Fair Trade or Strategic Concern: The Unocal War

What impact will the failed Chinese acquisition of Unocal have on future U.S.-Chinese business relationships?

The noise has quieted down at least for the moment. On August 2, 2005, China National Offshore Oil Corporation (CNOOC) announced it was withdrawing its bid to buy Unocal. This news followed the July 20 Unocal Board recommendation that its shareholders accept the bid submitted by Chevron and the August 1 statement by Institutional Shareholders Services, an influential shareholder advisory firm, that the CNOOC bid was not high enough to offset the political uncertainties associated with the purchase.[1] However, during approximately four weeks between the CNOOC offer and its withdrawal, the story dominated the headlines and newscasts.

Photo: Dawn Allynn

Why the uproar?

This was not the first time a Chinese firm had expressed interest in buying a U.S. firm. China’s acquisition activities began in earnest in 2002 with the purchase of the Asian subsidiary of Global Crossing by China Netcom Communications Group and continued through the purchase of IBM’s PC unit in December 2004 by China’s Lenovo Group. This is also not China’s first foray into the energy sector. During Spring 2005, CNOOC purchased a 17 percent stake in MEG Energy in Canada, and Sinopec acquired a 40 percent interest in the Canadian oil sands project. Local officials and the steel workers union applauded when China’s Laiwu Steel Group joined with Cleveland-Cliffs Inc., a U.S. mining company, to reopen an iron ore mine in northern Minnesota. Rep. James L. Oberstar (D-Minn.) even helped broker the deal.[2]

Nevertheless, applause was not the reception the Unocal offer received. On June 25, 2005, immediately following CNOOC’s bid, 41 members of Congress sent a letter to Secretary of the Treasury John Snow asking the Committee on Foreign Investments in the United States to “perform a thorough review” of the offer to determine whether CNOOC was using government funds or purchasing sensitive technology.[3] The House of Representatives passed two bills in late June that would block the proposed takeover because it “could threaten to impair the national security of the United States.”[4] Then during hearings on July 13, 2005, Rep. Duncan Hunter (R-Ca.), chairman of the House Armed Services Committee, said that Chinese ownership of Unocal would compromise U.S. national security and that he would try to stop the acquisition if Unocal shareholders or President Bush didn’t. Other witnesses at the hearing, including former CIA Director James Woolsey and Frank Gaffney, president of the Center for Security Policy, emphasized the strategic value of oil and the failure of China to follow international economic rules.[5]

So, why the uproar? And, more importantly, what are the implications of the failed bid to future business relationships between the U.S. and China? Is the political involvement in the proposed transaction a fluke, or the next step in defining the economic and political relationship between the U.S. and China? Will U.S. firms face government-created roadblocks or retaliation when seeking to establish or extend relationships with Chinese firms? These are the questions this paper will address.

Why is China interested in acquiring foreign assets?

China has intensified its overseas acquisitions for several reasons. These include an abundance of cash, the desire for international brands, and the need for energy sources.

China has amassed foreign reserves estimated at approximately $771 billion. The buildup has accelerated in recent months as China’s trade surplus continues to grow and foreign investment continues to flow into China. The inflow of speculative capital has also picked up as investors bet on the revaluation of the Chinese currency, the yuan.[6] Flush with cash, the Chinese are shopping shopping for real, physical U.S. assets.

China views purchases of well-known brands as a way to attain immediate status and respect. The bid submitted for purchase of Maytag by Haier Group, a large Chinese manufacturer, followed the push by the Chinese government to convert large companies into multinationals with recognized, global brands. Had the acquisition been successful (the bid was withdrawn after Whirlpool submitted a competing, higher bid), Haier would have been instantly transformed into one of the world’s most powerful appliance manufacturers with a large presence in the U.S. and Europe.[7]

China has become the number two global consumer of energy after the U.S. To support its growing need for energy, China’s largest oil companies PetroChina, Sinopec, and CNOOC have been seeking growth opportunities. However, their victories have been few and small and their losses often. The three companies have been able to commit only $15 billion over the last decade in their quest for equity stakes in oil and gas fields outside China. They are known to often pay top dollar for less than desirable projects. In addition, they have lost large projects such as part of the Kazakhstan field, which went to Western companies operating the fields and now Unocal. The Chinese energy companies are determined to increase their holdings and thus gain power and respect in the industry.[8]

China the Japan of the 2000s?

The increasing tensions between China and the U.S. over trade issues seem like déjà vu to many market watchers. Two decades ago, when Japanese companies were snapping up U.S. iconic entities such as Rockefeller Center and Columbia Pictures, many people worried about the ability of the U.S. to compete with a low-cost competitor, and Japan was accused of keeping its currency artificially low to increase its exports. During this period, the U.S. faced a spiraling trade deficit and the loss of high-paying manufacturing jobs. Sound familiar?

However, critical differences exist between the two experiences. Unlike Japan 20 years ago, China has the potential (and some think the desire) to become a military as well as an economic rival of the U.S.[9] The U.S. Department of Defense prepared a report in July 2005 stating that the increasingly powerful Chinese military poses a potential threat to other Asian countries. Although the Chinese government denounced the report and called it a misrepresentation of its “peaceful defense policy and reasonable military development,” many people remained unconvinced, especially when a senior Chinese military official called for the use of nuclear weapons against the U.S. if it interfered in a conflict between China and Taiwan.[10] While few think that nuclear war is imminent or inevitable, such events as these feed fear, uncertainty, and suspicion in both China and the U.S.

Additionally, globalization has tied the U.S. economy much closer to its trade partners than in the past. Ties between China and the U.S. are far more extensive than those that existed with Japan. Trade between China and the U.S. has grown dramatically in the last decade. China has become a top destination for U.S. funds and the fastest-growing market for many U.S. industries. Low cost goods from China have kept the U.S. inflation rate low, and Chinese purchases of U.S. Treasury securities have kept interest rates including mortgage rates low.[11]

Strategic Concern or Roadblock to Fair Trade:

Was the Unocal bid a strategic concern?

The chair of CNOOC emphasized that the proposed purchase was a business transaction that would be good for both China and the U.S. and that it was not a political move. But even William Reinsch, president of the National Foreign Trade Council, an organization established to promote global free trade, was uneasy about the Unocal deal. He supported a thorough national security review of the deal that focused not just on weapons technology, but also on energy security.[12]

The idea of a globally traded commodity becoming a strategic concern is new. Many economists and oil specialists believe that owning oil is not vital to national security as long as there is a sufficient supply of oil on the global market. Yet the U.S. dependence on imported oil for approximately half its daily consumption (much from the volatile Gulf region) and growing demand for energy from countries such as China and India have caused some people to question whether adequate supply will be available.[13] China has the potential to become a U.S. rival for limited energy sources in the future.

However, others note that foreign purchases of U.S. energy resources is not new and that deals approved in the past may be more worrisome than the Unocal bid. Over the last two decades, Saudi Arabia, Venezuela, Russia, France, Norway, and Brazil, among others, have acquired a wide range of U.S. energy assets all without roadblocks erected by U.S. politicians. Some experts have noted that Saudi and Venezuelan ownership of U.S. refining capacity and Russian ownership of gasoline stations could pose a greater threat to adequate U.S. energy supplies at a market based cost than would ownership of exploration and production assets.[14] This may be particularly true of Unocal, which has few strategic oil assets left in the U.S. and pumps only 57,000 of the 7.3 million barrels pumped daily in the U.S.[15] CNOOC’s real interest was in Unocal’s rich Asian gas reserves, particularly those in Thailand and Indonesia, and the company had considered spinning off U.S. assets to reduce opposition to the deal.

Photo: Andre Habermann

Was the Unocal bid fair trade?

The outcome of the CNOOC proposal sheds light not only on China’s ability to “close a deal,” but also on Wall Street’s clout. Large U.S. investment banking firms have made numerous trips to China in recent years to establish relationships and create deals going both ways U.S. firms buying Chinese firms and vice versa. While still setting the terms, China is encouraging more foreign ownership of Chinese firms as well as overseas acquisitions. Wall Street representatives in Washington have actively promoted the merits of doing business with China and the importance of strong economic ties with the country. Many fear that since the Unocal acquisition was decided on political rather than financial grounds, cross-border transactions will be set back.[16] Others fear that since the bid was withdrawn because of political pressure, China will retaliate.[17]

What are the rules for transactions between a U.S. and a Chinese firm? Does government ownership with its promise of low- or no-interest loans impact competition and fair play? CNOOC’s parent company is fully owned by the Chinese government, and the parent was providing its subsidiary with a combination of no-interest and below-market interest loans to finance the acquisition. Critics of the proposal say this explained the ability of CNOOC to offer a higher price than did Chevron. Chevron, with a market capitalization of $115 billion, is much larger than CNOOC at $22 billion, but could Chevron reasonably match the price offered by CNOOC? Others familiar with the structure of the loan agreement say its terms were not overly beneficial to CNOOC. The interest-free loans had to be repaid within two years by selling new stock, and the state-owned Chinese bank was charging market rates on its loans. The transaction would have left CNOOC with piles of debt that had to be repaid and with limited ability to make other acquisitions.[18] Experts disagree on whether this was a cause of concern, but they do agree that given China’s large stockpile of cash, this Chinese bid is not the last such bid for a U.S. firm.[19]

Conclusion

The war over Unocal has underlined the tense relationship between the U.S. and China. Issues of fairness and trust are being discussed by both sides. China has taken important steps to ease restrictions on foreign ownership of its firms. U.S. corporations are responding by pouring billions of dollars into the purchase of shares or outright control of Chinese firms. Nonetheless, the strong political opposition to CNOOC’s bid for Unocal has brought protest from the Chinese government. In the statement withdrawing the bid, Fu Chengyu, chairman of CNOOC, placed full blame on the “regrettable and unjustified” political opposition.[20]

How will this recent impasse impact the future relationship between firms in the U.S. and China? The rejected bid marks a setback. How much of a setback will depend on talks scheduled for late September between President Bush and President Hu Jintao of China. It will depend on how the leaders of China and the U.S. come to view each other as strategic allies or competitive foes, opportunity or threat. Many business leaders in the U.S. and China see economic ties not only as a win/win situation, but also as a necessity for future economic growth and stability. Will these views prevail or the views of those who see only one dominant economic and military power? The curtain has fallen on Act 1, but future acts in this drama are still to be played.


[1] Douglas, Elizabeth. “Chevron’s Unocal Bid Supported,” The Los Angeles Times, 2 August 2005: C-1.

[2] Iritani, Evelyn. “China Showing Bigger Interest in U.S.” The Los Angeles Times, 22 June 2005: C-1.

[3] Iritani, Evelyn. “Chinese Bid for Unocal Stirs Up Issues,” The Los Angeles Times, 25 June 2005: C-1.

[4] Reynolds, Maura. “House Says No to China Oil Deal,” The Los Angeles Times, 1 July 2005: C-1.

[5] Havemann, Joel. “Lawmakers Seek to Stop CNOOC Bid,” The Los Angeles Times,14 July 2005: C-1.

[6] For a complete discussion of the impact of the Chinese currency policy, see Crawford and Young. “The Yuan Floats!” Graziadio Business Review, Volume 8, Issue 2.

[7] Barboza, David. “From China, A New Bid For Maytag and Status,” The New York Times, 22 June 2005: C-1.

[8] Bradsher, Keith and Maouwad, Jad. “China Oil Giants Crave Respectability and Power,” The New York Times, 9 July 2005: B-1.

[9] Douglas, Elizabeth. “Familiar Trade Fears, but Bigger Risks,” The Los Angeles Times, 18 July 2005: C-1.

[10] Dickie, Mure and Sevastopulo, Demetri. “China hits at US claim of military threat,” The Financial Times, 21 July 2005: 2.

[11] For a complete discussion of the impact of Chinese policies on the U.S. trade and budget deficits see Crawford and Young. “The Twin Deficits: a Looming Crisis?” Graziadio Business Review, Volume 7, Issue 2.

[12] Lohr, Steve. “Who’s Afraid of China Inc.?” The New York Times, 24 July 2005: B-1.

[13] Lohr, Stephen. “Unocal Bid Opens Up New Issues of Security,” The New York Times, 13 July 2005: 61.

[14] Barrionuevo, Alexei. “Foreign Suitors Nothing New in U.S. Oil Patch,” The New York Times, 1 July 2005: C-1.

[15] Samuelson, Robert. “Let’s Stay Out Of This Fight,” Newsweek, 11 July 2005: 43.

[16] Wells, David. “CNOOC bid is acid test for US free trade,” The Financial Times, 9-10 July 2005:12.

[17] Lee, Don. “Unocal Bid Tests U.S.’ China Ties,” The Los Angeles Times, 11 July 2005: C-1.

[18] “Napoleon of the Oil Patch,” Business Week, 20 June 2005: 56.

[19] Brownstein, Ronald. “Fair Play at Issue in Unocal Bid,” The Los Angeles Times, 20 July 2005: C-1.

[20] Lee, Don and Douglas, Elizabeth. “Chinese Drop Takeover Bid for Unocal,” The Los Angeles Times, 3 August 2005: A-1.

Authors of the article
Peggy J. Crawford, PhD
Peggy J. Crawford, PhD,

, joined the faculty of Pepperdine’s Graziadio School in 1997 after serving on the faculties of the University of Houston, Fordham University, and George Mason University. She has published in a variety of journals on topics such as leasing, mortgages, closed-in mutual funds, the depreciation of the dollar, the trade and federal deficits, and the price of oil. She has served as a consultant for such firms as Sprint, AT&T, various state CPA societies, and the Washington Redskins (her favorite client!).

Terry Young, PhD
Terry Young, PhD,

, has over 15 years of business experience in Asia and the United States. Thoroughly versed in international economics, Dr. Young has extensive knowledge of the global marketplace, with primary emphasis on Asia. Her consulting expertise includes global sourcing, business start-ups and management in such industries as food distribution, the textile and garment industries, agriculture, electronics, and real estate development. Dr. Young’s 20-year university teaching experience includes assignments at the University of Southern California, at two California State University campuses, and a full-time professorship at Pepperdine University’s Graziadio School of Business and Management where she received the Luckman Distinguished Teaching Award in 1994.

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