Still tempting

Still tempting
Illustration: Huan Tran
Canada still tempts cash-rich state-owned enterprises, even in the closely watched energy sector, but government rules and the deliberate ambiguity that surrounds them are making it hard to advise clients how to proceed and factoring into a steep investment slowdown.

The slowdown, in a sector that needs billions of dollars to fund ambitious expansion plans, started in 2012, after Ottawa approved two big takeovers by state-owned enterprises, the $15-billion purchase of Nexen Energy by CNOOC, the Chinese National Offshore Oil Corp., and the $5-billion purchase of Progress Energy Canada Ltd. by Malaysia’s Petronas. But the government also said it will allow further takeovers in the oilsands sector by state-owned enterprises in exceptional circumstances only, a line in the investment sand nobody wants to be the first to test.

“Exceptional circumstances as yet have not been defined, and I don’t think anybody expects them to be defined until there is actually an application or an interest by an SOE to buy some additional oilsands control or additional oilsands business,” says Colin MacDonald, a partner in the corporate commercial group at Borden Ladner Gervais LLP in Calgary, whose areas of expertise include government relations, competition, and foreign investment law. “What it doesn’t prohibit is minority interest, or joint-venture interest. It also doesn’t prohibit SOEs from making investments in any other sector of the Canadian economy, including energy outside of the Canadian oilsands business.”

State-owned enterprises also have the option of boosting the size of an investment they already have, without triggering new government reviews. “We’ve got a bunch of players that are already in there, and they can continue to fund by way of additional capital contributions the advancement of those projects without having to trip over any new Investment Canada rules,” says Craig Hoskins, a partner at Norton Rose Fulbright in Calgary and an adviser to public and private corporations.

He described the changes to investment rules as they relate to state-owned enterprises as “an incremental increase” in the uncertainty that has always surrounded foreign takeovers in Canada rather than a deal killer. “If you wanted to do another corporate acquisition you’d be subject to Investment Canada rules, but since you’ve already got a sizeable interest in an early-stage project you are going to be bringing in capital to fund that.”

The net benefit test in the Investment Canada Act has long been one of the uncertainties for foreign firms seeking to invest in Canada, especially after the surprise 2010 rejection of BHP Billiton’s bid for Potash Corp. of Saskatchewan Inc. The lack of clarity over what is meant by net benefit gives the government more flexibility, but also make it harder for a company to determine in advance if a proposed transaction is likely to pass the test.

But a broader definition of what is meant by a state-owned enterprise has made the pitch harder for lawyers working with Asia’s state-owned enterprises, a diverse group of companies with different economic and strategic priorities.

In its latest rulings, Canada’s view on what is a state-owned enterprise has moved beyond the traditional idea of a firm directly owned by a foreign government to encompass ones that are influenced by governments, perhaps via indirect investments, government representation on a company’s board, or favoured terms in the domestic market. Experts say that has reduced clarity rather than adding to it, boosting the challenges for would-be investors. “There’s a significant amount of confusion that’s been created in the marketplace around what constitutes an SOE . . . and it impacts the confidence that those potential acquirers have that they can proceed with their transactions without invoking the concerns that the Canadian government may have,” says Keith Chatwin, a partner at Stikeman Elliott LLP in Calgary.

He notes would-be acquirers may have to provide detailed answers to questions on how they may be influenced by a government, and that SOEs might not always be able to disclose this information. “It’s proving to be quite challenging.”

For an investor, the dream is to find a transaction that will boost its profits, meet its strategic or security considerations, and then sail through Canada’s regulatory system without triggering long reviews. The nightmare is a drawn-out review process focusing on a company’s status, national security issues, or the net benefit test that forms a key part of the approval process. If long delays look likely, an investor may focus on another country instead of looking at Canada, despite almost unparalleled energy resources here.

Concerns about Canada’s national security would likely derail any attempt to buy up big pipeline operators like Enbridge Inc. or TransCanada Corp. But the national security review process is opaque, and the timeline for approval can be stretched in a way that could put the overall investment at risk. And while the Canadian capital market is far too small to provide the billions of dollars it will take to develop the oilsands, Canada has a distinct middle-of-the-road ranking in the Foreign Direct Investment Regulatory Restrictiveness index of the Organisation for Economic Cooperation and Development, reflecting the inward investment screening within the Investment Canada Act.

“It used to be about three out of four OECD members screened incoming investment, and now there are only five or six left, and one of them is Canada,” says Stephen Thomsen, a senior economist at the Paris-based institution. “We do find that more restrictive countries tend to receive less investment.”

Of course there are other factors behind the latest investment slowdown, and lawyers point to regulatory delays in approving pipelines and terminals, global competition for resources, and a diminishing appetite for energy from the United States, where oil and gas production is booming. Companies find it hard to convince critics about the advantages of a project amid tough opposition from environmentalists and First Nations. “Neil Young is putting up roadblocks now.
What next?” Hoskins asks.

Rock star Young held four concerts in Canada in January to raise money to help the Athabasca Chipewyan First Nation fund its legal challenge to the expansion of Shell Canada Ltd.’s Jackpine oilsands mine. In comments that provoked outrage in Calgary, Young described the oilsands developments as “a disaster area from war.”

Many observers see the liquid natural gas sector as the next big opportunity for Asian firms, given British Columbia’s relative proximity to energy-hungry Asia, and the fact low North American prices for natural gas boost the profit margins for terminals and exporters. It’s not an area where the state-owned enterprises face specific curbs, but Canada’s regulatory cogs grind slowly, and there is rising global competition in the race to build and operate terminals that can liquefy gas and export it to Asia.

In a global market profit-focused SOEs may find it easier to put their money elsewhere. “The world is looking at our LNG capability now,” says Mike Laffin, a partner at Blake Cassels & Graydon LLP in Calgary and head of the firm’s energy group. “The difficulty there is we are in a real race with the United States for this. The window has not closed, but it’s not like we can wait another five years before we make decisions on this.”

Don’t count Canada out of the foreign investment game yet, the experts say, given a clear legal framework and a still healthy investment climate. “We are a democracy. We are unlikely to nationalize their resources and take away their investment,” says Chatwin. “It’s a stable environment. It’s a legally well understood and functioning system, but there are a significant number of impediments. It’s a balancing act for them to determine where they are going to put their capital.”

Hoskins says it’s important for would-be investors, including state-owned enterprises, to keep lines of communication with the government open, so there are no surprises. “Our advice is if you are interested in the space . . . keep your government activities going and meet regularly with decision-makers in Ottawa,” he says. “Have a dialogue on what your objectives are.”

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