Canadian energy: Policy implications of Chinese investment – Canadian Government Executive

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May 7, 2012

Canadian energy: Policy implications of Chinese investment

Since its founding, Canada has looked either east to Europe or south to the United States for export markets. But the accelerating shift of the global center of economic gravity to Asia from Europe and North America will require a re-ordering of Canada’s foreign trade and investment priorities. 

The recent visit of Prime Minister Harper to China, centered on energy, highlighted the importance of what can now be described as Canada’s most significant bilateral relationship after the United States. A highlight of that visit was the conclusion of a Foreign Investment Promotion and Protection Agreement that had been under negotiation for almost two decades. The attention accorded this treaty, which still needs to be ratified, serves as a reminder that investment flows between Canada and China have emerged a major component of the bilateral relationship, particularly in the energy sector.

This was not always the case. From the 1970 establishment of diplomatic relations with the People’s Republic of China until the economic reform movement led by Party leader Deng Xiaoping, trade and particularly investment played a minor role in Canada-China relations. Only during the 1980s and 1990s did investment by Canadian firms in China’s expanding economy begin to be significant as China emerged as the largest recipient of Foreign Direct Investment (FDI) amongst developing countries.

Chinese investments into Canada’s oil and gas sector remained modest (with the exception of the purchase of the controlling share of Husky Energy by Hong Kong interests). One restraining factor was that Chinese State-Owned Enterprises (SOEs) were unfamiliar with both Canadian investment regulations and with operating conditions for Chinese SOEs in Canada. However, China’s economic fluorescence led to a rapid accumulation of foreign currency reserves, which in turn stimulated expansion of China’s foreign investment abroad.

China’s status as workshop for the global economy also fueled the Chinese search for raw materials, including petroleum, in Asia, Australia, Africa and Latin America. This wave of Chinese investment targeted either direct investment in foreign energy resources, or was directed to long-term energy purchase agreements. (The value of just one Chinese contract for Australian Liquid Natural Gas in 2011 exceeded US$70 billion.)

North America was largely untouched by the first waves of Chinese foreign investment, due in part to the political sensitivities in the United States regarding high-profile Chinese investment, particularly by SOEs.  

In the case of Canada, an abortive effort to purchase Noranda (2004) by China’s Minmetals Corporation soured Chinese interest in Canada’s resource sector. But the 2004 Noranda case turned out to be a temporary setback. By 2007 the pace of Chinese investment had increased, and from 2009 the trend accelerated. Total Chinese investment in Canadian energy resources now totals approximately $15 billion.

Chinese investment in the Canadian energy sector has generally followed three patterns. First, China has sought to acquire the overseas holdings of Canadian companies. Second, China has sought to acquire stakes in existing Canadian energy companies, but without reaching the level of investment that would involve control of the Canadian company. Third, China has sought joint ventures, often with rather large Canadian energy companies. None of these approaches tend to generate much controversy with the Canadian public or media, as compared with direct takeovers of high-profile Canadian energy companies.

The purchase of Daylight Energy by China Chemical and Petroleum Corporation (Sinopec) in 2011, closely followed by the purchase of OPTI by the China National Offshore Oil Corporation (CNOOC) represents a new chapter in the behavior of Chinese SOEs in Canada. While the purchase values, just over $2 billion in both cases, are not large by the standards of the capital-intensive petroleum business, neither are they insignificant.  

Chinese energy SOEs have ready access to capital for foreign investment through China’s state banks, and with China’s foreign currency reserves in the range of US$3 trillion, no potential purchase is, at least in theory, too large to contemplate. However, China remains sensitive to domestic political consideration in Canada and elsewhere, and appears reluctant to make purchases that would generate strong political resistance, as occurred with the Anglo-Australian firm BHP”s efforts to purchase Potash Corporation last year.

China’s motivations in seeking investment in the Canadian energy sector are several. It is keenly aware that its domestic petroleum production falls short of Chinese requirements, and this gap is growing. While China as recently as 1990 was self-sufficient in petroleum production, the declining output of its largest oilfields, but more importantly the growth in China’s energy appetite, has sharply increased Chinese demand.  

China is also increasingly dependent upon Middle Eastern supplies, and is the largest purchaser of Iranian oil exports. China is understandably wary of the stability of Middle Eastern and African energy exporters, having watched as dramatic 2011 events involving Libya, South Sudan and Yemen in 2011 cut those nations’ energy exports. Canadian energy production, particularly from the oil sands, is growing rapidly. This combination of instability in some of China’s key energy suppliers, combined with enhanced Canadian production capacity, has certainly been noticed in Beijing, a fact that helped underwrite Chinese support for Prime Minister Harper’s focus on energy during his February visit to China.

On the Canadian side, with only one substantive export destination for Canadian petroleum exports – the United States – there is an understandable desire to diversify. This convergence of respective national interests – the Chinese desire for import diversification, and the Canadian desire for export diversification – constitutes the mainspring of Canada-Chinese energy collaboration.

China is ready to make further substantive investments in the Canadian energy sector, even where there is no means to ship petroleum to China. The purchases are in line with publicly stated Chinese desires to reduce the share of Chinese foreign holdings in U.S. financial assets.

However, China would prefer to at least have the option of shipping petroleum from Alberta to China through energy corridors to the West Coast. But China has been wise in not directly involving itself in the sharp domestic Canadian debate over the proposed Northern Gateway pipeline project, or any of the various other rail and pipeline export corridors that have been proposed. China may actually be indifferent as to which project(s) goes forward.

There are a few misconceptions that should be addressed regarding Chinese investments in Canada’s energy sector. First, U.S. and European investment dwarf Chinese investment, and this dominance is unlikely to be altered in the foreseeable future. Second, Canadian oil that moves to market through Pacific ports will not all go to China. The Chinese economy only overtook the Japanese economy (in nominal GDP) in 2010, and Japan, Korea and several other Asian economies are highly dependent upon sea-borne oil imports. Finally, even if all of the energy corridors that are contemplated to the West Coast were to be constructed, along with the expanded port facilities that will be required, Canada will be only one modest part of the much larger solution that would be required to solve China’s petroleum dependency on foreign suppliers.
  

Gordon Houlden is the director of the China Institute and professor of political science at the University of Alberta. He served in the Canadian Foreign Service for 32 years.

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