msnbc.com staff and news service reports
updated 6/21/2005 1:48:45 PM ET 2005-06-21T17:48:45

To help fuel the growth of the country’s red hot economy, China’s third-largest oil company is considering trying to outbid energy giant Chevron’s $16.5 billion offer for U.S. oil and gas producer Unocal. But such a bid would face significant political hurdles in Washington and financial opposition from investors, say analysts.

The board of state-run China National Offshore Oil Corp. is scheduled to meet this week to review a potential bid. After rejecting an earlier proposal to buy Unocal, the board is set to approve the bid, according to the Financial Times. If successful, the deal would be the biggest-ever overseas acquisition by a Chinese firm.

Some analysts warn that attempting such a huge takeover could be a disaster for the Chinese oil firm. To finance the deal, CNOOC would have to sell off large chunks of Unocal’s assets, according to Bear Stearns oil analyst Adam Clarke.

“Entering into a bidding battle against supermajor Chevron Corp. could be the undoing of CNOOC,” Clarke wrote in a research report earlier this month.

Oil demand surging
China clearly needs to acquire more oil to keep up with the growth in demand. After passing Japan as the world's second-largest consumer of oil in 2003, China now accounts for some 40 percent of the growth in global demand, according to the U.S. Department of Energy.

To help fuel that demand, China restructured its oil and gas industry in the late 1990s, and sold minority stakes in three firms to foreign investors to raise capital. CNOOC, the third largest, handles offshore exploration and production.

Nearly 90 percent of China’s oil comes from domestic production. But with demand surging, China has been busy buying up oil concessions around the world, including deals in Kazakhstan, Venezuela, Sudan, Iraq, Iran, Peru and Azerbaijan. 

With global oil demand approaching the limits of production capacity, China has also begun building storage facilities for strategic oil reserves — similar to those maintained by the U.S. and European countries. A storage tank farm in the port city of Ningbo, in the booming east coast province of Zhejiang, is scheduled for completion in August. But with prices nearing $60 a barrel, it’s not clear when China will begin filling the first of its planned 100-million-barrel stockpile.

Though China’s planned reserve is far smaller than the U.S. strategic reserves of 700 million barrels, any oil diverted to those stockpiles could put further strain on an already very tight global oil market. The U.S. reserve is expected to top off at full capacity in August

A CNOOC takeover of Unocal, the ninth largest U.S. oil and natural gas producer, would help secure more capacity. And despite the pile of debt CNOOC would have to take on to buy Unocal, some analysts think the acquisition could make sense — especially if oil prices continue to rise.

"I have a 50/50 view on oil prices. If they keep increasing, CNOOC's bid should be a smart one," said Clive Zhang, chief investment officer at Partners Capital Asset Management, which does not hold CNOOC shares.

But investors in CNOOC stock aren’t convinced. Despite the rise in oil prices, CNOOC’s shares have fallen in recent weeks on fears that a possible Unocal bid could hurt the company’s earnings prospects. The stock fell another 3 percent on Tuesday. 

"This is a good test for CNOOC and also other Chinese companies making overseas acquisitions. Will they give priority to minority shareholders' interest?" asked Gideon Lo, an analyst at DBS Vickers Securities.

Chevron, meanwhile, is defending its Unocal bid, which has already won approval from U.S. regulators and is expected to close later this year. Two California lawmakers have urged the Bush administration to review and possibly block any bid by CNOOC.

CNOOC would also have to top Chevron’s bid, which includes stock, cash and assumption of $1.6 billion in debt. That would bring the bidding close to $20 billion, according to analysts, including the cost of a $500 million “breakup fee” it would owe Chevron.

Reuters contributed to this report.

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