The Fallout

China Retreats Now, but It Will Be Back (must register to view original article)

Published: August 3, 2005

HONG KONG, Aug. 2 - Just as a tactical retreat is sometimes useful in winning broader battles, as Sun Tzu wrote 2,500 years ago, the withdrawal of Cnooc Ltd.'s bid for Unocal seems unlikely to derail China Inc.'s economic expansion overseas, and may even hold a few lessons.

The sight of a Chinese company trying to buy a business once known for the Union 76 brand of gasoline made the proposed deal a lightning rod for American worries about everything from manufacturing job losses to high oil prices to the security of energy supplies. But while Congressional resistance appears to have torpedoed the Chinese bid, the economic fundamentals behind that bid remain in place, from China's vast foreign currency reserves to its ravenous appetite for imported oil.

The most immediate effect from the failed bid may be on Chinese public opinion toward the United States.

China's state-controlled media had devoted extensive coverage to the Cnooc bid, presenting it to the public as an exclusively commercial arrangement.

"This is a very symbolic deal that made Chinese people proud of themselves," said Jin Canrong, the associate dean of the School of International Studies at People's University. "Definitely, they will feel some kind of disappointment."

Chinese officials face the challenge of managing carefully any potential fallout at home from the deal's collapse. It is unlikely, however, to prompt the kind of public criticism directed against Japan this spring for whitewashing sections of history textbooks describing Japanese atrocities in China during World War II.

One worry outside China is that the failed bid could encourage Chinese oil companies to step up investing in countries like Sudan and Myanmar, whose leaderships are in poor favor with the White House and yet are eager for any investment they can get. Chinese companies also could buy more oil and gas from Russia and Iran.

But Mr. Jin and other specialists said on Tuesday that in any case, Chinese policy makers were likely to react pragmatically, with no effort to dump the central government's huge holdings of American securities and with little deviation from a long-term effort to acquire foreign brands, technology and energy assets. Christopher H. Stephens, a senior partner at Coudert Brothers specializing in mergers and acquisitions in China, said that China's leadership was most likely to opt for a narrowly commercial retaliation against the United States. "You may see a large aircraft order go to Airbus, or a large oil concession go to BP or Shell," he said.

The withdrawal of the Cnooc bid may even help less politicized deals move forward, like the agreement last Friday by Nanjing Automobile of China to buy an engine factory and other assets from the bankrupt MG Rover Group of Britain. Nanjing Automobile will box up the engine factory equipment and ship it to east-central China for use in engine production there.

That deal represented an important step by the auto industry of China to address one of its biggest weaknesses, the design and manufacture of reliable engines. China's ability to become an internationally competitive auto manufacturer may be more important to the country's economic success in the long run than its ability to buy oil and gas reserves overseas.

Many experts question whether China even needs to own more such energy assets. Japanese companies bought overseas oil fields in the 1970's only to conclude that they could more efficiently meet the country's import needs by buying on world markets.

William C. Ramsay, the deputy executive director of the International Energy Agency, said in an interview three weeks ago in Paris that the purchase of a large overseas oil company by a Chinese company with deep pockets might be good for global energy markets, by providing extra investment in oil fields that might otherwise be neglected. But he questioned whether bids like Cnooc's to own barrels of oil under the ground in foreign countries would increase China's energy security.

"It isn't necessarily about barrels but about price," he said.

Philip Andrews-Speed, an expert on China's oil industry at the University of Dundee in Scotland, said that Chinese oil companies were likely to continue the same slow, steady purchase of small oil fields that they have pursued for the last decade, while remaining on the lookout for bigger deals.

"You've got a range of possibilities - they buy whole companies, they buy parts of companies, or they go asset by asset," he said.

The Chinese government still has $711 billion in foreign currency reserves that need to be invested. The reserves are mostly parked in Treasuries, American mortgage-backed securities and a mishmash of other financial instruments earning single-digit interest rates, a meager return that has become controversial within China.

A Cnooc deal could have provided another investment opportunity; the government announced in late spring that it would inject $15 billion into a big state-owned bank, which in turn agreed to lend $6 billion for the Cnooc bid. Mr. Jin said that the State Administration of Foreign Exchange would continue managing the country's foreign exchange reserves with an eye to maximizing the return on them.

Cnooc's withdrawal comes after Haier, a Chinese manufacturer of appliances and electronics, pulled out of efforts to buy heavily unionized Maytag, a bid that also faced political hurdles, although smaller ones. But a less politicized deal, Lenovo's purchase of I.B.M.'s personal computer business, went through over the winter with less controversy despite some warnings that important American technology might end up in the hands of a potentially hostile power.

One lesson may be that Chinese companies are likely to complete deals that do not directly antagonize any large economic interest in the United States. The Haier proposal was a potential challenge to the United Automobile Workers, one of the largest and most politically influential unions in the United States and easily the wealthiest. The Unocal bid upset Chevron, which had submitted what now appears to be the winning bid for Unocal and which lobbied Congress heavily against the Cnooc bid.

Mr. Stephens said that Chinese companies might show a broader wariness of investing in energy deals in the United States, because of the sector's strategic importance. Chinese companies may also become more cautious about purchases of labor-intensive companies, even including nonunion businesses, for fear of antagonizing politicians who fear that the buyer would move production home to China.

Cnooc has learned the hard way the importance of paying attention not just to the executive branch in Washington but also to Congress. That may be a difficult point to grasp for Communist officials raised in a country where the National People's Congress has long done little more than rubber-stamp decisions by the leadership, although this has started to change in China as well.

Cnooc's advisers checked with administration officials before starting the bid and encountered no strong opposition, but did not try the more arduous - and less leakproof - approach of sounding out a spectrum of members of Congress, a person involved with Cnooc's bid said.

Japanese companies responded to protectionism in the United States in the 1980's by hiring hundreds of lobbyists in Washington, including many former government officials. But Chinese companies like Cnooc have barely begun trying to influence the American political process in this way.

"The lesson is when you move into the huge takeover game, there's a huge amount of due diligence you need to do before you announce anything," Mr. Andrews-Speed said, adding that in the Cnooc deal, "they clearly didn't do that on the political side."