very low point in Sino-Canadian diplomatic and political relations. Under the Conservative government of Prime Minister Stephen Harper, China was not on Canada's foreign policy priority list. Prime Minister Harper did not pursue a visit to China during his first three years in office, resulting in the suspension of bilateral summit diplomacy. [3] Since early 2009, the Canadian government has changed course in its China policy. Ottawa dispatched key cabinet ministers to Beijing, reassuring the Chinese that Canada values its relations with China and that Chinese investments are welcome. Such consistent and conciliatory messages culminated in a December 2009 visit when Harper visited China. This attitude shift and improved political relations were important precursors to China's renewed investment activities in Canada's energy and resources sectors.

Global oil prices represent another reason why Chinese interest in Canadian energy has recently increased. After a brief plunge to the low $30 per barrel range during the economic crisis, oil prices quickly climbed back and stabilized at the $80-90 range. Various forecasts place future oil prices from $80 to $100 per barrel - a level that would sustain profitability for Alberta's oil sands extraction.

One major question Chinese oil companies have asked is whether the global market would be able to support an oil price range high enough to justify long-term investment in Alberta's oil sands. The current oil prices seem to have removed initial doubts and Sinopec's generous payment for the ConocoPhillips shares in the Syncrude deal displayed a considerable new confidence from the Chinese side.

Chinese state banks also have provided large, state-owned energy and resource companies with loans and overseas expansion credits. Many cash-strapped Canadian energy and resource firms welcome such financial strength and secure funding. At the same time, the North American stock market was hit hard during the economic crisis and many energy and resource companies have become very good investments - an opportunity that has not gone unnoticed by Chinese NOCs.

Even though the market has recovered significantly, the Chinese are optimistic that the timing is still good and their investments will yield further returns when the world economy finally climbs out of recession.

Implications for North America
Although top Chinese companies have leaped into Canada with fast pace, the total amount of investment is relatively small if measured against these companies' overall global investment. In the past two years, China's top energy firms have arranged various forms of loans in exchange for oil supply contracts with Russia ($25 billion), Kazakhstan ($10 billion), Brazil ($10 billion) and Venezuela ($20 billion). Chinese oil companies have become involved in joint ventures in Iraq and Australia. The Chinese presence is also a relatively recent phenomenon, as foreign FDI, primarily from the United States, had poured in some C$125 billion by 2009.

The Sinopec-Syncrude deal announcement spurred talk about potential Chinese leverage over Canada's resources. Some have repeated charges that Chinese investment will lead to Chinese control of Canada's natural endowments - an accusation that lacks credible evidence or research backing.

Others warn that any Chinese voice in the development of Alberta's oil sands would be counterproductive to Canada's national interests. Nonetheless, if the smooth approval of recent Chinese investments by the government of Canada is any indication, future Chinese capital inflow into Canada may not face substantial questioning or barriers.

Still, renewed Chinese investment in the Canadian energy sector raises some questions that need to be addressed.

First, does China insist on shipping its overseas oil production back home? This is clearly not the case for Sinopec's deal with Syncrude. There is no known clause in the transaction that states certain portions of production will be shipped to China. In fact, Sinopec may have made the investment on two assumptions. The first is that exporting oil to China will be possible only on a small scale in the foreseeable future, given the existing modest pipeline infrastructure on the west coast. The potential for large-scale supply exists only if Enbridge's Gateway pipeline gets the regulatory approval required for its construction.

The second assumption may represent a shift in Chinese thinking - China's companies are now willing to invest in Canada's energy sector even without large-scale access to Canadian oil production for China's domestic use. Contrary to popular assumption, much of China's global oil production is not shipped to China, but is sold on the world market, like oil produced by Western oil companies. At the moment, Syncrude production will continue to flow south to the United States and Sinopec's 9% ownership will not change this arrangement.

Second, is a pipeline that ships oil from Alberta to the Canadian west coast still desirable for the Chinese and Canadians? Currently, there is no large-capacity, direct pipeline from Alberta to the west coast. Kinder Morgan, however, completed its TMX Loop project in 2008, linking pipelines from Alberta to the existing Mountain pipeline, which reaches a port in southern Vancouver. The TMX Loop has a shipping capacity of 300,000 barrels per day (bpd). If construction of Enbridge's Gateway pipeline goes ahead as planned, it would have an additional 550,000 bpd capacity, but it will not be functional for several years.

Recently, the Chinese have inquired about the state of the Gateway pipeline project and have continued to express strong interest. Such interest is understandable: this pipeline would certainly increase China's incentive to further invest in Alberta's oil sands. Also, an additional pipeline or two is beneficial for Canada as this would diversify its international markets.

Canada currently sells crude oil to the United States at $20 below the global market price. None of the planned diversification projects, however, would fundamentally change the fact that Canada is overwhelmingly dependent on the US market. Regardless, it is almost certain that if there are increased means of transporting Alberta's oil to the west coast, Chinese and other Asian investment will increase.

Third, is it in Canada's interest for Chinese and other Asian investors to build refineries in Alberta? Most of Alberta's pipelines run south, shipping bitumen to US refineries for value-added upgrading. It has been long known from both sides of the border that this is the nature of a North American integrated market. It is also true that Alberta's government has promoted a development strategy that will see investment being made to build refineries around Edmonton, thus taking advantage of the booming energy market in creating value-added jobs in Canada.

If Chinese and other Asian economies become involved in Alberta oil sands extraction, there is good reason to consider investing in refineries as part of a long term strategy - especially under the condition that upgraded product oil may one day be shipped via improved pipeline and rail capacities to the west coast and then on tankers.

Fourth, should Canada pursue Chinese investment as a part of its diversification strategy away from the US market and, if yes, should Canada worry about the potential for Sino-US competition for Canadian oil? The question begs a response from Canada as much as from China and the United States.

For Canada, the answer seems to be more of a market-oriented one than a strategic one. When US demand was high, there was very little discussion concerning diversification among Canadian producers. Alberta was content to ship most of its exports to the south. The recent US economic downturn and talk of labeling oil sands production as "dirty oil" has concerned Canadian producers. Consequently, there has been a renewed Canadian interest in market diversification.

Chinese investment came at the correct time and this investment has been welcomed by Canadian producers. There is also an indication that the United States and China are moving toward treating each other as partners rather than as competitors in seeking energy cooperation, as seen by US Secretary of Energy Steven Chu's approach of active engagement in this area. This places Canada in an advantageous rather than antagonistic position.

Finally, where is the red line for Chinese investment in Canada's energy sector? In the global context, Chinese oil companies certainly possess the financial wherewithal to invest and have done so on a large scale - up to $40 billion in some countries. In the past few years, Canada has become more confident in believing that the country has the necessary regulatory framework in place to cope with increased Chinese investment. The current Canadian national discourse is more focused on whether investment from China will provide social and economic benefit to Canada and on the environmental impact of pipelines running to the west coast and prolonged large scale extraction of oil sands.

Facts run against the assumptions of those who perceive China's "Go Out" strategy as a predatory behavior, or those who are concerned that Chinese presence in Canada's energy sector may deprive the United States of its supplies. The dragon has returned to Canada, but cautiously. Beijing has been sensitive to the political, economic, social and environmental conditions of its investment in Canada, settling for minority positions in their equity and joint venture agreements. Most importantly, at present, crude produced by Chinese capital in Canada is only flowing south to the US market, helping to the secure US energy supply.

Notes
1. Alberta Minister of Energy Ron Liepert, Lunch Keynote Speech at the Canada-Asia Energy Cooperation Conference and the 7th Canada-China Energy & Environment Forum, Calgary, September 8, 2011.
2. For an earlier assessment of Canada-China energy relations, see Wenran Jiang, "Fueling the Dragon, China's Quest for Energy Security and Canada's Opportunities, Asia Pacific Foundation of Canada.
3. For a more detailed analysis on Canada-China relations under the Harper government, see Wenran Jiang, "Seeking a Strategic Vision for Canada-China Relations", The International Journal, Vol. 64, No. 4, Fall 2009.

Wenran Jiang, PhD, is the Mactaggart Research Chair of the China Institute at the University of Alberta and a Senior Fellow at the Asia Pacific Foundation of Canada.

(This article first appeared in The Jamestown Foundation. Used with permission.)

(Copyright 2011 The Jamestown Foundation.)


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