Penn West executives on their 2010 visit to China: From left, Hilary Foulkes, Bob Shepherd, Keith Luft and Gregg Gegunde.
The foreign investment rush that prompted Ottawa to cordon off Alberta's oil sands can be traced to a furious pre-dawn game of Pictionary in the Chinese city of Panjin nearly three years ago.
Four Calgary oil executives had travelled to the city, three hours north of Beijing, to promote a vast Alberta oil sands deposit local geologists had never seen and a planned thermal drilling technology they didn't understand. Growing frustrated, the Canadians grabbed markers and decorated a nearby easel, sketching fat rocks, granules of sand, buried oil reservoirs and complex math formulas. At first, even an attending Chinese translator was bewildered.
Although the game took time, there was magic in those markers. In the middle of the night, shortly before 3 a.m., officials of China's Great Wall Drilling Co. began nodding their heads. Soon the nondescript office in a squat, stone building shook with laughter as relieved English and Chinese officials bowed and congratulated each other.
"It was a breakthrough," says Hilary Foulkes, a former executive vice-president of Penn West Petroleum Ltd., who led the presentation for what she believed was a long-shot bid to attract scarce capital to the company's Peace River oil sands property in Northern Alberta. "We made a connection and there was a camaraderie and trust that was developed."
There were a few breakthroughs in Panjin that night. The late-night gathering sparked a joint venture between Penn West and a Chinese fund, China Investment Corp. (CIC).
It also set in motion a flood of interest from state-owned enterprises in the oil sands, culminating in CNOOC Ltd's $15.1-billion (U.S.) takeover of Nexen Energy Inc. The massive Nexen deal – China's largest overseas investment – led Ottawa to lay down new restrictions on foreign investment in Canada's oil patch. Critically, those new guidelines push state-owned investors from China and other countries toward joint ventures, precisely the model pursued by Penn West.
Gwyn Morgan, former CEO of Encana Corp., says CIC's investment in Penn West was a "page turner" that flashed a green light to Chinese investors after years of indifference from the Conservative government and the oil patch. "The fact that the deal was accepted, that it went through, was a sign we're different than our neighbours to the south," Mr. Morgan says.
Although Ottawa has slammed the brakes on state-owned takeovers, deal makers expect the volume of joint ventures will grow and Chinese companies will likely continue to dominate these energy partnerships.
"New transactions will get done and there will be joint ventures," said Felix Chee, head of CIC's Canadian branch. Indeed, six days after Ottawa's policy shift, PetroChina International Investment Co. Ltd. announced Thursday a $2.2-billion (Canadian) investment to jointly develop a natural gas project with Encana.
One night in Panjin
That night in Panjin, the Penn West team convinced Great Wall's representatives of the technical and economic feasibility of a complex steam process for melting and drilling syrupy oil from an underground reservoir. Great Wall officials endorsed the project to their client, CIC, and four months later in May, 2010, the giant Beijing-based investment fund announced a $1.2-billion deal to acquire a 5-per-cent stake in Penn West and jointly develop the oil sands project.
Their deal marked the first time that a prominent Calgary oil player had embraced an equity investment by a state-controlled Chinese company. Overnight, Alberta companies began to rethink investments fr
"My phone was ringing off the hook," says Phil Hodge, an experienced China hand and Calgary-based investment banker who introduced CIC to Penn West and later advised the energy company during negotiations. "It was the first equity investment that involved one of Canada's senior companies. It changed perceptions."
Few could have predicted the rush that followed Penn West's CIC pact in 2010. During the next two years, foreign state-owned companies, most of them Chinese, invested more than $10-billion in oil sands projects, a 25-per-cent increase from the previous two years. The surge turned into an avalanche earlier this year when CNOOC launched its bid to acquire full control of Calgary's Nexen. News also surfaced that other state-owned buyers from Kuwait to South Korea were assembling multibillion-dollar energy offers.
Ottawa approved the Nexen deal last week, along with a $5.2-billion takeover of Calgary gas producer Progress Energy Resources Corp. by Malaysia's state-owned Petronas, even as it said that any such future bid would only be approved in "exceptional circumstances." By effectively saying no to future purchases by foreign state companies, Ottawa is cooling down a courtship that some believe had heated up too quickly.
"I think this is just a pause to allow everybody to kind of check their status," says Marcel Coutu, CEO of Canadian Oil Sands Ltd. "I think the relationship will grow."
Deal makers say that despite the setback, they expect partnerships between the two countries to continue to flourish. Alberta needs patient long-term investors to help foot the bill for spiralling oil sands productions costs that are scaring away publicly traded companies and their impatient shareholders. At the same time, China, a net importer of oil, is on the hunt for long-term energy investments even though profits and exports will likely be elusive for years. The country also views Canadian energy bets as a hedge that protects them from future price increases.
As the volume of energy partnerships increases, Canadian companies and Chinese suitors have a lot to learn about each other's different business cultures. Unlike takeovers that shift corporate control from one owner to another, the success of joint ventures hinges on a strong working relationship between the partners. When the partner is Chinese, the relationship can require a lot of patience.
For example, when Canadians sign a letter of intent on a deal, it usually marks the final stage of a transaction. For the Chinese, Calgary banker Mr. Hodge says, letters of intent are merely a way of saying "Okay, we are going to keep talking."
He should know. As a former senior executive with natural gas engine maker Westport Power Inc., Mr. Hodge spent nearly a decade negotiating joint ventures in China. The Vancouver-based engine maker struck a joint venture with Chinese engine giant Weichai Power in 2008 to build engines for heavy trucks, but the alliance is still road-testing the engines. "They view business relationships like we view marriage. Things change and you adapt ... it takes years."
'Welcome Pepsi Delegates'
It only took four months of negotiations for Penn West to land its venture with CIC, but the relatively quick journey had its bumps.
When Ms. Foulkes and three fellow Penn West executives travelled to China in 2010 to initiate confidential discussions with CIC, the two companies agreed to refer to each other in correspondence and presentations by code names to shield the purpose of their meetings. CIC was code-named Coke and Penn West was Pepsi.
When the Penn West team travelled to Panjin to meet with CIC's engineering advisers at Great Wall Drilling, they were greeted with a surprise. Hanging over the entrance to Great Wall's front door was a billboard-sized red-and-white banner that said "Welcome Pepsi Delegates."
Ms. Foulkes diplomatically explains: "It was an indication of the effort they were making to get to know us." Fortunately, she adds, "I don't think anyone would have had a clue in the middle of Panjin what the hell Pepsi meant."
Vancouver mining giant Teck Corp. faced a much steeper learning curve when CIC first approached it in 2009 with an investment proposal. CIC was offering to make a $1.7-billion investment at a time when Teck was recovering from a debt restructuring.
Teck's initial reaction to the offer shocked CIC. During negotiations, the miner was so worried about CIC's intentions that it asked the Chinese fund to agree to a condition that would have restricted it from selling its minority stake in Teck to other state-controlled companies.
CIC's Canadian representative on the deal, Mr. Chee, says the miner "was being discriminatory." Mr. Chee succeeded in convincing Teck that far from being a monolith, CIC actively competed against other state-owned companies for deals.
At Teck, the demand reflected bruised feelings about a multimillion-dollar sale of 1.8 million tons of coal to Chinese commodity traders that was never paid, and fears that CIC might transfer its stake to one of Teck's Chinese mining competitors.
Teck dropped the demand for the stock standstill and its deepening relationship with CIC has opened doors to new customers in China that now account for more than 20 per cent of Teck's coal sales. "We tended to think of China as one big monolith," says Teck's CEO Don Lindsay. Today, Mr. Lindsay says, the company no longer makes that mistake.
"They said they wanted to be a long-term investor and that they were going to help us with our business," Mr. Lindsay says. "We have had a very, very good relationship."