“If your will is not strong, if your thought does not oppose injustice: you will fritter away, stuck inthe commonplace, silently submitting to the bonds of emotion, forever cowering beforemediocrities, never escaping the downward flow.”

The Downward Flow: A Business Perspective of the Failed CNOOC-Unocal Deal

Zhuge Liang, Chinese military strategist

Introduction

In the summer of 2005, CNOOC Ltd., a subsidiary of the Chinese state owned oilcompany CNOOC, offered $18.5 billion in an all-cash bid for the California-based oilconglomerate, the Unocal Corporation. The bid beat out America’s Chevron, which offered$16.5 billion in a combination of cash and Chevron stock (Foss). However, given the climate of rising oil prices and America’s increasing concerns over the realties of a growing China in a moreglobalized world, the ostensibly routine business transaction proved politically sensitive. Amidthe American public’s uproar and voices from Congress calling for the deal to be nixed, theSenate sent the proposed acquisition to the Committee on Foreign Investment in the UnitedStates (CFIUS), a rare invocation of the Exon-Florio provision of the Defense Production Act(governing that the legislature cannot get involved in a business deal unless the terms are athreat to national security). In addition, Congress overwhelmingly passed an energy bill thatwould require CNOOC Ltd. to face an additional 120 days of investigation in CFIUS. (Chen)Facing months of congressional hearings and regulatory risk, Unocal shareholders optedinstead for the lower Chevron bid. In the wake of this decision, CNOOC Ltd. abandoned itsefforts, declaring Washington’s reaction “regrettable and unjustified” (White). Indeed, Congresswas required to justify its involvement on a various number of rather dubious national securityissues due to the specific language in the Defense Production Act. Yet in an objective analysis of the sale, it remains clear that the potential acquisition was not a matter of national security,posing no threat to the American economy (or even gas prices) as well. The deal fell throughdue to the political climate of paranoia – Congress and the American people showed theinternational community that even the world’s largest and most robust economy can succumbto the sophomoric dogma of economic nationalism.

Was the acquisition of Unocal by CNOOC a threat to Energy Security?

Many of those in Congress, both conservative and liberal, argued fiercely that thepurchase of Unocal was a threat to the national security of the United States on the basis that itharmed the nation’s energy security (in other words, made the United States more dependanton imported oil). To accept this line of thinking, one must first believe that a lack of energyindependence is indeed a matter of national security. Many politicians, unfamiliar with basiceconomics, regard oil as a strategic commodity. At first glance, this makes intuitive sense: oil is

needed to run everything, especially a military. If one cannot control any energy, one surelycannot hope to run an army. As a strategic commodity, states would scour the globe in searchof oil, and keep tight control of their energy exports as to minimize the potentiality of its rivals.Richard D’Amato, the chairman of the US-China Economic and Security Commission, is quotedas saying that the CNOOC Ltd. acquisition of Unocal was “not a business transaction at all […]the Chinese government is going after these energy supplies to control them and lock them up.”(Ding, 5).Yet this model of the oil industry is completely baseless. If oil actually is a strategiccommodity, as uranium is widely accepted to be currently, then blocking foreign corporationsfrom owning our oil companies would certainly seem understandable. But in the discussion of oil, it is important to remember that unlike uranium, oil is a fungible (interchangeable)commodity traded on the open market. Oil drilled out of the ground from an Americancompany such as Exxon-Mobil or Unocal does not exclusively head back home to the Americanmarket. Indeed, it would be poor business. The fundamental purpose of a corporation is tomake a profit, not be agents of nationalism, so it is the local price that determines to whichmarket a company sells its product (this local price is in turn determined by supply anddemand). The nationality of the company never seems to enter the equation: Exxon-Mobil sellsto Europe, BP sells to Australia, Citgo sells to the United States, et cetera.The obvious fear is that CNOOC Ltd. would discontinue selling oil to the United Statesand focus solely on their home market of China. So what if CNOOC Ltd., for political reasons,decided to not sell to the United States? It is common sense to assume that the price of oilwould increase due to a decrease of supply, just as the OPEC embargo caused in the late 1970s.But the OPEC embargo was a special situation due to the fact that it was an entire cartel of countries that enacted the embargo, not just an individual corporation. One company alonecannot control the supply for a fungible commodity like oil. The oil supply in a particular marketis usually determined by how extensive the infrastructure is in that given market. More oilreaches the United States than Ghana, because the United States has pipelines, highways, andother methods of transporting the commodity that simply makes it cheaper for oil to reach ourmarket than Ghana’s market. On a micro level, if the transport costs are lower, especially for ahigh-volume commodity like oil, a particular company can afford to transport more oil to theUnited States at a lower price. At the same time, the United States has the largest demand foroil, by far, of any country in the world – America consumes over 20 million barrels of oil per day,over three times the amount of China (second in the world in oil consumption) (“EnergyStatistics”). Given the United States’ extensive modern infrastructure and insatiable demand foroil, it makes the United States the most attractive market for selling oil in the world. So, if forsome peculiar reason, CNOOC Ltd. decided not to sell to the American market, because oil isfungible, another company would certainly sell in their place. The result would be a shift inneither supply nor demand, and thus no shift in price. Even with Unocal’s reserves, CNOOC Ltd. just would not have enough oil to make a dent in the flow of oil into the United States.

Because CNOOC Ltd. is a corporation driven by profit, it seems unlikely that CNOOC Ltd.would not sell oil to the United States for petty political reasons. However, CongressmanD’Amato is certainly correct in saying that China wishes to “lock up” energy supplies, yet it is abit more accurate to say that the Chinese government is simply looking to create a strategicenergy reserve. This is nothing out of the commonplace - most industrialized nations dependenton oil imports have such reserves, including the United States. They were created in the wakeof the OPEC embargo to keep oil refiners from suffering setbacks from temporary supply shocks:refiners typically hold 10 to 30 days of crude oil, but the promise of crude oil in the case of emergency allows refiners to hold less working capital and produce more efficiently. (“StrategicEnergy Reserves”)In addition, China’s buying spree of oil is dwarfed by the United States’. China is in theprocess of stockpiling a planned 100 million barrels of crude oil, in which they are about onethird complete. The United States, on the other hand, is nearly complete its 700 million barrelstockpile. By Congressman D’Amato’s rationale, if any government is looking to “to lock up andcontrol energy supplies”, it seems to be our own. (“China”)There has been many misunderstandings and much misinformation in regard to the oilindustry. The industry is probably the most politically sensitive in American business, given itssize and geopolitical reach. It also seems to be a lightning rod for those in a constant state of trepidation regarding an American economic collapse: after all, oil touches nearly every sector,from farming to finance. The CNOOC Ltd. bid for Unocal is most likely the best example of thispermeation of misconceptions and misleading information, as CNOOC Ltd.’s potential ownershipof Unocal would not have remotely affected the American economy or its energy security. Itappears that Congress has no interest in dispelling these foolish notions of how the economyworks, else the raucous rhetoric in Washington would have surely given way to more soberpolicies.

Fear and Loathing in Washington D.C.: was CNOOC a threat to national security?

In the debate over the 2005 energy bill, House of Representatives Democratic minorityleader Nancy Pelosi demanded loudly on the house floor that the CNOOC Ltd.-Unocal deal notgo through, because China would gain access to Unocal’s cavitation technology (used for drillingoil in deep water). This would allow China, Pelosi reasoned:“to do nuclear tests underground and to mask them so we would not ever beable to detect them. […] this coupled with their military buildup andauthoritarian systems, China becomes a threat. That's enough to block it onnational security grounds.” (Ding, 4)Pelosi’s argument, however, was somewhat irrational. China is already a nuclear power, and theChinese government could simply buy cavitation technology if they so desired. Yet perhapsPelosi’s comments indicated the true reason behind the political backlash of CNOOC Ltd. bid for