China: Expanding Into U.S. Oil Sweet Spot?


Today's Analysis: China's Unocal Gambit And Washington's Silent Fear

China continues its attempt to become a major global oil producer. Having mishandled and prematurely depleted the reserves within its own borders, it has embarked on a strategy of global acquisitions. The latest acquisition attempt, is a big step for the Chinese, as they are reportedly attempting to buy a top tier U.S. oil and exploration company.

According to the Wall Street Journal, citing a Financial Times report: "China's third-largest oil and natural-gas company is eyeing Unocal Corp., the ninth-largest oil company in the U.S. -- the latest sign of how China's search for oil, commodities and consumer markets is fueling Chinese acquisitions overseas. The interest by China National Offshore Oil Corp. is highly preliminary, say people familiar with the matter, who add that there are no assurances a deal will ever be struck. It's unclear whether the company is interested in all or part of Unocal."

The reasons for the interest are obvious. Unocal is a pure play on exploration and energy assets. The company is no longer involved in retail operations, and "is viewed as a likely takeover target. The El Segundo, Calif., company has amassed an attractive array of oil and gas assets in Southeast Asia, but is still considered relatively underpriced. After selling off its refineries and gas stations in 1997, the company has focused purely on exploration and production, generally considered the high-profit part of the oil industry."

This is a bold move by China. And the announcement could be a trial balloon. And if it is such an attempt to test the waters, it looks to us as if it's been a success. No real answer has come from the White House or any other U.S. government agency.

And yet, it is clear that there should be a response, a carefully worded, but stern response from multiple agencies, and as soon as possible.

It should be equally clear to anyone with any horse sense, that any attempt by the Chinese to buy a major U.S. oil company, should send shivers through any bureaucrat's spine in Washington. Aside from the political repercussions, there are some serious national security issues to consider, given the fact that China is well known to traffic in technology, including nuclear related materials, with countries that the United States describes as "supporters of terrorism," and "rogue states." The constant friction between the U.S. and China on the political and ideological fronts is also well known, as China makes no secret of the fact that it is unhappy with the U.S. position at the top of the heap in the world.

There are logistical and business issues as well, given the poor handling of their own fairly adequate oil supplies. The journal noted that China's managers "still lack much of the financial and legal experience to put together a sophisticated transaction of the size of Unocal. While relying heavily on advice from U.S. and European banks and lawyers, the country is ["handicapped by a cumbersome and time-consuming decision process on M&A,"] says Mason Cargill, an attorney at law firm Jones Day based in Shanghai. ["In M&A, big decisions have to be made quickly."]

But that has not stopped China from aggressively pursuing international acquisitions. "China and Canada are nearing a general agreement on Chinese investment in Canadian oil resources that could be signed as early as this month by the two governments. Among its few details is potential investment in Canada's so-called oil sands in the province of Alberta, an industry executive who has seen a draft of the pact said. The accord mentions China's three major oil companies -- China National Petroleum Corp., China Petrochemical Corp. and China National Offshore Oil -- each of which has expressed interest in taking stakes in oil-sands projects, the executive said. Oil sands, gritty tar-like deposits that can be refined into crude oil, have largely been seen as a costly alternative to extraction from normal oil fields. But with improvements in technology and oil prices on world markets likely to remain high, refining oil from oil sands is becoming more commercially attractive, industry executives said."

China's interest in Canada extends into other areas. "China Minmetals Corp., the country's state-controlled trading giant, has been in talks to buy Canada's Noranda Inc., the world's third-largest zinc and ninth-largest copper producer, though those discussions have bogged down in recent months. In Russia, Kremlin officials have said CNPC could become a minority investor in a new state oil company that would include Yuganskneftegaz, a big Siberian oil producer that by itself pumps about 1% of the world's crude, or about as much as Indonesia. Yugansk was a unit of OAO Yukos until Russian authorities forced a sale of the unit to cover $28 billion in back-tax claims against the former oil titan."

As we have noted before, China is also very active in Africa, and South America. "In Africa, China has purchased several blocks to explore for oil and gas and has set up refinery operations as well. In Sudan, it runs a major drilling operation that has become an increasingly crucial supplier to its domestic market, and a cash cow for the Sudanese government. China recently signed a deal to rehabilitate old oil fields in Gabon in west Africa, an area where China has expertise thanks to declining production at its own oil fields. In Angola, it is providing the government with almost zero-interest loans in return for guaranteed oil sales while in South Africa. It has also formed a new joint venture that aims to create oil out of coal, and that company is now mulling an initial public offering to raise cash for additional investments. "

In South America, "China, according to a November 2004 report by the United Nations Conference on Trade and Development" has invested "some $4.6 billion since 1993 - a pittance compared with the nearly $30 billion U.S., Japanese and European firms invest annually in Latin America, but the figure is expected to grow rapidly."


Wall Street is salivating, as it hopes that a Chinese bid for Unocal feeds the recent M & A boom, by adding a consolidation frenzy in the oil and energy sector.

But, from our point of view, this is a serious situation and could set some dangerous precedents.

Chinese expansion seems unstoppable, as Beijing's influence has quietly seethed its way into the U.S.'s backyard, and front yard, with aggressive projects and deals in Canada, and South America.

Meanwhile, the U.S. seems to have no response, and no counter strategy.

And yet, as much of the world has already forgotten, China's double standard in the way it does business is indeed a problem. The China Aviation Oil situation in Singapore is a perfect example of what can happen when Chinese government owned companies dabble in the real world of finance. That situation remains unresolved. Most ironic is that China's financial backing for their expansion has come from the U.S., who buys its products, and builds plants on Chinese soil which make products to sell to the U.S. The huge expansion in money supply and the post 9/11 lowering of interest rates by the Federal reserve sped up the Chinese expansion, as capital flew away from the U.S. and was lured to China by the prospects of slow growth.

Indeed, the U.S., willingly or otherwise is mostly responsible, for China's expansion. And the quiet from inside the beltway about the situation sends only one message. The U.S. didn't see it coming, may not realize the extent of the problem, and worst of all possibilities does not seem to know what to do about it.

Indeed, the dragon is circling the beltway.

Oil Markets:

India Considers Buying Yukos Assets

Russia's sprint away from the U.S. in the oil sector continues at a rapid pace. According to "A subsidiary company of India's Oil & Natural Gas Corporation (ONGC Videsh) would like to buy a 15 percent stake in Yuganskneftegaz, the former crown jewel of Yukos Oil Company. The Indian company is ready to pay up to $2 billion for the stake, the Indian Business Standard newspaper reported on Friday, January 7."

Oil Market Summary And Outlook: Look To Friday Close For Price Clues In Crude

March crude oil futures closed above the 50 day moving average and above $45 on 1-6. If the market can deliver a close above these two key chart points on Friday, we may have a trend reversal, with the potential for a test of the $50 area.

What happens after a move to $50, if it comes to pass is up in the air.

There are several crosscurrents at play. Crude supplies are falling. Product supplies are rising. And OPEC is apparently implementing production cuts. That means that the cartel, as far as can be ascertained is trying to reign in supply. U.S. import levels have also begun to fall.

But, as the Iraq elections near, the chances of an attack on a major oil installation might be on the back of traders' s minds.

More interesting, though, is the notion that China, India, and Russia are starting to work together as a block which can dictate, or at least influence oil supply in the next few years.

Oil and oil are still in short term down trends, but are due for a bounce. The action in the stocks, if the futures continue to climb will be important. We'd like to see the stocks reverse, if indeed any rally in crude is likely to last.

The key for crude, depends, as it has for some time, on what happens at the $40 area, which now has held.

There are three other key chart points to watch. 1) The 200 day moving average, which is near $41.40, and which has also held. This is the divide between a long term up trend and long term down trend. 2) the $40 area. This is the psychological point. A break below $40 should be good for a dip into the $35-$37 area. 3) The $45 area. A sustained close above $45 could lead to a test of $50.

The Philadelphia Oil Service Index (OSX) climbed above 120, but remained below its 20 and 50 day moving averages. 128 is tough resistance. Volatility will likely increase here in the next few days. For more details on trading the energy sector visit our energy timing page, featuring our highly effective OIH timing model and our Top Ten Energy Stock List.

The Amex Oil Index (XOI) remained below 700, but remained inside the 686-720, pivot band. XOI also closed below the 50 day moving average, suggesting that prices are getting ready to attempt a move up. For immediate analysis, including stock picks, and the latest in technical analysis of the entire energy complex, our subscriber section has a full complement of recommendations in oil service and the rest of the energy complex.

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