CHARLES DHARAPAK / AP

CLASHING: Treasury Secretary John Snow is calling for a revalued yuan

Frayed Ties
	The Gloves are Off
	By Matthew Forney

Posted Monday, May 23, 2005; 20:00 HKT
Among the advisers to top management at one of China's biggest oil companies, the deal is code-named Operation Treasure Ship. The plan is for the China National Offshore Oil Corp. (CNOOC) to buy Unocal, the ninth largest oil company in the world. This week, CNOOC's top managers gather in Hong Kong for a conference with their board of directors, as well as the annual shareholders meeting. Operation Treasure Ship will be front and center, as CEO Fu Chengyu seeks the board's approval to move ahead with the bid.

If he gets the nod, it would be historic. Chinese companies have bought U.S. outfits before—late last year Lenovo acquired IBM's personal-computer business. But if CNOOC proceeds and prevails, it would be the first time a Chinese firm has beaten a top-flight American one in the race for a prized asset. For in early April, Chevron—the fifth biggest oil company in the world—announced it was buying Unocal for about $17 billion. The U.S. company beat CNOOC and Italy's oil giant Eni to the punch. Chevron is awaiting regulatory approval in the U.S. for the deal, but since the merger was announced, both Chevron's and Unocal's stock prices have sagged, creating the opening for a competing offer. CNOOC decided to think about getting back into the game. Fu, who has a master's degree in petroleum engineering from the University of Southern California, was keen on CNOOC's initial interest in Unocal and is thought to be determined to proceed. Xiao Zongwei, director of investor relations at CNOOC, declined to comment on its intentions.

The acquisition, if it happens, would be further evidence of China's determination to secure access to natural resources around the world. From soybeans in Brazil to oil in Iran to natural gas and iron ore in Australia, China's limitless appetite for the materials that fuel its boom is making suppliers rich—while roiling established political patterns. CNOOC's Unocal deal would augment China's growing clout in Southeast Asia, where nearly two-thirds of the company's assets are located. Unocal owns natural gas reserves in Vietnam, Burma and Thailand, as well as big geothermal energy projects in Indonesia. Stock analysts say CNOOC's motivation for the deal is commercial, but it would inevitably be seen as having strategic consequences. "You're talking about an American company owning these reserves vs. a Chinese company," says an oil-industry consultant close to CNOOC. The message across the region: the big new kid on the block doesn't wear Stars and Stripes.

Will CNOOC go ahead? In fact, the plan to buy Unocal is deeply controversial inside the company, which is why this week's board meeting is pivotal. Fu's rationale for purchasing Unocal is precisely those rich assets in Southeast Asia. But skeptics inside and outside the firm wonder if buying them really makes sense—particularly at the price CNOOC would have to pay. CNOOC has been building liquefied-natural-gas terminals on the coast of China, with the intent of shipping gas it discovers offshore to bustling markets inland. But for now, analysts say, Unocal's gas reserves in the region are spoken for. Thailand and Bangladesh—another place where Unocal owns reserves—have been reluctant to export their own gas, and shipping some of Vietnam's gas to eastern China would be very expensive. At least as it stands now, says one source, "there's no Unocal gas that can be brought to market in China."

Neither is it clear how CNOOC would finance the purchase. Chevron is set to pay about $17 billion, mostly in stock for Unocal. CNOOC would have to top that bid, send a breakup fee to Chevron of $500 million if the original deal went sour, and pay for it all in cash. More than 70% of CNOOC's shares, which trade on the Hong Kong and New York stock exchanges, are controlled by a state-owned parent company in Beijing. To finance a takeover with new shares would massively dilute existing shareholders' stake in the company, which would both anger minority shareholders and water down the government's control. That's "not an option," says one banker. The only alternative for CNOOC, whose current market capitalization is just $22.5 billion, would be to finance a cash offer with debt. That prospect spooks some analysts, who believe "Unocal is just too big for CNOOC," as one who has worked with the Chinese company says.

If size matters, so does timing. The renewed talk of a deal comes at a time of tension between Washington and Beijing over trade and the value of the Chinese currency. To date, Beijing—Fu's boss—has treated the potential takeover bid as a commercial matter best left to the company. But officials may not think this was a great moment for a company still effectively owned by the Chinese government to buy a large U.S. enterprise. Might Beijing quietly step in and persuade Fu to look elsewhere for reserves?

If not, CNOOC may yet bet that it can convince Unocal shareholders by offering something that everybody from Beijing to Wall Street understands: more money. They don't call it Operation Treasure Ship for nothing.

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