07/27/2012 05:58 EDT | Updated 09/26/2012 05:12 EDT

Should the U.S. Stick Its Head in Our Oil Sands?

Senator Chuck Schumer, New York Democrat and one of the leading figures in the Democratic majority, wants the U.S. government's Committee on Foreign Investment in the United States (known as CFIUS) to intervene to block the China National Offshore Oil Corporation (CNOOC) -- a state-owned firm -- from purchasing Nexen, a Canadian energy company active in the oil sands of Alberta.

At first glance, it seems awfully presumptuous of the United States government to intervene at all. But CNOOC actually requested the CFIUS review of their investment to avoid future trouble. Since the Chinese have posed the question, should the United States make trouble?

Senator Schumer and some prominent Republicans have concerns about the investment, but they have called on CFIUS to block the CNOOC investment in Nexen in order to make a point about reciprocal access to the Chinese market for U.S. and Canadian investors. And while the Nexen sale may go through, U.S. politicians are signaling that the United States is watching China carefully, and could intervene against future investments.

This kind of political posturing is understandable in a U.S. election year. China is a rising power with an impressive economy built around large, state-owned firms like CNOOC. U.S. officials blocked CNOOC's investment in Unocal in 2005 out of concern that the Chinese government would manipulate the investment for strategic purposes.

Sovereign wealth funds and state-owned firms are not always bad, but pose problems in a free market context when they behave according to political dictates and not to generate the best returns to their shareholders the taxpayers.

And it is true that China often does not treat foreign investors in China fairly, often providing legal sanction to the theft of intellectual property and canceling contracts for political reasons. China has historically been plagued by corruption, even within the ruling Communist Party.

To understand Chinese behaviour, it has to be recognized that China's economy is dependent on imported resources and needs secure access to foreign supplies of energy, including oil. In the past, CNOOC has invested in dodgy places like Sudan to gain access to oil. In a developing country with weak rule of law and poor state capacity, Chinese investment can finance local corruption and even human rights abuses.

As a country with a history of outside interventions by imperial powers, Chinese foreign policy has traditionally avoided intervention in the domestic affairs of other countries. As a result, China has been accused by the governments of Canada and the United States (among others) and civil society groups of turning a blind eye to the human rights and environmental records of the countries that benefit from Chinese investments.

Now, with Nexen, China is seeking to invest in a western country with strong rule of law: Canada. Moreover, Canada and the United States have pledged (in the Canada-United States Free Trade Agreement) not to withhold oil supplies from one another even in times of shortage, so Nexen could not divert oil to China from North American buyers that had contracted for it at a market price.

The real challenge of the CNOOC purchase of Nexen is for China to show that its state-owned firms can play by the rules in a well-governed market economy. Accordingly, the last thing that either Washington or Ottawa should do is to politicize the investment review process -- exactly what China has been accused of doing at home. Instead, CNOOC should be allowed to make a transparent investment and demonstrate, by its behaviour, that it will be a good investor and corporate citizen in North America.

To that end, neither Washington nor Ottawa should bend or waive the rules for CNOOC, either. The Chinese company should be treated fairly, like any other foreign investor, so long as it behaves by that standard. And herein lies the strategic opportunity in the Nexen deal.

After the Japanese invasion of China's Manchuria province in 1931, the League of Nations imposed an oil embargo on Japan -- like China, an oil-poor rising economy at that time. Although meant to punish Japanese militarism, the oil embargo hurt the entire Japanese economy, fueled a nationalist reaction and convinced the Japanese government that the United States was opposed to Japan's rise; the attack on Pearl Harbor soon followed.

It is clear that China needs oil to fuel its economy. It is also clear that China will go to dubious places to obtain the oil it needs, and that China's investments can underwrite undemocratic regimes that do not respect human rights norms.

Now, China is looking to Canada for oil. The Obama administration and the Harper government should give this investment full scrutiny, and approve or reject the investment on the merits. By demonstrating the principle of equal treatment under the rule of law, the governments could use the Nexen investment to send an important signal to China of how governments ought to behave toward firms in a free market economy.

The U.S. rejection of CNOOC's bid for Unocal put the company and the Chinese government on notice. CNOOC's Nexen bid has been more transparent and forthright. China will learn more from a positive experience with free markets as it revamps investment rules at home. And Beijing will know that Washington and Ottawa are watching.