Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

August 2010

Fuelling the recovery

Executive summary Methodology China M&A survey findings M&A review Historical overview of outbound Oil & Gas M&A Macroeconomic drivers of outbound Oil & Gas M&A Chinese Outbound Oil & Gas investment case study - Canada The regulatory perspective: An interview with a leading Canadian legal advisor Chinese outbound Oil & Gas investments into Africa - an insider's view Chinese outbound Oil & Gas investments into Africa - Deloitte's standpoint Deloitte principal contacts End notes

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Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

Executive summary and methodology

Executive summary Companies from China have undertaken a significant number of outbound investments in the global Oil & Gas sector with 46 transactions coming to the market since the beginning of 2005, carrying an aggregate disclosed value of US$44.4 billion. In keeping with the drivers of investment in other commodities, Chinese companies have looked to broker deals in a bid to secure supply and support for the continued rapid growth of the domestic economy. This is particularly prevalent in the case of crude oil with the growth rate of domestic consumption outstripping the rise in production in recent times. Significantly, more than half of Chinas oil is now imported and this trend looks set to continue, particularly as no new domestic exploration projects are planned to come online in the foreseeable future. This will likely spur dealmaking as Chinese National Oil Companies (NOCs) seek to secure the supply of upstream assets through M&A, rather than buy inputs from global spot markets. Indeed, one survey respondent reinforced this view commenting, As the price of crude oil rises, I would expect Chinese Oil & Gas companies to acquire more resources in order to achieve input price stability. Tellingly, survey respondents are confident about the M&A prospects in the sector with 57% expecting M&A activity to increase over the next 12 months. Future outbound deal flow also looks set to increasingly center on emerging markets. The nascent economic recovery in the global economy has helped push up commodity prices and this is likely to continue. Nearly 90% of respondents expect the price of both crude oil and natural gas to rise over the next year. Against this backdrop, valuations of Oil & Gas corporates situated in developed economies have rebounded, which will likely push Chinese NOCs to invest in alternative locations such as Africa, the Middle East and South America. Remarkably, 59% of respondents believe Africa will witness the bulk of outbound investment from China over the next 12 months: China is a huge investor in places like Sudan they pay for massive infrastructure projects and are therefore allowed access to large reserves of oil, one respondent explained. The global push for a greener future could also hasten a change in the nature of future deal flow in the sector as 90% of respondents expect the Copenhagen treaty and various national government initiatives to impact upon the activities of Chinese Oil & Gas firms. In this regard, the domestic natural gas industry should benefit given that it is the greenest of the fossil fuels. One respondent added, This is a huge positive for the gas industry in China. Natural gas is a relatively low polluting energy source compared to other sources. Certainly, respondents foresee increased levels of investment in this space, with 71% expecting the natural gas and crude oil extraction subsector to see the most activity going forward. Elsewhere, investment in R&D-based businesses is also likely to increase as firms look to ensure that they are well-placed to take advantage of

the changes in the global marketplace. Such deals that do come to the market may well take the form of joint ventures and strategic alliances. 62% of respondents expect Chinese Oil & Gas firms to primarily conduct either one of these deal types over the next 12 months.

Methodology Over the course of April and June 2010, Remark, the research and publications division of The Mergermarket Group, canvassed the opinions of 28 mainland China-based Oil & Gas corporates. Respondents were asked to give their opinions on a number of issues, including the key opportunities and challenges that businesses in the sector face in the current trading environment. All answers were confidential and results have been reported in aggregate.

Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

China M&A survey findings

The vast majority (more than 90%) of respondents have undertaken an M&A transaction over the past three years with just 3.6% indicating that they have not transacted over the period. Pre-qualifiers/respondent information Has your business undertaken an M&A transaction over the past three years?
3.6% 3.6%

92.8%
Yes No Unsure

While the bulk of respondents rate their transaction as successful, a meaningful minority of respondents didn't agree. Indeed close to one-in-five state that the transaction was merely neutral in terms of outcome.

If so, how would you rate its success?

11.1% 18.5%

70.4%
Very successful Neutral Successful

Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

What will be your primary corporate strategy(ies) over the next 12 months?
To acquire exploration and development prospects other than by M&A transaction To focus on a strategic acquisition of other companies or assets To grow reserves and production from existing inventory of exploration and development prospects

53.6

Just under one third of respondents remark that their primary corporate strategy over the coming 12 months is to conduct a strategic acquisition of another company or its assets. At the same time, just over half explain that their firm's strategy is to grow inorganically.

32.1

25.0 20 30 35 40 45 50 55% Percentage of respondents (Respondents may have selected multiple answers) 25

Overall, how do you now view your companys prospects of achieving these corporate goals relative to six months ago?
7% 25%

Exactly three quarters of respondents believe that the macroeconomic climate is now more conducive to achieving their strategic aims compared to six months ago while 25% consider that such prospects remain the same. No respondents think that the likelihood of these prospects coming to fruition diminished over the period in question.

68%
Significantly improved The same Improved

Overall deal drivers The majority of respondents remain optimistic about global M&A prospects in the Oil & Gas space over the coming 12 months More than three quarters (78.6%) believe that M&A in the sector will increase over the period. At the same time, just 3.6% think that activity will decrease while 17.8% suggest that deal flow will remain the same. One such respondent explains, As the price of crude oil rises again, Oil & Gas companies will want to acquire more natural resources in order to achieve input price stability.

What do you expect to happen to the overall level of M&A transactions in the global Oil & Gas sector over the next 12 months?
3.6% 17.8%

78.6%
Increase Decrease Remain the same

More than one half of those surveyed expect M&A activity conducted by Chinese Oil & Gas companies to rise over the next 12 months A combined 57.1% of respondents expect the level of Chinese Oil & Gas M&A to rise over the next 12 months, with 14.2% foreseeing significant increases in deal flow. However, a considerable 42.9% of respondents expect to see no rise in M&A activity, highlighting to good effect the degree of uncertainty surrounding this particular M&A market. One such respondent explains that, Chinese Oil & Gas companies have undertaken enough asset purchases over the past few years and therefore, activity is unlikely to boom now.

What do you expect to happen to the overall level of M&A in the Chinese Oil & Gas sector (inbound and domestic acquisitions of Chinese Oil & Gas assets over the next 12 months)?
14.2%

42.9%

42.9%

Increase greatly Remain the same

Increase

Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

Respondents expect the Copenhagen treaty and current raft of government clean energy initiatives around the globe to have a limited impact on Oil & Gas M&A Some 61.9% of respondents believe that the overall impact of the recent raft of clean energy initiatives to come to light would, at worst, only slightly impact the level of Oil & Gas M&A being undertaken by Chinese businesses. However, the topic obviously remains contentious with the remainder, a combined 38.1%, suggesting that these initiatives would have an impact on M&A flow, all of which indicates that it is perhaps too early to say how Oil & Gas M&A activity may be impacted by the shift towards clean energy. One respondent, who falls into the latter category, writes that the implementation of the Copenhagen treaty will influence the crude oil refining process, meaning that the requirement to implement technological-best practices will be greater. Another believes that the move towards more environmentally-friendly fuels is a positive draw for the Chinese gas industry because natural gas is a less-polluting energy source compared to other carbon fuels. However, many respondents echo this particular respondents sentiment, The Copenhagen treaty is only good on paper. It cannot be implemented realistically and, thus, wont have any major impact on the level of Chinese Oil & Gas M&A.

Given the impact of the Copenhagen treaty and the introduction of various governmental initiatives around the globe, how will the current focus on renewable energy impact Chinese Oil & Gas companies going forward?
9.5% 9.5%

28.6%

52.4%

No impact Some impact

Slight impact Major impact

Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

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Which subsectors do you expect to see Chinese Oil & Gas businesses conduct the bulk of their M&A activity in over the next 12 months?
Crude petroleum and natural gas extraction LNG Petroleum and petroleum products wholesalers Oil & Gas (Other) 7.1 Oil & Gas industry regulation

Crude petroleum and natural gas extraction M&A tops list of expected subsector deal flow for the coming year A combined 71.5% of respondents believe that the crude petroleum and natural gas extraction space will be one of the most active subsectors in terms of Oil & Gas M&A in the coming year, with 28.6% of total respondents suggesting that it will be the most active arena for M&A. At the same time, 25.0% of respondents believe that liquefied natural gas (LNG) plays will trump other subsector deal flow as the most active Oil & Gas M&A niche. At the other end of the scale, just 17.8% of respondents believe the oil refining space will see an active level of acquisitions taking place.

28.6 25.0 21.4 21.4 7.1 7.1 7.1 3.6

25.0 25.0 21.4 3.6

17.9

10.7

Oil rening 7.1 3.6 7.1

10

20

30

40

50

60

70

80%

Percentage of respondents (Respondents may have selected multiple answers)

Most active Very active Active

One respondent simply explains that crude petroleum extraction will be the most active Oil & Gas segment because there are now an increasing number of cars in China.

The bulk of respondents expect an increase in Oil & Gas M&A valuations over next 12 months A total of 82.1% of respondents consider that Chinese Oil & Gas M&A valuations will rise over the next 12 months, with more than two thirds (67.9%) indicating that prices will rise by more than 5%. Indeed, more than one in six say that Chinese Oil & Gas M&A values will go up by more than 25%. One respondent, who is very bullish on future price increases explains that, The Chinese Automotive industry is growing rapidly, meaning that demand for foreign oil exploration and production businesses is rising too. Meanwhile, another says valuations will climb simply because the natural resources in question in this case, Oil & Gas are non-renewable inputs. Lastly, another respondent, who is slightly less optimistic on future price hikes, remarks that prices will only rise slightly because everyone has already factored in mounting oil prices over the next year or two.

What do you expect to happen to M&A valuations in the Chinese Oil & Gas sector over the next 12 months?
17.9% 17.9%

14.2%

50.0%
Rise by more than 25% Rise by between 525% Rise by less than 5% Remain the same

Three in four respondents foresee an increase in global private equity M&A activity in the sector over the coming year Respondents are similarly optimistic on the amount of private equity M&A activity in the global Oil & Gas sector over the next 12 months, with exactly three quarters believing that private equity dealmaking will increase, and 14.3% foreseeing large increases in activity over the period. One bullish respondent notes, Crude oil prices are rising and private equity funds are actively looking to the Oil & Gas sector in order to make acquisitions, meaning that private equity activity in the sector will certainly increase.

What do you expect to happen to the level of private equity acquisitions in the global Oil & Gas sector over the next 12 months?
14.3% 25%

60.7%
Increase greatly Remain the same Increase

Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

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In which region do you expect to see the bulk of Chinese outbound Oil & Gas M&A activitity over the next 12 months?
Africa Middle East South America Australasia North America Central & Eastern Europe (including Russia) North Asia Europe (other)

Chinese Oil & Gas majors are likely to shift M&A attention to Africa over the next 12 months say majority of respondents
59.3 29.6

18.5 11.1 7.4 7.4 3.7 3.7 0 20 30 40 50 60% Percentage of respondents (Respondents may have selected multiple answers) 10

Close to 60% of respondents expect to see the bulk of Chinese Oil & Gas acquisitions abroad being undertaken in Africa, while a further 29.6% forecast purchases to be made in the Middle East. Impending South American buys are also in the pipeline according to 18.5% of respondents. In contrast, just 3.7% in each category think that North Asian and other European Oil & Gas targets will prove to be the most attractive to Chinese Oil & Gas bidders.

Australia has an abundance of offshore gas resources. The Middle East has plenty of resources on offer. Chinese firms will invest in Africa as the labor there is cheaper. China and South American countries have good, solid economic and trade relationships.
Survey respondents

Respondents identify stock as the most likely means of financing M&A in the next 12 months When asked how Chinese Oil & Gas majors would pay for their transactions over the next 12 months, the bulk of respondents some 44.4% expect that future Chinese outbound Oil & Gas M&A will be paid for through share swaps, while a further 40.7% say that Chinese bidders will pay with cash. A sizable 29.6% mention that debt could be utilized for future purchases, while 14.8% suggest that Chinese bidders will use a mixture of all three in order to pay for an acquisition. One Beijing-based business went on to explain that, Basically, there are so few possibilities to fund bids. One is to go to the capital markets, the second is to approach mainland Chinese banks

and financial institutions, and the third one is from private sources of capital. Another writes that, Cash is most the likely avenue Chinese Oil & Gas SOEs (state-owned enterprises) will take, because they are all very liquid. However, respondents are split as to whether financing options have shifted markedly since 2009, with exactly half commenting that deal financing conditions have not changed substantially since 2009.

Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

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The bulk of Chinese outbound Oil & Gas M&A is likely to consist of joint ventures and strategic alliances according to respondents Some 61.6% believe that the bulk of outbound Oil & Gas M&A will comprise either joint ventures or strategic alliances, while more than a quarter (26.9%) mention that majority stake (>50.0%) acquisitions are the likely choice for acquisitive Chinese Oil & Gas firms. Just 11.5% remark that Chinese bidders will pursue minority stake buys, presumably because such holdings will not allow buyers to achieve their stated M&A aims.

What type of transaction do you expect Chinese Oil & Gas firms to undertake over the next 12 months?
11.5%

26.9% 61.6%

Joint ventures/Strategic alliances Majority stake (>50%) acquisitions Minority stake (<50%) acquisitions

More than four-out-of-five respondents believe SOEs will conduct half or less of all Chinese outbound Oil & Gas M&A in 2010 More than four in five respondents (82.2%) believe that state-owned enterprises (SOEs) will undertake half or less of the total number of outbound Oil & Gas acquisitions over 2010, with over half of them (57.2%) expecting that SOEs will carry out 25.0% or less of all overseas purchases. However, at the other end of the spectrum, a relatively substantial 17.8% consider that SOEs will make up the bulk of Chinese Oil & Gas bidders buying abroad. Interestingly, SOE activity expectations differ depending on the location of the respondent: Shanghai-based Oil & Gas businesses are the most bullish on SOE deal flow, with 50.0% suggesting that they would undertake more than half of all outbound Oil & Gas acquisitions. In contrast, only 23.1% of Beijing-situated respondents agreed with them.

What percent of outbound Oil & Gas M&A acquisitions do you expect will be undertaken by state-owned enterprises in 2010?
3.6% 28.6% 3.6% 10.6%

25%

28.6%
More than 90% 76 90% 51 75% 26 50% 10 25% Less than 10%

Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

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What do you expect to happen to crude oil and natural gas prices over the next 12 months?
% 100 90 Percentage of respondents 80 70 60 50 40 30 20 10

Both crude oil and natural gas prices are expected to rise over the next 12 months, respondents indicate Respondents are almost universally united when asked about potential price hikes in crude oil and natural gas, with 89.3% in each category suggesting that prices for both oil and gas will rise.

10.7

10.7 18.8

78.6

82.1

10.7
Crude Oil
Increase greatly Increase

7.2
Natural Gas
Remain the same

What role do you think these prices will play in determining the level of outbound M&A from Chinese Oil & Gas companies?
10.7% 3.6%

Respondents believe that rising prices will influence future overseas M&A activity by Chinese Oil & Gas companies Close to two thirds of respondents go on to say that changing Oil & Gas prices play at least a sizable role in shaping the level of outbound M&A from Chinese Oil & Gas bidders, with one quarter thinking that price volatility is at least a large market determinant. At the same time, however, over one third of respondents think that oil and gas price movements have a minor impact on outbound M&A flows, or don't impact at all.

21.4%

25.0%

39.3%
A very large determinant A large determinant A sizable determinant A minor determinant Not a determinant

The majority of respondents view regulatory issues as a significant obstacle to dealmaking Three quarters of respondents view regulatory issues encountered during an outbound M&A deal as a significant impediment, with one respondent stating that cultural differences, as well as onerous environmental and antitrust legislation are chiefly to blame for this. However, the remaining 25.0% of respondents were no less vocal with one saying that, Chinese bidders are now interested in acquiring in either Africa or the Middle East where regulatory issues do not play a major role. In addition, there is good government support for Chinese Oil & Gas firms buying abroad, so local regulatory approvals are easy to come by.

Do you believe regulatory issues are a significant impediment to Chinese Oil & Gas companies looking to undertake deals abroad?
25.0%

75.0%

Yes

No

More than one third of those surveyed say local regulators are more intransigent than their foreign peers Surprisingly, 35.7% of respondents highlight local Chinese authorities as the most intransigent regulator to deal with when seeking approval for overseas Oil & Gas acquisitions, with a cumulative 64.3% citing Chinese regulators as at least intransigent. At the other end of the scale, Australian regulators are the least stubborn, with only a collective 32.1% of respondents suggesting that they are a hindrance when dealmaking.

If so, how intransigent do you consider the following national regulators to be?
% 70 60 50 40 30 20 10 Chinese regulators
Intransigent regulator

Percentage of respondents

14.3 14.3

14.3

28.6 21.4 14.3 35.7 21.4

North American regulators

17.9 3.6
EU regulators

7.1 10.7
Australian regulators

Most intransigent regulator

Very intransugent regulator

Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

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More generally, what do you consider to be the most significant obstacles/challenges Chinese Oil & Gas companies face when looking to undertake deals abroad?
General macroeconomic environment Domestic political risk Exchange rate volatility Terrorism/global political risk Protectionism Labor risks

Nearly one third of respondents cite macroeconomic volatility as the most significant challenge facing acquisitive Chinese Oil & Gas firms looking abroad
32.1 25.0

17.9 17.9 14.3 7.1 0 10 15 20 25 30 35% Percentage of respondents (Respondents may have selected multiple answers) 5

Close to one third of respondents (32.1%) consider that the most significant barrier to the successful completion of a deal is macroeconomic uncertainty, while a further 25.0% believe that domestic political risk in the targets home country is the largest challenge to overcome. In contrast, only 14.3% and 7.1% of respondents respectively refer to protectionism and labor risks as the most important hurdle to outbound M&A success.

M&A Review

Historical overview of outbound Oil & Gas M&A Yu-Dong Yuan, Oil & Gas sector Director for Deloitte China, expects Chinese Oil & Gas bidders to look to targets outside of the traditional markets of Canada and Australia as they attempt to secure overseas Oil & Gas assets to sate Chinas booming domestic economy.

NOCs are going to be buying up international Oil & Gas assets for the next two decades, Yuan says. Indeed, Chinese Oil & Gas majors find it prohibitively expensive to buy inputs from global spot markets, preferring to lock in a stable source of supply, primarily stemming from the acquisition of upstream assets. It is arguable that such a concerted drive to acquire overseas assets has already had a potentially negative impact on recent acquisitions. Yuan believes that the global economic recovery and rising Oil & Gas prices have already pushed up M&A valuations, a process which is exacerbated by the relatively small number of attractive assets that are available. These factors have combined to increasingly push Chinese NOCs away from the traditional target markets of Europe, Asia-Pacific and North America, as local acquirers have actively looked to buy in alternative locations. Moreover, Oil & Gas assets in Europe are dwindling and Yuan suggests that Chinese firms will increasingly shy away from doing deals in that market. Instead, acquirers will look to invest in exploration and production projects in South America and West Africa. This trend is borne out by the Bridas Corporation transaction, as well as recent mergermarket.com intelligence reports, which suggest that CNOOC is currently participating in the auction process for a reported 23.5% in the Jubilee Oil Field off the coast of Ghana, from Kosmos Energy. Yuan also points out that the falling number of quality targets has resulted in Chinese bidders starting to undertake slightly riskier transactions in their bid to secure upstream assets. Indeed, there have been examples of firms buying into early-stage exploration businesses as well as targets without proven reserves. Until recently, Chinese Oil & Gas bidders would generally not look at a target with less than 100 million barrels of oil in proven reserves, although this figure has recently dropped to around 50 million. The competitive landscape of the domestic market also serves to drive a degree of outbound M&A activity in the Oil & Gas sector. Yuan

Outbound M&A activity Between Q1 2005 and H1 2010, Chinese Oil & Gas players undertook 56 acquisitions of foreign Oil & Gas assets, worth a cumulative US$55.6 billion. Over the period, the frequency and composition of transactions was fairly constant, with three deals, averaging around US$2.5 billion each, coming to market per quarter. However, the first half of 2010 saw eight outbound investments worth a total of US$11.1 billion, led by the US$4.65 billion acquisition of a 9.03% stake in Syncrude Canada Ltd, the Canadian crude oil producer, by Sinopec, in April 2010. Another notable deal was the US$3.1 billion acquisition of a 50.0% stake in Bridas Corporation, the Argentinian Oil & Gas exploration firm, by CNOOC. Such heightened levels of activity seems to be a sure sign that, with little chance to grow inorganically at home, Chinese Oil & Gas majors are increasingly targeting overseas competitors, especially those located in emerging markets. Yuan suggests that over the past six months, Chinese Oil & Gas players have increasingly been lining up foreign targets in their crosshairs as they look to secure supplies of crude oil and, to a lesser extent, natural gas. China now has to import more than half of its oil from abroad, Yuan says, meaning that Chinese National Oil Companies (NOCs) are having to work harder in order to balance the supply and demand for Oil & Gas inputs. And this push to buy abroad is not a short-term initiative either, With no new domestic Oil & Gas projects coming online in the foreseeable future, I expect that Chinese

Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

21

explains that of the three largest NOCs, Sinopec has the lowest proportion of upstream assets. This means that the firm is likely to be the most acquisitive in the next couple of years. However, this view is tempered somewhat by the fact that Sinopec is the least monetised of the three, obviously constraining its level of investment in the near-term, especially at the top end of the market.

Looking forward While financial investors have been largely absent from the Oil & Gas M&A space in the past, the aforementioned Kosmos Energy situation is emblematic of a developing trend within the market. Indeed, Yuan explains that, although private equity firms have been relative latecomers to the field, there are examples of funds acquiring early-stage Oil & Gas exploration and production companies themselves in the hope that they can flip it to a Chinese NOC at a later date. Interestingly, Kosmos Energy moved to sell an undisclosed stake in itself to Blackstone and Warburg Pincus back in 2008 for US$500 million, a deal which if the sale of its stake in the Jubilee field to CNOOC goes ahead successfully could reap a significant return for the financial investors. Casting an eye towards regulatory issues, Yuan comments that while Chinese regulators tend to approve Chinese Oil & Gas firms moves to buy abroad, the attitudes of many foreign regulatory bodies are cool at best. Nonetheless, Yuan believes that attitudes are slowly changing as overseas politicians and regulators increasingly view Chinese Oil & Gas players in a more positive light.

Oil & Gas M&A valuations As large corporate entities, it is perhaps unsurprising that 39.0% of Chinese outbound M&A acquisitions of foreign Oil & Gas assets have been valued at US$500 million or above, a percentage which rises to 50.0% when looking at H1 2010 data alone. And with crude oil prices likely to rise over the short-term, valuations are also expected to continue climbing. M&A valuations in the Oil & Gas sector are correlated to the price of oil, so if the price of crude rises, the market value of a target follows. This means investors increase their long-term forecast of crude prices for project evaluation purposes and short-term prices will continue to move up , Yuan explains. Not that this is of particular worry to Chinese Oil & Gas SOEs, all of whom have access to a range of policy bank lenders, including the Chinese Development Bank and the China EXIM Bank, which provide long-term preferential loans to local Oil & Gas majors looking to acquire abroad. At the same time, SOEs are also able to turn to the China Investment Corporation (CIC), the countrys sovereign wealth fund, if they require co-investment in a bid. The CIC is required to conduct a certain proportion of its M&A investments in the Oil & Gas sector and looks to leverage off its counterparts' sector experience when doing so - hence a number of consortium bids between the CIC and Chinese NOCs of late. Meanwhile, other players can look to finance acquisitions by turning to state-owned commercial banks or, in some cases, equity capital markets.

Macroeconomic drivers of outbound Oil & Gas M&A Chinese oil trends The Chinese crude oil industry is slowly making its presence felt on the world stage with production rising from 4.4% of the global total in 1998 to 4.6% ten years later. Furthermore, this figure looks set to continue climbing as Chinas economic miracle gathers pace. Indeed, between 1998 and 2008, Chinese production of crude oil rose from 3.2 million to just under 3.8 million barrels a day. Notably, production was up 4.2% over the 2004/2005 period when annual production jumped from an average of 3.481 million barrels a day to 3.627 million barrels. While oil production has grown of late, it has been outstripped by consumption which has risen from around 4.477 million barrels a day in 1998 to just under eight million in 2008, to give an average annual growth rate of 6.7% over the period. As a result, more than half of Chinas oil requirements now originate from outside the country a trend which is likely to continue going forward. It is undisputable that this rise in demand is associated with economic growth, with nominal GDP and oil consumption over the period being very closely correlated. In 2008, China imported some 4.393 million barrels of oil per day, with more than 40.0% of these imports stemming from the Middle East. West Africa and Former Soviet Union imports accounted for a further cumulative 28.1% of imports while oil inflows from other Asia-Pacific countries comprised just over another 10.0%. At the other end of the spectrum, imports from North America and Europe accounted for less than half a percent of all oil imports.

Chinese oil trends

9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0
65 68 71 74 77 80 83 86 89 92 95 98 01 04 20 19 19 19 19 19 19 19

Million barrels per day

Production
Source: BP Statistical Review of World Energy, 2009

Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

19

Consumption

19

19

19

19

20

20
23

07

Renery utilization rate

In terms of domestic production capabilities, Chinas proven reserves have fallen from around 17.4 billion barrels in 1998 to 16.1 billion in 2007 and 15.5 billion in 2008. By the end of 2008, Chinas Reserve-to-Production (R/P) ratio stood at 11.1 years, highlighting the amount of time left until domestic oil reserves run out given current levels of production. The figure also places China in the lowest quintile of all oil-producing countries in terms of their R/P ratio. Meanwhile, Chinas capacity to distil crude oil has expanded by more than two thirds between 1998 and 2008, rising from a capacity to process 4.592 million barrels a day in 1998 to 7.732 million barrels a day in 2008. However, this recent rise in processing ability was almost certainly driven by the explosion in demand for oil-related products in China over the past five years, with refinery utilization rates (calculated by dividing refinery capacity by refinery throughputs) recently returning to levels last seen in the late 1980s.

Chinese refinery utilization rates

% 90 85 80 75 70 65
80 82 84 86 88 90 92 94 96 98 00 02 04 06 20 19 19 19 19 19 19 19 19 19 19 20 20 20 20 08

Source: BP Statistical Review of World Energy, 2009

Chinese imports of crude oil by country, 2008

Country Middle East West Africa Former Soviet Union Other Asia-Pacific South & Central America East & Sub-Saharan Africa Japan Singapore North Africa Australasia US Europe India Total imports
Source: BP Statistical Review of World Energy, 2009

Millions of imported barrels of crude oil a day (2008) 1843.81 782.74 453.13 442.38 333.98 212.93 102.57 92.88 83.33 19.11 16.03 5.11 4.86 4,392.86

% of total 42% 18% 10% 10% 8% 5% 2% 2% 2% <1% <1% <1% <1% 100%

Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China

25

Chinese gas production & consumption (billions of cubic meters per day)
90 Billions of cubic meters per day 80 70 60 50 40 30 20 10 0
70 73 76 74 77 80 83 86 89 92 95 98 19 19 19 19 19 19 19 07

Chinese natural gas trends Long-term national gas consumption and production metrics have broadly moved with one another, both more than doubling over the past ten years. Given this, it is clear that China will not have to begin importing large quantities of natural gas anytime soon. Chinese gas reserves have been steadily expanding since the 1980s, meaning that Chinas R/P ratio for Gas is 32.3 years. Chinese Gas imports account for a much smaller proportion of the countrys overall Gas market, accounting for just 5.5% of total consumption in 2008. In that year, some 4.44 billion cubic meters of Liquefied Natural Gas (LNG) was shipped to China, the vast majority of it from Australia. African suppliers of LNG made up a further 19.0% of the total.

Production
Source: BP Statistical Review of World Energy, 2009

Consumption

19

19

19

19

19

20

Chinese imports of natural gas, 2008 Chinese proven gas reserves (trillions of cubic meters)
3 Trillions of cubic meters
Country 2008 Gas imports (bcm) Percentage of daily imports

Australia Egypt Nigeria 2 Algeria Equatorial Guinea Malaysia 1 Total

3.61 0.25 0.24 0.17 0.16 0.01 4.44

81% 6% 5% 4% 4% <1% 100%

Source: BP Statistical Review of World Energy, 2009

0
19 80 19 86 19 92 20 06 84 90 96 98 00 02 04 2 8 4 19 8 19 8 19 9 19 19 19 19 20 20 20 20 0 8

Source: BP Statistical Review of World Energy, 2009

Potential drivers of Chinese Oil & Gas M&A over 2010 and beyond The economy and Oil & Gas M&A Looking forward, a number of factors are likely to impact on Chinese Oil & Gas M&A acquisitions, not least Chinas booming economy. With the IMF predicting 2010 growth to top out at around 10.0%, domestic demand for Oil & Gas products is almost certain to increase markedly. This will, therefore, widen the gap between Chinese oil production and consumption even further, ultimately providing added impetus for Chinese Oil majors to redouble their efforts in securing foreign sources of crude to sate Chinas growing demand for oil. The prospective removal of the temporary peg between the US Dollar and Chinas RMB, currently standing at around RMB6.78 to the dollar, is also another potential driver of outbound Chinese Oil & Gas acquisitions, with recent talks between the US and China refocusing attentions on the likelihood of a RMB revaluation. According to market reports, analysts expect China to continue to allow the RMB to strengthen over the remainder of 2010, ultimately letting it appreciate by between three to four percent over the next year. This is further reinforced by the fact that the Governor of the Central Bank recently described the peg as a special response to the financial crisis which would end sooner or later. The anticipated revaluation of the RMB will have a significant impact on the outbound investment plans of many Chinese Oil & Gas businesses, particularly in the case of two of Chinas National Oil Companies (NOCs). Indeed, China National Petroleum Corporation (CNPC) and PetroChina have recently declared that they are planning to spend around US$60 billion respectively over the next decade acquiring overseas assets. Acquisitive state-owned Oil & Gas majors are also likely to be joined on the global M&A stage by the Chinese sovereign wealth fund, China Investment Corporation (CIC). The fund, with a reported US$288 billion M&A war chest, has undertaken three specific Oil & Gas acquisitions since the second half of 2009, acquiring an 11.0% stake in Kazakh Oil & Gas firm KazMunaiGas Exploration & Production for US$939 million, a 45.0% stake in the Nobel Oil Group, the Russian oil exploration

RMB/USD exchange rates, Q2 2005-Q1 2010

8.4 RMB/USD exchange rate 8.2 8.0 7.8 7.6 7.4 7.2 7.0 6.8 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10

Source: Yahoo Finance

The anticipated revaluation of the RMB will have a significant impact on the outbound investment plans of many Chinese Oil & Gas businesses, particularly in the case of two of Chinas National Oil Companies - CNPC and PetroChina.
Fuelling the recovery: A review of outbound Oil & Gas M&A activity from China 27

and production company, for US$100 million, and finally, a duo of asset acquisitions in Penn West Energy, the Canadian Oil & Gas exploration company, for a total of US$1.2 billion, in May 2010. CICs involvement in the sector is likely to continue as the fund has recently been rumored to be interested in partnering with Storm Exploration, a Canadian Oil & Gas exploration company. The business, which was previously purchased by the ARC Energy Trust for US$680 million earlier in 2010, could still benefit from additional capital to fund activities in its Montney acreage, which has the potential for horizontal drilling and generally, more extensive development. If CIC decide to partner with Storm, it could represent an exciting new trend for M&A practitioners. One president of a US energy consulting firm is forecasting a surge in the number of deals financed by alternative sources of capital, explaining that "recent Oil & Gas acquisitions have involved mixed financing, usually with the company taking the major portion of risk and a corporate parent or government entity providing the real backing." However, one likely hindrance to outbound M&A deal flow from China stems from the fact that Chinese authorities have recently instructed state-run companies to form bidding consortiums when bidding for overseas Oil & Gas assets in order to avert bidding wars breaking out. The six companies in question; CNPC, Sinopec, CNOOC, Sinochem, Citic Resources and Zhenhua Oil, have all been advised that if more than one of these companies were shortlisted during an auction process, the lowest bidder would lead peers forward.

the greenest of fossil fuels. One partner at a global management consultancy firm, recently maintained that they are "bullish on the long-term demand prospects for natural gas it is the fuel of choice in a low-carbon world. Many companies are employing M&A, including joint ventures, in order to increase their exposure to natural gas, from multiple shale gas partnerships in the US to unconventional gas tie-ups in China." The message has certainly not been lost on Chinese Gas firms, many of whom have been busy hunting for targets across the globe. One such firm, China Oil and Gas Group, the Hong Kong-listed natural gas business, recently announced that it will focus on M&A following its 2009 year-end announcement. Citic Resources, a similar business, is also likely to be acquisitive after recently reporting that it is looking to buy gas fields in Asia and Africa. Such companies could be making preemptive M&A moves so as to ward off potentially onerous environmental regulations which could occur in the near-future. Indeed, documentation covering the recent acquisition of leading North American shale gas player XTO, by Exxon, included a clause which allows the bidder to exit the deal if federal lawmakers prohibit, or make hydraulic fracturing no longer commercially viable - one of the drivers of the deal in the first place. As well as making anticipatory investments, Chinese Oil & Gas businesses could also be looking to boost their R&D divisions as they look to reshuffle their operations in a bid to take advantage of the growing popularity of clean technologies. As the regulatory environment develops further, sector practitioners are expecting to see more transactions from Oil & Gas companies to secure carbon credits, as well as acquire companies for other renewable efficiencies. However, such moves could depend upon size of the company in question, with larger firms likely to move more aggressively than their

The quest for new energy Chinas Gas firms may also be driven to target overseas supplies of gas due to the fact that it is

smaller counterparts because of cost constraints. In fact, this shift towards R&D-related businesses is seemingly already underway in the wider Energy & Mining space with Shenhua Energy mulling over a proposed joint venture with Dow Chemical, the US Chemicals conglomerate. The planned US$10 billion coal-to-chemical project would see Dow Chemical provide the technical know-how, while Shenhua would put up the majority of the cash needed to construct the plant. With this in mind, it will be interesting to watch the upcoming sale of a 67.0% stake in state-owned Guizhou Liuzhi Anjiazhai Coal, an entity which is engaged in the research of coal and chemical-related technology.

into the 'large' category, carrying a disclosed deal value of more than US$500 million. Such activity is consistent and in keeping with the strategic rationale of Chinese acquirers, which is to secure access to key resources. Against this backdrop, it is only natural that Chinese Oil & Gas companies would turn their eye towards Canada and the market has been of key interest to acquirers in recent years. Indeed, a total of six such deals worth US$15.3 billion have been announced since the beginning of 2008 with three of them being worth more than US$1 billion each. Tellingly, one mega transaction has already come to the market in 2010 with Sinopec moving to acquire a 9.03% stake in crude oil producer Syncrude Canada for a consideration of US$4.65 billion. Recent deal flow clearly suggests that Chinese buyers are placing increased emphasis on Canada as an investment destination. A sign of this continued commitment to the market is the fact that the largest outbound deal announced by a Chinese buyer in the wider Oil & Gas space involved the acquisition of a Canadian target in the form of the abovementioned Addax Petroleum transaction. The acquisition was the first step in Sinopec's expansion overseas which, according to Chairman Su Shulin, will also focus on transactions in Africa and South America. Interestingly, Addax Petroleum, while listed in Canada, operates in the West African countries of Nigeria, Cameroon and Gabon, as well as in Northern Iraq. Elsewhere, it is worth noting that four of the ten largest outbound M&A deals done by Chinese buyers in the Oil & Gas space since 2005 were of Canadian targets. Aside from Sinopec's acquisitions of Addax Petroleum and its stake buy in Syncrude, CNPC International acquired PetroKazakhstan, the Canadian-listed company, for US$3.9 billion in June 2005, while China Petroleum & Chemical spent US$1.8 billion on the acquisition of Tanganyika Oil,

Chinese Outbound Oil & Gas investment case study - Canada Chinese buyers have long looked for M&A deals outside their own country to expand their footprint in the Oil & Gas space, with a significant amount of such outbound deal flow focusing on North America and, particularly, Canada. In recent years, the temperature has undoubtedly started to heat up and if the large-cap activity in the first quarter of 2010 is an indication of what is to come, the year could well see activity reach record heights. So what have been the key features of Chinese outbound M&A activity in the Oil & Gas sector? For a start, Chinese M&A activity in the space has been marked by a number of large-cap transactions coming to the market in recent times. Indeed, North America has recently become the key market for Chinese buyers in the Oil & Gas space, with the largest announced outbound deal being Sinopecs US$8.8 billion acquisition of Addax Petroleum, the Canadian-listed Oil & Gas exploration firm, in the third quarter of 2009. Looking at the deal size split of wider outbound activity, it is unsurprising that the bulk of deals fall

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another Canadian firm, in September 2008. Going forward, market observers predict that the love affair between Chinese buyers and Canadian targets is set to continue. But what makes these businesses so attractive to Chinese buyers? As touched on earlier in this piece, Chinese buyers are pursuing an aggressive acquisition strategy that will allow them to gain even greater access to resources. Aside from this strategic objective that Chinese buyers in the Oil & Gas space are keen to satisfy, there are a number of reasons why Canadian targets are willing to be bought out by the Chinese. Firstly, Chinese buyers have in most cases shown no interest in changing, or even taking over the management of acquired businesses. Instead, they are generally more interested in simply extracting its resources. Furthermore, in addition to buying businesses in the traditional Oil & Gas space, Chinese buyers are also showing interest in businesses involved in copper, molybdenum and oil sands extraction and production - all of which are plentiful in Canada. Finally, acquisitions are usually funded in cash, a fact that no seller would be unhappy about.

to the high quality of its assets, as well as their relative cheapness, with the countrys Alberta oil sands specifically garnering much attention from foreign investors keen to gain extractive exposure in this fast-developing niche. Investment in Alberta's oil fields has been made even more attractive due to the progressive royalty regimes that have recently been put in place by the provincial government. Recognizing that producers must deliver a rate of return on significant capital investments, the regime gives producers the opportunity to recoup some of their investment relatively early on. From January 2011, Oil & Gas firms in Alberta will benefit from, among other new initiatives: A maximum royalty rate on conventional oil wells of 40% of revenue, from 50%, and a shift to 36% from 50% for natural gas wells. A current maximum 5% royalty on the first year of a wells life, unless it hits a production threshold first (This policy was previously introduced merely as a temporary measure). None of this has escaped Chinese buyers who are eager to expand their footprint in the Oil & Gas industry. Still reeling from the fallout of the 2005 CNOOC/Unocal ruling, a deal which attracted significant political opposition in the US, Chinese Oil & Gas players are increasingly looking towards Canada as an investment destination. Is it because Canada provides a more favorable regulatory environment for foreign investors and has proved to be more understanding towards Chinese buyers? Local industry experts certainly believe so and point towards recent changes to two pieces of legislation that govern foreign investment into Canada: the Competition Act and the Investment Canada Act, both of which serve to expedite the country's M&A processes. Indeed, as a result of this, practitioners are cautiously optimistic about

The regulatory perspective: An interview with a leading Canadian legal advisor To gain an understanding of the challenges and opportunities open to Chinese investors in Canadas Oil & Gas space, mergermarket interviewed a leading legal advisor with experience in Oil & Gas sector dealmaking. Their comments form the basis of this feature article. Canadas stable political system, coupled with a strong legal framework, makes the resourcerich country an attractive investment destination for buyers from a wide range of geographic markets. Investors looking to do a deal in the Canadian Oil & Gas space are naturally drawn

the future, hinting towards a possible increase in M&A activity stemming from Chinese buyers snapping up Canadian Oil & Gas assets. Despite prior industry rulings which were widely construed to be primarily politically motivated, industry insiders stress that Chinese bidders are not being treated differently to buyers from other countries. Indeed, they are keen to point out that all foreign buyers have to go through the same procedures of submitting an application to the relevant local authorities. The ensuing discussion will then always center on the issue of whether the deal will ultimately benefit Canada. However, Canadian regulators have balanced the doubleedged sword well insofar as it has never been forced to implement additional procedures in place to further encourage investment. As to be expected, while encouraging foreign investment in the Canadian Oil & Gas industry, regulators will always have the national interest close to their heart. The impact of the abovementioned CNOOC/Unocal deal is still felt across the North American market although when it comes to the reception of Chinese buy-side interests in Canadian assets, the Chinese appear to have little to fear. Nevertheless, it is important to note that Chinese buyers still face difficulties when making an investment in Canada. However, challenges encountered stem less from regulatory issues and more from a transitional and/or operational viewpoint. Industry experts claim that the biggest challenge for Chinese buyers when doing a deal in Canadas Oil & Gas industry is making the transaction work post-deal, as opposed to actually executing the acquisition. How to generate value from minority stake investments, implementing appropriate and efficient decision-making processes in equal partnership agreements and

dealing with a lack of experience in relation to the operation of more complex ventures, such as oil sands, are all challenges that acquisitive Chinese buyers may need to address when transacting in Canada. These challenges are best overcome by teaming up with excellent local partners, something that Chinese buyers are already doing. This means that many locals that have witnessed investment from China are still being managed in the same way, with operational control lying with the old management team.

Chinese outbound Oil & Gas investments into Africa - an insider's view mergermarkets Douglas Robinson talked to Dr Martyn Davies and Steven Ombati of Frontier Advisory, an African-focused capital advisory, strategy, and research company, on the current state of play of Chinese Oil & Gas acquisitions in Africa, a market which has seen four M&A transactions being announced since the beginning of 2005. Martyn Davies is the regions foremost authority on China. He is CEO of Frontier Advisory and Director of the China-Africa Network at the Gordon Institute of Business Science, University of Pretoria. He is a regular commentator for the international media and is a regular contributor to Chinas CCTV-9 news channel. Steven Ombati is a Senior Analyst at Frontier Advisory. In this role he tracks relevant political and economic trends on the African continent and performs market research and analysis across diverse sectors including energy. He has recently been involved in monitoring the activities of Chinese Oil & Gas companies in Africa.

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Douglas Robinson: What do you feel have been the fundamental factors impacting Chinese Oil & Gas investments into Africa over the past decade? Martyn Davies: The vast bulk of Chinese Oil & Gas majors are state-owned and therefore, are chiefly driven to acquire abroad in order to ensure Chinas energy security over the foreseeable future. This need to secure dependent supplies of downstream Oil & Gas assets has been made all the more urgent given three recent events. Firstly, the US-led invasion of Iraq, which resulted in a sharp rise in crude oil prices; Secondly, the rejection, by the Committee on Foreign Investment in the United States, the US national security regulator, of CNOOCs bid for UNOCAL, in 2005; and finally, the agreement between Russia and Japan to route the Eastern Siberia Pacific Ocean oil pipeline to the Russian Pacific Ocean port of Nakhodka, which offers easy transshipment services to Japan, instead of to China. All three events ultimately resulted in Chinese Oil & Gas businesses increasingly looking to invest in Africa as one of the few remaining regions where large-scale Oil & Gas downstream targets are still available to buy. Africa is strategically open for Chinese investment. Aside from the strategic need to secure raw inputs, Chinese Oil & Gas firms are also targeting African assets in order to shield themselves, to some extent, from volatile price shifts in the Oil & Gas spot markets. For example, Sinopecs joint venture with Angolan firm Sonangol, Sonangol Sinopec, recently spent US$692 million acquiring stake holdings in three Angolan oil exploration blocks with cumulative proven reserves totalling 3.2 trillion barrels of crude a worthwhile investment given that a barrel of Brent Crude has risen in price by more than 20.0% over the past year.

Buying up African Oil & Gas assets is also a method of currying favor with Chinas fastestgrowing export market, which is expanding by more than 30.0% a year, as well as lubricating relationships from a political viewpoint. Douglas Robinson: Looking forward, a number of Chinese Oil & Gas majors have indicated that they are planning acquisitions in Africa over the next two years. Do you think that these market rumors will eventually come to fruition? Steven Ombati: Prospective Oil & Gas deal flow conducted by Chinese firms in Africa does indeed look like it will increase over the foreseeable future with the sale of Ugandan oil assets on Lake Albert to Chinese Oil & Gas player CNOOC looking especially likely over the coming 12 months. CNOOC has reportedly offered vendor Tullow Oil, the UK Oil & Gas exploration & production firm, US$2.5 billion for a rumored 50.0% stake in its two Ugandan oil fields. Chinese Oil & Gas majors are also likely to start making moves in Nigeria, with last years offshore oil exploration & production license auction indicating that competition for such assets is likely to be high going forward. Indeed, with further exploration and production licenses coming up for auction over 2010, Chinese Oil & Gas executives should begin readying themselves for the long flight to Lagos or Port Harcourt sooner as opposed to later. Douglas Robinson: Which Chinese Oil & Gas players do you think will prove to be the most acquisitive in Africa over the foreseeable future? Steven Ombati: We expect to see all the major Chinese Oil & Gas businesses moving into Africa, although we believe that CNOOC will most likely stand out as being the most acquisitive. This is

simply because, out of the big four players, the firm has the smallest number of downstream assets a situation which they are very keen to rectify. Reinforcing this perception is the fact that CNOOC (and to a lesser extent, Sinopec), were proactive in their pursuit of a US$1.3 billion for 20.0% stake acquisition in Angolan oil field Block 32, from US firm Marathon Corporation, in mid-2009. Douglas Robinson: What form do you envision this expected surge in Chinese Oil & Gas investments into Africa to take? Will it consist of offshore Oil & Gas exploration & production license/block purchases, or will Chinese firms look to acquire African corporate entities outright? Martyn Davies: I dont think its a question of how Chinese Oil & Gas firms are going to structure their future acquisitions in Africa. Instead, what we need to understand is that these players will structure an acquisition in any way possible if it means that they will achieve the ultimate aim of securing downstream assets. So, in answer to your question, I expect to see a real mixture of deal types moving forward. Douglas Robinson: Do you expect to see forthcoming Chinese Oil & Gas acquisitions in Africa taking place predominantly in the large-cap (US$500 million) space or not? Martyn Davies: Yes, Oil & Gas M&A overwhelmingly takes place in the large-cap space anyway and I dont think this particular niche will be any different. In addition, Chinese acquirers are cash-rich, have the political license to acquire assets abroad and arent afraid of spending big in order to successfully close a deal. Douglas Robinson: Do you expect Chinese Oil & Gas bidders moving to buy African assets will end up overpaying for them or

do you think they will achieve relatively fair value? Martyn Davies: While there have been some accusations that Chinese bidders have overpaid for African Oil & Gas targets in the past. I dont actually believe that Chinese acquirers have been ripped off in Africa. This is mainly because what can look like an overly-expensive Chinese acquisition in Africa also tends to include a substantial amount of project financing which goes towards the construction of supporting infrastructure projects ultimately dressing up the final price paid for the asset which isnt strictly the true value of the target. Douglas Robinson: Do you envision that Chinese private equity firms will also begin making Oil & Gas-based M&A acquisitions in Africa over the foreseeable future? Martyn Davies: At the moment, I dont see many Chinese-based private equity firms looking to invest into the African Oil & Gas space. However, this doesnt mean that it wont occur in the foreseeable future. As the valuations and profit expectations of African Oil & Gas companies rise, local investors could increasingly look to earn healthy returns on investment, perhaps by snapping up early-stage assets themselves, and then selling them onto Chinese Oil & Gas majors as they mature. Douglas Robinson: What are the foremost obstacles facing Chinese Oil & Gas businesses acquiring into Africa at the moment? Steven Ombati: Africa is a developing region and, while many potential Oil & Gas targets here are more than happy to be snapped up by a foreign corporate, there are signs that the beginnings of a backlash are starting to appear. The fact that Libyas National Oil Corporation

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exercised its right of first refusal to buy Verenex Energy, ultimately scuppering CNPCs bid, is a prime case in point, with both the Angolan and Nigerian authorities also taking a sterner view on Chinese Oil & Gas acquisitions within their respective jurisdictions. Continuing along this vein, I think that the other major hurdle that Chinese majors will face is a marked rise in competition for African targets. Chinese players in Africa have always faced stiff rivalry from other National Oil Companies, but as Africa develops and Oil & Gas prices remain high, I expect to see local players increasingly facing off against Chinese bidders for regional assets. Douglas Robinson: Do you think that African antitrust and/or other national security regulators are likely to prove a significant hurdle to Chinese Oil & Gas players looking to acquire in Africa? Steven Ombati: This is a good question insofar as while regulatory frameworks are starting to be set up in Africa to monitor precisely these types of transactions, its very difficult to assess the net impact they are likely to have on Chinese Oil & Gas acquisitions. For example, industry insiders widely consider that Nigerias recent Petroleum Industry Bill will reduce the attractiveness of Nigerian Oil & Gas assets as the authorities are believed to be adopting an increasingly protectionist attitude towards foreigners holding stakes in the country. However, increasing regulation can also have a positive impact on deal flow insofar as it solidifies otherwise opaque M&A regulations, or in some cases, creates them. Ugandas efforts to set up an M&A legislative framework is a case in point, with the authorities keen to attract foreign investment through the creation of a transparent regulatory environment which overseas players can feel

confident about investing in. In this regard, regulatory reforms are certainly a force for good. Douglas Robinson: Finally, what three pieces of advice would you offer a Chinese Oil & Gas player looking to acquire in Africa? Martyn Davies: In no particular order, the following advice should be needed: 1) Ignore pressure from third-parties with vested interests. Chinese investors tend to suffer from a lack of positive PR insofar as many broadcasters (wrongly in my view) correlate such transactions to wider, unrelated macroeconomic issues. My advice is to concentrate on the deal at hand and ignore outside criticism over the geographical implications of the transaction. 2) Manage political risk. I find that many Chinese Oil & Gas majors, whether publicly or privately-owned, are oblivious to political risk in Africa. Its therefore vital that Chinese acquirers looking to buy in the region take onboard all aspects of political risk. 3) Dont 'do a Shell' in the Niger Delta. Avoid Royal Dutch Shell's experience in the Niger Delta, which (to some observers), was a primary driver of the Nigerian Civil War in the 1970s. Such disastrous programs of engagement with local communities and lack of environmental concerns can only have negative repercussions. Avoid the mistakes of many traditional western firms.

Chinese outbound Oil & Gas investments into Africa - Deloitte's standpoint mergermarkets Douglas Robinson talked to Anton Botes, Director and Leader of the Oil & Gas Industry unit of Deloitte Consulting in South Africa, as well as the Leader of its Africa division. Douglas Robinson: How do you view Africas Oil & Gas industry and Chinas interest in it? Anton Botes: Africa is in many respects seen as the last frontier, with its oil and gas reserves attracting the attention of many large Oil & Gas NOCs including players from USA, Russia, China, the Middle East, India and Europe. And with good reason too because, if you look at the top 500 African companies over 2009, 12% were involved in the Oil, Gas and Petroleum industry, collectively generating an annual turnover of $148.7 billion, which accounted for 26.3 % of the total turnover (excluding Financial Services sector firms) of this prestigious group of corporations. It is clear that Africa holds tremendous potential with proven oil reserves making up 10% of global totals according to a 2004 estimate. In addition, exploration for new sources of Oil & Gas inputs has recently slowed in many of Africas oil-rich countries due to political instability, ultimately meaning that current real reserves in Africa could be much higher. Chinese companies continued focus on African Oil & Gas reserves is therefore a wise strategic and long-term decision - both for China, which is in need of Oil & Gas inputs, and Africa, which is in need of foreign direct investment (FDI). Douglas Robinson: In your last remark, you implied a mutually beneficial relationship between China and Africa. Can you elaborate on this?

Anton Botes: We have been tracking the relationship between Chinese investment and African economic growth and it is clear that Chinese FDI has played a large role in sustaining Africas growth metrics throughout the economic downturn. In addition, the Chinese authorities have made it clear that they are committed to the development of Africa and are not only interested in its resources. The various recent visits to African countries that are not traditionally viewed as resource-rich by Chinese President Hu Jintao, as well as the fast amounts of monetary assistance in general, are all indicative of this statement, as does Chinas official view on Africa, first publicized in its 2006 Africa First policy which states: China is working to establish and develop a new type of strategic partnership, characterized by equality, mutual confidence and trust in the political sphere and mutually-beneficial cooperation in the economic sphere. There are also peculiar similarities between Africas predominant Ubuntu ethic and Chinas Confucian philosophy, both of which propagate an adept understanding of the co-existence of happiness and sorrow, as well as with others. This deep cultural understanding, as well as other factors, means that both Africa and China are well-placed to strengthen economic, as well as political relationships over the foreseeable future. Douglas Robinson: We are now touching on more qualitative aspects of dealmaking on the continent. How do Chinese companies approach the regulatory and political hurdles of transacting in Africa? Anton Botes: The risks and challenges associated with Africa have, in the past, led many Western companies to avoid parts of the continent as viable oil-producing regions due to onerous

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political, regulatory and reputational risks. Yet, while the traditional European and American ways of doing business have resulted in various difficulties when interacting with African countries, the Chinese companies have adopted an approach of non-interference. This improved match in business cultures, therefore, supports strengthening trade ties between China and Africa at the expense of Western businesses that are not willing to invest in the region. Furthermore, Chinese M&A bids are further strengthened by an intense diplomatic effort which often provides grants and aid unconditionally. Although much criticism is bestowed by the West on Chinas modus operandi in dealing with political issues, many African countries view Chinese investment as a welcome reprieve from Western capital inflows, which locals perceive to come with onerous conditions attached. Ultimately, this means that they appreciate Chinas more positive focus on mutually beneficial relationships. Douglas Robinson: This leads me to another question concerning your view on environmental issues. Do you think the Copenhagen Accord has had an impact on the Oil & Gas industry in Africa? Anton Botes: Since December 2009, 25 African countries have indicated support for the Copenhagen Accord, with South Africa being the only African country to firmly and publically declare a commitment to reduce national carbon emissions. The South African Government is on the brink of finalizing its first piece of climate change legislation which will set the framework for national carbon emission reductions of 34% by 2020 and 42% by 2025. In addition, Government is exploring fiscal instruments to encourage reductions in carbon emissions including the proposed introduction of a carbon tax by the

National Treasury. While many other countries have not yet made formal commitments to measure and reduce their carbon footprint, it is likely that, over the short term, they will come under increasing pressure to declare their carbon reduction commitments and begin implementing legislation and regulation to ensure that reduction targets are met. Investors are hoping that these will emerge over the coming two to three years, with further details of reduction commitments likely to emerge at the UN COP16 meeting in Mexico later this year, as well as the UN COP17 meeting in South Africa in 2011. Meanwhile, the South African Government is on the brink of finalizing its first piece of climate change legislation which will set the framework for national carbon emission reductions of 34% by 2020 and 42% by 2025. In addition, Government is exploring fiscal instruments to encourage reductions in carbon emissions including the proposed introduction of a carbon tax by the National Treasury. Hopefully such legislation will galvanize other African countries into action, many of whom have not yet declared their carbon emission reduction targets. Investors can be assured that these will emerge over the coming two to three years, with further details of reduction commitments likely to emerge at the UN COP16 meeting in Mexico later this year and UN COP17 meeting in South Africa in 2011. Douglas Robinson: Finally, what three pieces of advice would you offer a Chinese Oil & Gas player looking to acquire in Africa?

Anton Botes: I think the following snippets of advice should prove to be useful for acquisitive Chinese Oil & Gas players: 1) Understand the various cultures in Africa: Although there are touch points between African and Chinese culture, Africa, like China, has many sub-cultures. Studies have shown that many economically viable acquisitions fail due to cultural misunderstandings and sound future co-operative mechanisms. For instance, in an oil-rich country such as Nigeria, there are 36 states and 36 state governors. English is the official language but the country has four main languages and 4000 other dialects, indicating to good effect, the vast array of sub-cultures, leadership structures and ranges of culturally sensitive stakeholder interactions required to make acquisitions sustainable over the long term.

2) Understand and manage risk: Due to the work that Deloitte undertake, we are often engaged in assessing and providing structures and processes to manage all manner of risks, including political, regulatory, tax and customs, infrastructure, economic, social, environmental and technological risk issues. Companies that manage these risks efficiently end up being the companies that do well and ultimately achieve their long-term goals. 3) Capitalize on a technically sound skills base: Although Africa is often cited as lacking in technical and managerial skills, many young African graduates residing abroad strive to return home to utilize their skills. These individuals have the requisite local knowledge and could greatly assist in ensuring successful acquisitions by aligning and bridging managerial and cultural styles.

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Deloitte principal contacts

Lawrence Chia Partner, Financial Advisory Services National leader of Financial Advisory Services Beijing, China Tel: + 86 (10) 8520 7758 Email: lawchia@deloitte.com.cn Charles Yeung Partner, Audit National Leader of Energy & Resources Hong Kong, China Tel: + 852 2852 5601 Email: chayeung@deloitte.com.hk

Ivan Wong Partner, M&A Transaction Services FAS Head of Energy & Resources Beijing, China Tel: + 86 (10) 8520 7756 Email: iwong@deloitte.com.cn

Yuan Yu-Dong Director, Financial Advisory Services Shanghai, China Tel: + 86 (21) 6141 1668 Email: ydyuan@deloitte.com.cn

John Abbott Executive Advisor, Financial Advisory Services Calgary, Canada Tel: +1 403 267 1809 Email: joabbott@deloitte.ca

End notes

Publisher: Naveet McMahon naveet.mcmahon@mergermarket.com Analysts: Douglas Robinson Matthew Albert Tom Coughlan Editor: Catherine Ford Production: Anna Henderson anna.henderson@mergermarket.com Joyce Wong joyce.wong@mergermarket.com Managing Director: Erik Wickman erik.wickman@mergermarket.com

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