By Eskor Edem, Staff Writer
A Chinese state-owned company, CNOOC, wants to take a controlling interest in Canadian energy company Nexen. The hang-up? The bid must satisfy the “net benefit” requirement that Canadian law imposes on all foreign direct investments exceeding C$299 million. Critically, while the “net benefit” test is—on paper—a six-pronged legal test, a political figure—Minister of Industry and member of the Stephen Harper cabinet member Christian Paradis—applies the test. Thus, political, not the legal, factors will likely determine if CNOOC’s bid passes the net benefit test. CUSLI-Nexus staff writer Eskor Edem reviews the “net benefit” test, identifies the three political factors critical to Mr. Paradis’ decision, and concludes that CNOOC’s bid will likely pass the “net benefit” test. But that won't be the end of the story: the CNOOC bid still has other administrative hurdles to clear.
“Net Benefit” Test
Although established as statutory law, the “net benefit” rule is really more a political test allowing the seating administration the block foreign investment injurious to its policy vision. Under the Investment Canada Act transactions are reviewable when they exceed the threshold of C$299 million. The final decision of whether a transaction is a “net benefit” is made by the Minister of Industry. As the Minister is an appointed political position, the economic policy of the governing party plays a prominent role in reaching an answer to the “net benefit” question. In determining whether foreign direct investment is a “net benefit”, the Minister of Industry considers a number of factors related the potential economic and cultural impact of the investment. The economic factors weighed range from the potential impact on domestic jobs, the participation of Canadians in the venture, and the impact on Canada’s global competitiveness. Cultural factors can be seen as a catch-all for a range of politically sensitive, non-economic topics—like a foreign investment’s impact on Canada’s indigenousness population, the First Nations.
Lessons from Canada’s “Net Benefit” Rejection: BHP Billiton and Potash
PotashCorp. made up 54% of Canoptex’s output at the time of BHP’s bid to acquire it. As such, BHP’s insistence that it would take PotashCorp. out of Canoptex would have dealt a significant, if not fatal blow, to Saskatchewan’s influence on the price of potash on the international market. Opening up Canada’s potash market posed a serious threat to the Canadian economy and, perhaps more importantly, Saskatchewan’s finances. A law firm advising the Province on the matter in Jan. 2011, Jones Day found:
Given the high level of public disapproval of the takeover, approving BHP’s bid carried significant political down side for the Harper administration. On top of public disapproval, Conservative provincial officials voiced their avid resistance to the transaction. In making their case against BHP, provincial officials argued that an “increasingly strategic” resource required maintaining Saswatchan’s influence over global potash prices. According to some, approving BHP’s takeover held the potential of reducing Canada’s food and energy security.
Conclusion
The CNOOC bid, albeit not without some belly-aching, is very likely to pass Canada’s “net benefit” test. First, while superficially a 6-pronged legal test, the “net benefit” rule is really more a political test: giving the Canadian government a way to block foreign investment that may compromise core Canadian economic interests. And as BHP’s failed bid shows, the political variables at play are: (1) the size and scope of the targeted Canadian company, (2) support on the provincial level for the acquisition, and (3) the economic rewards of approving the bid. With Nexen a relatively small player in the Canadian oil and gas industry, Alberta’s support of CNOOC’s bid, and the Harper government’s eagerness to open up the lucrative Chinese marketplace to Canadian firms, CNOOC’s bid for Nexen is very likely to clear the “net benefit” hurdle.
Although established as statutory law, the “net benefit” rule is really more a political test allowing the seating administration the block foreign investment injurious to its policy vision. Under the Investment Canada Act transactions are reviewable when they exceed the threshold of C$299 million. The final decision of whether a transaction is a “net benefit” is made by the Minister of Industry. As the Minister is an appointed political position, the economic policy of the governing party plays a prominent role in reaching an answer to the “net benefit” question. In determining whether foreign direct investment is a “net benefit”, the Minister of Industry considers a number of factors related the potential economic and cultural impact of the investment. The economic factors weighed range from the potential impact on domestic jobs, the participation of Canadians in the venture, and the impact on Canada’s global competitiveness. Cultural factors can be seen as a catch-all for a range of politically sensitive, non-economic topics—like a foreign investment’s impact on Canada’s indigenousness population, the First Nations.
Lessons from Canada’s “Net Benefit” Rejection: BHP Billiton and Potash
In 2010, then Minister of Industry Tony Clement rejected BHP Billiton’s proposed hostile takeover of the Canadian mining company PotashCorp. The negative impact of BHP’s proposed takeover on Saskatchewan’s mining economy was the determinative factor in Minister Clement’s rejecting the bid on “net benefit” grounds. Saskatchewan is home to 1/3 of the global potash market. Naturally, this means that the government derives significant revenues from potash mining companies—15% in 2008. But the province also plays a critical role in potash pricing: with a Canadian industry body, Canpotex, the sole distributor for Canadian potash that is marketed outside North America. Canpotex’s exclusive control over the marketing of Canadian potash provides price stability on which Saskatchewan can rely in estimating its future revenue stream.
PotashCorp. made up 54% of Canoptex’s output at the time of BHP’s bid to acquire it. As such, BHP’s insistence that it would take PotashCorp. out of Canoptex would have dealt a significant, if not fatal blow, to Saskatchewan’s influence on the price of potash on the international market. Opening up Canada’s potash market posed a serious threat to the Canadian economy and, perhaps more importantly, Saskatchewan’s finances. A law firm advising the Province on the matter in Jan. 2011, Jones Day found:
[T]here was a risk of significant job losses by other Canadian potash manufacturers as a result [of] BHP’s plans to run its Jansen mine “flat out” and its threatened departure from Canpotex… Saskatchewan could [have] los[t]up to CAN $6 billion in tax revenues if BHP operated PotashCorp mines at full capacity.Independent marketing could have potentially resulted in the (1) the loss of price setting abilities which the province had enjoyed to date; (2) a significant decline in the potash prices largely due to BHP’s level of production; and (3) a significant decline in tax revenue.
Given the high level of public disapproval of the takeover, approving BHP’s bid carried significant political down side for the Harper administration. On top of public disapproval, Conservative provincial officials voiced their avid resistance to the transaction. In making their case against BHP, provincial officials argued that an “increasingly strategic” resource required maintaining Saswatchan’s influence over global potash prices. According to some, approving BHP’s takeover held the potential of reducing Canada’s food and energy security.
The “Net Benefit” Test’s Political Factors and Why CNOOC Passes the Test
A decision in CNOOC’s favor would provide credibility to Prime Minister Harper’s policy of strengthening Canada’s economic ties with Asia. Minster Paradis’ final determination will be guided by Prime Minister Harper’s goal of ensuring Canadian natural gas and oil producers get access to China's growing energy appetite. As such, application of the “net benefit” rule to CNOOC will likely diverge from the strict letter of the law. In reaching his decision, Paradis will likely consider three political factors: (1) the nature of the targeted company; (2) The level of provincial support for the CNOOC’s acquisition; and, (3) the possibility of greater market access for Canadian firms operating in China.
Unlike Potash, Nexen is not uniquely dominant in Canadian industry. Nexen only ranks as a middling player in Canada’s oil and gas sector. John Manley, a former Liberal Minister of Industry, made clear if a larger Canadian oil and gas company was at stake, the government would be likely to block a takeover bid on “net benefit” grounds, in this Bloomberg Sept. 2012 article:
Furthermore, unlike the Potash bid, the provincial government of Alberta supports CNOOC’s bid. During a recent interview, Alberta’s Premier Alison Redford spoke favorably of CNOOC’s acquisition of Nexen, stating:
A decision in CNOOC’s favor would provide credibility to Prime Minister Harper’s policy of strengthening Canada’s economic ties with Asia. Minster Paradis’ final determination will be guided by Prime Minister Harper’s goal of ensuring Canadian natural gas and oil producers get access to China's growing energy appetite. As such, application of the “net benefit” rule to CNOOC will likely diverge from the strict letter of the law. In reaching his decision, Paradis will likely consider three political factors: (1) the nature of the targeted company; (2) The level of provincial support for the CNOOC’s acquisition; and, (3) the possibility of greater market access for Canadian firms operating in China.
Unlike Potash, Nexen is not uniquely dominant in Canadian industry. Nexen only ranks as a middling player in Canada’s oil and gas sector. John Manley, a former Liberal Minister of Industry, made clear if a larger Canadian oil and gas company was at stake, the government would be likely to block a takeover bid on “net benefit” grounds, in this Bloomberg Sept. 2012 article:
‘[If Suncor were the target company]…you would have a different set of questions being asked, simply because of [Suncor’s] scale and…importance in the Canadian context,’…Suncor is Canada’s ‘biggest independent, and that puts it in a somewhat different category.’CNOOC’s takeover of Nexen does not threaten Alberta’s finances. Unlike the Potash market, in which Canoptex plays a price setting function, factors inherent to the oil and gas markets prevent any single player from determining market prices. In the oil and gas market prices are largely set by supply and demand, with spontaneous political events playing an influential role in short-term price volatility. As such, Alberta does not have the ability to set the market price its oil and gas producers get for their output. Hence, in this regard CNOOC’s acquisition of Nexen will not affect Alberta’s royalty stream; thus, CNOOC’s bid avoids a major point of contention in BHP’s bid.
Furthermore, unlike the Potash bid, the provincial government of Alberta supports CNOOC’s bid. During a recent interview, Alberta’s Premier Alison Redford spoke favorably of CNOOC’s acquisition of Nexen, stating:
At the end of the day, our view is that if this is in Alberta’s interest, it should go ahead. And we think there’s a lot of benefit for Alberta and Canada in this deal.And in discussing CNOOC’s bid, public commentators have stressed a potentially large up-side for Canada if the bid is approved: If Canada grants China market access within the energy sector, other Canadian companies may find it easier to get access to the burgeoning Chinese marketplace. As reported by the Wall Street Journal, DBRS debt rating agency has found:
‘This transaction would dramatically improve Canada-China relations, which could in turn provide greater economic trade between the two countries.’…add[ing] that approval could also open the door for Canadian businesses in China.And, obviously, CNOOC’s Nexen bid would strengthen energy ties between China and Canada. Given Canada’s unease with the Obama administration’s reluctance to approve the Keystone XL project, laying the foundation for substantial growth in Sino-Canadian energy trade has become a major policy objective of the Harper administration.
Conclusion
The CNOOC bid, albeit not without some belly-aching, is very likely to pass Canada’s “net benefit” test. First, while superficially a 6-pronged legal test, the “net benefit” rule is really more a political test: giving the Canadian government a way to block foreign investment that may compromise core Canadian economic interests. And as BHP’s failed bid shows, the political variables at play are: (1) the size and scope of the targeted Canadian company, (2) support on the provincial level for the acquisition, and (3) the economic rewards of approving the bid. With Nexen a relatively small player in the Canadian oil and gas industry, Alberta’s support of CNOOC’s bid, and the Harper government’s eagerness to open up the lucrative Chinese marketplace to Canadian firms, CNOOC’s bid for Nexen is very likely to clear the “net benefit” hurdle.
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