Much comment has been made on the perceived threat posed by Asian national oil companies' (NOCs) expansionist moves to Western international oil companies (IOCs) interests and energy-supply security in general. While it is true that the international expansion of the Asian NOCs has increased competition for opportunities in some areas, the conventional wisdom that the Asian NOCs are unfairly dominating the upstream M&A sector and indulging in a "win at all costs" strategy is questionable. Asia's most expansive NOCs (China's CNPC/PetroChina, Sinopec and CNOOC Ltd., India's ONGC, and Malaysia's Petronas) completed upstream asset and corporate acquisitions amounting to US$13 billion during the five-year period from 2001-05. However, given the upstream value of the organizations involved, estimated by U.K.-based energy research and consulting firm Wood Mackenzie at around US$360 billion, the scale of NOC acquisitions remains relatively modest. This is underlined by a comparison with the M&A activity of IOCs. For example, ConocoPhillips' December 2005 bid for Burlington Resources was valued at US$35.6 billion, and during the five-year period of 2001-05 completed acquisitions for a comparable five-company IOC group (BP, ConocoPhillips, ENI, Occidental and Devon Energy) totaled in excess of US$33 billion. Another point is that, contrary to popular perception, the Asian NOCs have not drastically overpaid for asset acquisitions. Even when the impact of rising commodity prices is removed, the majority of acquisitions made during 2001-04 have provided adequate, if not spectacular returns. Furthermore, deals completed during the last two years imply long-term oil prices that compare favorably to the increasingly inflated prices paid by some leading international companies. By targeting areas of higher political risk and avoiding head-on competition with established IOCs, the Asian NOCs have been able to access substantial opportunities at reasonable prices. Cooperation among some of the companies has increasingly been used to mitigate the risk of overpaying. Development of trading and government-to-government relationships has also been employed, most notably by Sinopec in Angola, to gain access to upstream acquisition opportunities. Deal-making Some of the largest deals attracting industry headlines during the past five years have been CNOOC's US$2.3-billion purchase this year of a stake in the deepwater OML 130 project in Nigeria from Sapetro; the US$4.2-billion acquisition of PetroKazakhstan by CNPC in October 2005; and CNOOC's unsuccessful US$18.5-billion bid for Unocal in mid-2005. Further, at press time, CNPC and ONGC are reported to have submitted a joint bid to acquire Ominex in Colombia, while CNOOC is understood to be evaluating a potential purchase of Nations Energy in Kazakhstan. Sinopec has also been revealed as the successful bidder in TNK-BP's US$3-billion-plus sale of its Udmurtneft production unit in Russia. Sinopec, through the Sinopec-Sonangol joint venture, has also grabbed industry headlines by offering a reported US$2.4-billion signature bonus for deepwater exploration blocks 17 and 18 offshore Angola. CNPC, the largest of the Asian NOCs and of supermajor scale, is financially capable of launching an acquisition bid in the US$20- to US$40-billion range. Given that CNPC's strategy is to diversify its portfolio and expand its range of upstream capabilities, a step change in the scale of the company's acquisitions is a distinct possibility. Contrary to popular belief, an analysis also suggests that the Asian NOCs have not paid substantial premiums for the assets that have been acquired to date. A look back at deals completed from 2001-04 shows that, using current oil-price assumptions, the majority of deals will produce rates of return in the range of 15% to 20%. Even when the impact of increasing commodity prices is taken into account, the value created in most deals is estimated by WoodMac to be adequate, with rates of return of around 10% being achieved. There is little evidence that the Asian NOCs have completely discarded financial returns to acquire oil output at any price. The contention that "win at all costs" tactics are being pursued by the Asian NOCs in asset acquisitions is simply not substantiated. WoodMac has undertaken a review of deals completed by the Asian NOCs in 2005 and 2006 using the firm's asset-by-asset economic models. Based on the analysis of the assets acquired, the Asian NOCs have paid considerations that imply long-term oil prices in the range of US$23 to US$35 per barrel. In an increasingly buoyant asset market, which has seen implied prices move towards US$50 per barrel, the asset acquisitions made by the Asian NOCs look attractive. Awider comparison with major deals completed by IOCs underlines the attractive pricing of the NOC deals. During the last two years, implied oil prices in major international upstream transactions (deals of more than US$100 million) have risen from around US$20 per barrel to some US$40. Headline deals, such as ConocoPhillips' acquisition of Burlington Resources and Apache's acquisition of BP's shallow-water assets in the Gulf of Mexico, have implied long-term oil prices towards US$50. Based on the WoodMac analysis, the deals completed by the Asian NOCs fall below the trendline of increasing prices paid by IOCs. On a purely financial basis, the recent acquisitions made by Asia's NOCs may appear attractive. However, the majority of assets acquired by the Asian NOCs have been in countries of elevated political risk. In a time of heightened global uncertainty, and with IOCs shying away from political risk, it is perhaps unsurprising that the Asian NOCs have achieved access to attractive upstream assets at lower-than-average prices. However, the group of five NOCs is well-placed to take on these risks. With each company's core domestic operations unlikely to face substantial political disruption, expropriation or major hikes in fiscal take, the Asian NOCs may be more willing to assume overseas risks. Furthermore, with state governments remaining majority owners, the companies are better placed than IOCs to mitigate overseas political risks through direct political influence and relationship-building. Internal advantages As well as targeting regions of higher political risk at the periphery of IOC interest, the Asian NOCs are increasingly engaged in cooperation as a means to access upstream opportunities. Cooperation among the five companies themselves and with the NOCs in host countries are both being utilized. Joint bids have been made by various combinations of CNPC, Sinopec, ONGC and CNOOC during the last five years, most recently by CNPC and ONGC for PetroCanada's holding in Syria. The overseas asset acquisitions of the three Chinese companies are coordinated by the Chinese government. Chinese companies need to apply to the National Development and Reform Commission (NDRC) to gain permission to progress with international bids. In cases of multiple requests to bid for the same asset, approval is typically granted to the company that submits its bid first to NDRC, although in strategically important assets the NDRC can take more direct involvement in awarding approval. During the last few years this has produced coordinated cooperation among the Chinese NOCs in overseas acquisition. The result has been joint acquisitions or the involvement of only one Chinese company in overseas competitive bidding situations. CNPC and ONGC of India have also emerged as joint acquirers of overseas assets. The most significant recent development is a joint venture with India's ONGC to acquire PetroCanada's assets in Syria. This was followed by the signing of a broad-based cooperation agreement between CNPC subsidiaries and ONGC in January 2006. The long-term viability of a substantive partnership between CNPC and ONGC remains to be fully tested, although a joint bid for assets in Colombia is reported to be under consideration. Of perhaps more significance is the emergence of cooperative relationships between the Asian NOCs and the governments and NOCs of host countries. Petronas has targeted countries of political and cultural affinity to Malaysia, particularly in Africa. Meanwhile, some overseas acquisitions by Chinese companies have been linked to Chinese government aid and the development of engineering projects in that country. The most high-profile example is Sinopec's investment in Angola. By using Sonangol's pre-emption rights, Sinopec gained access to a 50% interest in the important Block 18 deepwater development during 2004. The deal was assisted by a US$2-billion credit line from China to the Angolan government. Sinopec has subsequently developed its relationship with Sonangol. The Sinopec/Sonangol JV took a 25% stake in Block 3/80 in July 2005 upon the expiry of Total SA's development license and has made successful bids in the current deepwater licensing round. Agreements have also been signed on a long-term crude oil supply deal and plans for a joint study for a new refinery in Angola. The importance of the Sonangol/Sinopec JV relationship is illustrated by the fact that Angola is currently China's single-largest crude oil supplier, ahead of Saudi Arabia, Iran and Russia. Objectives Although cooperation between Asia's NOCs has been witnessed, it is important to recognize each company as a distinct organization. The companies are of varying scale, have differing strategic goals and can call upon varying capabilities and resources. The drivers to engage in international upstream M&A therefore vary across each of the five companies. Even common themes, such as Chinese government objectives regarding oil security of supply, weigh more heavily on some companies than others. With these thoughts in mind, we examine each of the five companies with respect to future moves in upstream M&A. CNPC/PetroChina This is China's largest onshore oil producer and the largest of the five Asian NOCs. Of supermajor scale, it has the resources to expand substantially in the international upstream arena and has bold strategic objectives to compete with the largest international players. It has both the motivation and means to step up its M&A activity-its considerable financial firepower means a deal in the US$20- to US$40-billion range would not be out of the question. Arguably, a deal of this scale can be expected if the company is to truly internationalize its operations, access material growth opportunities and start to address Chinese government supply-security concerns. In addition to bolt-on deals in existing core areas of operation, CNPC might also look to the asset market to help address strategic gaps in its portfolio. The Canadian oil-sands sector could make an excellent strategic target for CNPC, providing access to massive, long-life oil resources. Offshore expertise, high-impact-and particularly deepwater-exploration and global gas opportunities-and the pursuit of skills that it can apply to its domestic business-are also likely target areas for an increasingly bold and internationally expansive CNPC. Sinopec This is China's second-largest oil producer and the country's leading downstream and petrochemicals player. It has lesser financial resources than CNPC/PetroChina and is currently burdened with negative margins in its domestic refining operations. It appears it has effectively ruled out large-scale corporate acquisitions in the upstream sector. Instead, the company is likely to focus on the acquisition of upstream assets in resource-rich areas, such as the Middle East, Caspian, North and West Africa, South America and Russia. Sinopec's international expansion moves have also, to date, included a bias towards exploration. Significant acreage positions have been acquired in Kazakhstan, Yemen and Saudi Arabia. Exploration will continue to be an important theme in Sinopec's future expansion strategy. The news of very aggressive bids in Angola's deepwater licensing round is not surprising, although the scale of the bids is perhaps the one instance where project returns appear to have taken second place to the strategic goal of securing the asset. Sinopec is also likely to exploit its position of access to the Chinese downstream market as it seeks to secure further international opportunities, and seek upstream opportunities by using oil and liquefied natural gas (LNG) trading agreements, thereby avoiding competition with other NOCs and IOCs in the M&A market. It is likely to consider supporting investments in downstream infrastructure in host countries as a means to develop overseas relationships, and will attempt to replicate its success in Angola where it has developed a key relationship with the state's Sonangol in its other target areas: Africa, South America and the Middle East. CNOOC Ltd. This is China's offshore oil producer and holds a first-mover advantage in the development of LNG import terminals in southern China. Its US$18.5-billion bid for Unocal in 2005 revealed the scale of its ambitions in the M&A market. However, another acquisition attempt on the scale of Unocal is unlikely in the near term. Strong competition from other international players, political opposition in the U.S., integration concerns and the fear of another high profile failure are all likely to discourage CNOOC from another major corporate acquisition attempt in the near future. The focus is likely to return to asset and smaller corporate acquisitions that complement its existing business. Asia-Pacific, Africa and Central Asia are likely to be the main areas of attention and further deals on the scale of the recent US$2.3-billion Nigeria deepwater acquisition can be expected. What is more unclear is whether, in its drive to achieve the desired scale of business and ensure continued internationalization, it will seek more significant corporate acquisitions. A corporate acquisition of up to US$10 billion would not be out of the question if the target company provides a suitably attractive strategic fit. Non-U.S.-owned companies with exposure to offshore growth developments, particularly in Africa, would be the most likely targets. There are currently limited opportunities that fall into this category. On balance, therefore, we believe that future M&A activity will focus on further asset deals and corporate acquisitions in the US$2- to US$4-billion range. ONGC This is India's leading upstream player and, in terms of asset value, ranks alongside Sinopec and CNOOC. Despite having been frustrated in some of its recent M&A initiatives, ONGC remains committed to an acquisition-led international growth strategy. Demonstrating the company's ambitions in M&A, it recently stated that it is in negotiations to acquire more than US$15 billion of foreign oil and gas assets. Opportunities currently being pursued include the underwriting of part of Rosneft's multibillion-dollar part-privatization in 2006 in return for a long-term strategic alliance that could open opportunities in Russia and provide Rosneft with access to ONGC's Indian refining and gas projects. ONGC has also yet to make a significant breakthrough in Central Asia and, accordingly, a potential bid for Nations Energy in Kazakhstan is a distinct possibility. In common with the Chinese NOCs, an entry into the Canadian unconventional oil sector will also remain on ONGC's radar screen. Despite ONGC's undoubted M&A ambitions, a US$10-billion-plus corporate acquisition is highly unlikely. The focus will be on smaller asset and corporate deals in the US$2- US$3-billion range. ONGC is also likely to make greater use of strategic alliances as it develops its international portfolio. With access to both the Indian upstream and downstream markets becoming increasingly sought after, the company's dominant domestic position provides a significant competitive advantage. As such, ONGC is likely to seek to leverage strategic alliances, such as those already in place with Shell, ENI and BG, into new international opportunities. Petronas This Malaysian NOC has ambitions to rank in the second tier of major IOCs. It is a major player in the Pacific LNG market and its domestic oil prospects have been transformed in recent years by a number of deepwater discoveries in Sabah. Petronas retains significant financial firepower it could direct at further M&A. As of March 2005, the company was in a net cash positive position of some US$5.9 billion and, with high levels of free-cash-flow generation, this position will have strengthened. However, despite its financial position, the balance of Petronas' growth will likely remain organic-led and a step change in M&A activity is not envisioned. The current inflated asset prices and a lack of M&A opportunities that fit the company's strategic objectives are likely to limit future deal activity. Furthermore, unless an acquisition is of a highly strategic nature, Petronas has a relatively low risk tolerance when it comes to big investments in M&A. There is little opportunity for Petronas to expand its upstream LNG portfolio through the asset market, and limited corporate acquisitions targets that would fit tightly with its strategic objectives. Rather, Petronas will likely continue to seek bolt-on asset deals in the Asia-Pacific region as it looks to further strengthen its portfolio of gas-supply assets. Of a potentially larger scale, the asset market may also be put to work in addressing a lack of deepwater development experience, although, so far, Petronas' preference appears to be to gain deepwater experience through exploration with production-sharing-contract (PSC) partners in Malaysia. Further downstream, the purchase of LNG regas capacity in North America or Mexico and the addition of new European regas capabilities cannot be ruled out. With a strong and developing domestic business, Petronas has a number of attractive bargaining chips that could be used in future deals. And it is perhaps through more innovative transactions, rather than straight asset acquisitions, that Petronas will develop its upstream business. Conclusion Going forward, the international upstream M&A market is likely to remain extremely active. The growing cash piles of the large-cap companies and a relative lack of organic growth opportunities is increasing pressure to make further acquisitions. Should oil prices dip sharply (and share prices fall faster), the financially secure, larger players will move to acquire the most attractive of the second-tier companies. In the past, Big Oil has had this playing field to itself. In the future, as the Asian NOCs become more experienced in the M&A market and begin to punch their relative weight, a new axis is likely to appear, with the establishment of Big Eastern Oil as major international players on a scale to rival Big Western Oil. M Norman Valentine and Tom Ellacott are senior analysts with U.K.-based energy research and consulting firm Wood Mackenzie in its corporate analysis group. Valentine has spent the past seven years analyzing the upstream industry in the Asia-Pacific region. Ellacott is responsible for research on the supermajor and major oil companies.