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Muddled thinking on SOEs; A few state takeovers like Nexen deal won't destroy market

Yuen, Pau Woo. National Post; Don Mills, Ont. [Don Mills, Ont] 14 Sep 2012: FP.11.

As the clock ticks on the 45-day review period for the proposed CNOOC-Nexen acquisition, at least one thing has become clear: Critics on the left are in rare alignment with critics on the right in their uniform opposition to the deal.

The arguments are of course different. While economic nationalists call for government to block the sale of a private asset, free-market champions oppose the deal precisely because the acquisitor is a government-linked entity. In other words, those who traditionally favour a larger role for the state in the economy oppose a stateowned entity (SOE) buying this asset, and those who traditionally resist intervention in the marketplace support a government decision to block the sale.

At the heart of this puzzle is the fact that CNOOC is a state-owned company from a country that has an economic system that is described confusingly as "market socialism." The Chinese economic model may not be everyone's cup of tea, but it is the chosen model in China and there is little likelihood that SOEs will be dismantled in the foreseeable future.

It so happens that when it comes to the oil and gas sector, China's preference for state ownership is not unique. State-controlled companies account for nearly 80% of the world's oil and gas reserves. Many of them are already operating in Canada, for example Statoil, Japan Oil, Gas and Metals National Corp., Korea Gas Corporation, CNOOC Ltd., Petronas, and PTT Exploration and Production Public Company Ltd..

Canada chose a different route 21 years ago with the privatization of Petro-Canada. Many in this country who fought so hard for the divestment of government from industry now see the threat of foreign SOE investment in Canada as a kind of back-door nationalization. The concern is on two fronts: that foreign SOEs have a lower cost of capital and hence can outbid private firms for assets in Canada; and that state-run companies underperform private firms in the long run.

If CNOOC was a Canadian state-owned company, I would be unhappy about my tax dollars subsidizing its perhaps too-rich offer to buy Nexen. Chinese citizens may well be upset about the deal, but that is for the Chinese government to worry about. If CNOOC is indeed paying too much for Nexen, hooray for Nexen shareholders. As for whether or not CNOOC has outbid another buyer through its unfair use of government subsidies, there are two points to consider: Nexen has been the subject of acquisition rumours for a long time, including a failed deal with Total of France in 2009, and many other potential buyers would have been state-owned companies as well, given their domination of the oil and gas industry.

It may be true that state-owned companies in general underperform private firms, but research on national oil companies has found very wide variation in their performance, depending in part on the nature of their assets, governance, quality of human resources, and the degree of political interference that they are subject to. There is similar variation in the performance of private companies, even if the question of political interference is not usually a factor. Indeed, Nexen has long been seen as a performance laggard in the industry. Should we be relieved that a state-owned company has picked up this underperforming asset or alarmed that the new owner will do an even worse job of running the company? The answer to this question should be the same as if the acquiring company was a private enterprise: It is for shareholders to decide, not the government.

In coming to this conclusion, I am not arguing that state-owned enterprises are identical to private firms. By the very nature of their ownership and control, state-owned companies have the potential to behave in ways that are motivated by "non-commercial" concerns. It would be naive to think otherwise. This is fundamentally why Canada chose to keep government out of business (forthe most part), and went through awave of privatizations starting in the 1980s. But this is not the choice taken (so far) by many other countries, and particularly not so in the oil and gas industry.

In accepting that SOEs may not behave like private firms, the important questions to ask are what these deviations might be and what recourse is available to the government of Canada. There is already a suite of domestic laws on unfair competition, labour and environmental practices, consumer safety, etc., that govern business practice in Canada. I am hard pressed to think of a situation where an undesirable practice would not or could not be addressed by domestic laws.

These laws of course apply equally to foreign state-owned and private firms operating in Canada, which underscores the basic point of non-discrimination between these two categories of foreign investor. Perhaps there are extreme scenarios where prevention is better than redress, but even in these situations, I would sooner apply the "national security" filter in the investment review process than to make a hard distinction between foreign state-owned firms and private ones.

We should reject the notion that by accepting investment from foreign SOEs, Canada is in effect adopting a statist model of economic development and allowing the "nationalization" of industry. This is a spurious argument, not only because of the extremely small share of foreign SOEs in Canada but also because the market framework governing industry is more important that the fact of foreign state ownership in that industry. However, they might behave in other parts of the world, SOEs in Canada have to play by Canadian market rules.

Canada is not alone in its anxiety over foreign state-owned investment, and there is similarly muddled thinking on this issue in the United States, Australia, and in the EU. Across the west, a combination of discomfort with SOEs and fear/distrust of China is encouraging policymakers to put up investment barriers. Which is why Canada has an opportunity to stake a unique position by being the most open of industrialized countries to all forms of foreign investment.

By rejecting false dichotomies between state-owned and private foreign investors and conflated arguments about foreign SOEs leading to nationalization, the Canadian government can claim a unique space for its investment regime - one that is committed to market forces, underpinned by strong domestic regulation, and which does not single out state-owned companies for special scrutiny.

Yuen Pau Woo is chief executive of the Asia Pacific Foundation of Canada.