China Foothold in U.S. Energy

By RYAN DEZEMBER in Oklahoma City and JAMES T. AREDDY in Shanghai

Fu Chengyu's first attempt to buy a piece of the U.S. oil industry kicked up a storm of protest and ended in failure. Seven years later, the Chinese executive is pouring billions of dollars into the oil patch without even a whisper of trouble.

WSJ's Ryan Dezember reports on China's growing investment in U.S. oil and gas companies, which as of 2010 had topped $17 billion. Photo: REUTERS/Fred Prouser

His new recipe for success: Seek minority stakes, play a passive role and, in a nod to U.S. regulators, keep Chinese personnel at arm's length from advanced U.S. technology.
Since 2010, Chinese companies have invested more than $17 billion into oil and gas deals in the U.S. and Canada, according to data provider Dealogic, giving their energy-thirsty nation a long-coveted foothold in a region known for innovative new drilling techniques. North America has become China's top region for oil and gas deals. Mr. Fu has been leading the push, first as chairman of China National Offshore Oil Corp., known as Cnooc, then as chairman of China Petrochemical Corp., called Sinopec, one of the largest oil companies in the world.

The recent deals are nothing like Mr. Fu's audacious, unsuccessful bid for Unocal Corp. in 2005. They typically involve a Chinese firm paying upfront for a stake in an oil or gas field and agreeing to cover some drilling costs. Cnooc executives figured such joint ventures "might be a nonthreatening way to get back into America," says Aubrey McClendon, chief executive of Chesapeake Energy Corp., CHK +0.21% who struck a 2010 deal with Mr. Fu that marked the beginning of the Chinese investment surge.
The deals address pressing needs for both sides. U.S. companies have developed revolutionary new ways to extract oil and gas, but they need lots of capital to make that happen. China's state-owned energy companies, for their part, have been scouring the globe for supplies of oil and gas to help power the nation's surging economy, and the knowledge to extract their own hard-to-tap reserves back home.

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The North American energy push is part of a wave of investment money from Chinese state-owned and private enterprises into the U.S. and other Western nations. A big chunk of the investment is oriented to energy, mining and other areas critical to China's fast-growing economy. The deals are giving Chinese buyers a foot in new markets, and in some cases, exposure to American technology and management techniques they can use in China.
China surpassed the U.S. in 2009 as the world's largest consumer of energy in all forms. The International Energy Agency estimates that China also could become the world's largest consumer of oil, thanks to the affinity of its growing middle class for cars. Currently, imports fulfill more than half of its oil needs—much of them from such potential trouble spots as Iran and Sudan. Its natural gas consumption nearly doubled between 2006 and 2010, according to the BP Statistical Review.
China's new approach to investing in U.S. energy companies suggests it has learned lessons about how to make the industry and American politicians more comfortable with Chinese money. "Buy a portion of that company, work together with that company, and that company is your strongest ally in the U.S.," says S. Ming Sung, a former executive at Royal Dutch Shell RDSB +1.50% PLC who has advised Sinopec and is now an adviser to several organizations that promote clean energy.

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Bloomberg News

Fu Chengyu, chairman of Sinopec, sparked China's drive to invest in U.S. energy. He spoke last year in Beijing.

Sinopec's Mr. Fu, who declined to comment for this article, has been China's most visible proponent of the new approach. Born in China's remote northern Heilongjiang province, the 60-year-old executive earned a master's degree in petroleum engineering in 1986 from the University of Southern California, where he now serves on the board of trustees. Like other leaders of major state-run companies, he is a senior member of the Communist Party.
Those who know him say his technical and operational knowledge of the oil industry is considerable. "He built his foundation in engineering," said Iraj Ershaghi, a professor of petroleum engineering at USC who taught Mr. Fu in the 1980s.

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Mr. Fu joined Cnooc when the state-owned company was set up in 1982, and held senior positions in its joint ventures with foreign companies such as Shell and the former Phillips Petroleum, now part of ConocoPhillips COP +1.50% .
By 2005, China's oil consumption was surging, and Chinese companies of all sorts were beginning to explore major acquisitions abroad.
Mr. Fu, by then Cnooc's chairman, began negotiating directly with Unocal's then Chief Executive Charles Williamson to buy the El Segundo, Calif.-based company for $18.5 billion. News of the offer brought criticism from U.S. lawmakers, who argued the deal would put crucial U.S. energy resources in Chinese hands. U.S. lawmakers passed a resolution asking the Bush administration to review any Unocal-Cnooc deal.

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Mr. Fu spoke out publicly in defense of the deal—an unusual move for the leader of a state-controlled company. In an opinion piece in The Wall Street Journal titled "Why is America Worried?", he argued that most of Unocal's reserves were outside the U.S. anyway, and that Cnooc would preserve American jobs and "will be an open and responsible participant in the process."
Nevertheless, members of the Committee for Foreign Investment in the U.S., an interagency body chaired by the Treasury Department, indicated they would recommend that President George W. Bush block the deal, say people briefed by members. The Treasury Department declined to comment, saying it doesn't talk publicly about specific cases reviewed by the committee.
After lawmakers passed language in a bill that would delay a deal, Mr. Fu pulled the offer. Cnooc blamed "unprecedented political opposition." Unocal subsequently was bought by Chevron for $17.3 billion.
In a 2006 interview with the Journal, Mr. Fu said that Cnooc "learned we need to be more prudent in terms of public relations and political lobbying when dealing with such a big deal. We now understand American politics better."
In the wake of the busted deal, Chinese energy firms shied away from North America. State-owned oil companies began striking energy deals elsewhere in the world, such as in Nigeria and Yemen, which gave it access to significant reserves.
Meanwhile, back in North America, new techniques were being developed to extract oil and natural gas from shale formations deep underground, from tar sands in Canada, and from deep water in the Gulf of Mexico. Chesapeake and its competitors were rushing to buy drilling rights to U.S. shale fields.
Such projects require vastly more capital to drill than conventional reservoirs. A single shale well can cost more than $9 million, U.S. companies say. But the global financial crisis was constricting capital for these expensive projects, so energy companies began looking for new sources of funding.
In 2009, China National Petroleum Corp., or PetroChina, bought 60% stakes in two oil-sands projects from a Canadian operator for about $1.9 billion. The following year, Sinopec committed $4.65 billion for a 9% stake in Alberta's Syncrude oil-sands project, one of Canada's biggest energy projects. Last summer, Cnooc agreed to pay $2.1 billion for OPTI Canada Inc., a producer that held a minority stake in a large oil-sands project. There was little political opposition in Canada.
Cnooc tiptoed back into the U.S. in 2009 with a small deal to provide development funding and receive a minority stake in some of Statoil ASA's STO +1.03% Gulf of Mexico leases.
Oklahoma City-based Chesapeake began looking to Asia as a source of capital, says Mr. McClendon, the CEO. In 2010 it sold preferred shares to a unit of Singapore's Temasek Holdings Ltd. and Hopu Investment Management Co., a China-focused private-equity firm. Other investors with ties to the governments of South Korea and China followed with similar investments in Chesapeake.
The deals gave Chesapeake "the Good Housekeeping stamp of approval in Asia," says Mr. McClendon. Encouraged, Chesapeake approached Chinese oil companies, and Mr. McClendon developed a rapport with Mr. Fu, who he describes as "comfortable with Americans." Mr. McClendon says Cnooc executives were openly saying: "Since 2005, we haven't had a strategy to invest in the U.S., and we think now is the time to do it."
In 2010, Cnooc agreed to pay Chesapeake $1.08 billion for a one-third stake in 600,000 acres in the oil-rich Eagle Ford Shale formation in south Texas, and to spend another $1.08 billion on drilling there. The two executives struck a similar deal, worth nearly $1.3 billion, for stakes in Wyoming and Colorado fields.
Messrs. McClendon and Fu were intent on avoiding the kind of political opposition Cnooc faced five years earlier in its ill-fated bid for Unocal. The deals were structured so that Cnooc didn't get an ownership stake in Chesapeake itself and didn't control production.
"They didn't come over here and try to buy Chesapeake," Mr. McClendon says. "They came over here to buy a minority, nonoperating interest in an asset and not take the oil and gas home."
The Chesapeake deals also included an unusual provision regarding "secondment"—the temporary assignment of employees to another company, a common practice in the oil industry. On Chesapeake's Oklahoma City campus there are Norwegian and French oil workers, a result of the company's joint ventures with France's Total SA TOT +2.05% and Norway's Statoil.
Mindful of the political backlash that might result if Cnooc employees had the run of Chesapeake's facilities, the two executives agreed that the Chinese deals wouldn't allow for any secondment, Mr. McClendon says.
Nevertheless, the Chinese companies hope to gain insight into how their new partners decide things like where to drill wells and how to set up the infrastructure around them, people involved in the deals say.
Last year, Mr. Fu left Cnooc to become chairman and Communist Party secretary of Sinopec—part of the occasional reshuffling of top executives that occurs at China's state-owned companies. Sinopec, one of China's largest state-controlled firms, is mostly a refiner, but that business is tough in China because the government keeps consumer fuel prices low, pressuring profit margins.
With Mr. Fu at the helm, Sinopec agreed in January to pay $2.5 billion to Devon Energy Corp. of Oklahoma City for a one-third stake in about 1.3 million acres of drilling property in Ohio, Michigan and elsewhere. As in Chesapeake's deals with Cnooc, Devon's pact with Sinopec allows the American company to keep full operating control as well as control over sales of oil and gas from the wells.
David Hager, who heads Devon Energy's exploration and production business, says he expects to work with Sinopec on other fronts. "The most likely outcome is that they would want us to participate with them in China," he says.
Zhong Hua, chief financial officer of the publicly traded arm of China's Cnooc, said in an interview that the company's U.S. exposure will advance its technical know-how. "With the U.S. experience, the company is fully capable of developing and deploying its own technologies within a short period of time in the coming years," he said.
The U.S. Energy Information Administration estimates that China's shale formations hold 1,275 trillion cubic feet of gas that can be extracted using current drilling technology, or more than the recoverable reserves in the U.S. and Canada combined. China already is getting some help from U.S. companies in tapping shale energy. Houston-based Baker Hughes Inc. BHI +0.50% said recently that it participated in drilling China's first horizontal shale-oil well late last year.
Chinese firms now are attempting to negotiate partnerships with FTS International, a Fort Worth, Texas, company that specializes in hydraulic fracturing, a process used to extract energy from shale, according to one person familiar with the matter. FTS, which is owned by Chesapeake and a consortium of Asian investors, would use proceeds from any deals to expand internationally, this person says. FTS Chief Executive Marc Rowland said in a statement that the company is "actively seeking international opportunities" but "has no announcements at this time."
Mr. Fu, for his part, appears eager for Sinopec to step up shale-gas exploration in China. Mr. Ershaghi, the USC professor, visited Beijing last July at his former student's request to lecture Sinopec managers and engineers on shale-gas production.
"He did mention to me his desire to raise the awareness of shale gas in China," says Mr. Ershaghi. "He thought that's going to be one of the major developments that's going to solve China's energy needs."
In January, in a New Year's address to Sinopec employees, Mr. Fu signaled that he expected foreign deal-making to continue.
"The slowdown of the global economy brings us new opportunity to go overseas, expand overseas M&A and introduce advanced technology and talent," Mr. Fu said.