12/11/2012 05:27 EST | Updated 02/10/2013 05:12 EST

Undertakings Essential to Assessing CNOOC-Nexen Deal

Contrary to what you might have heard, it's impossible to judge the CNOOC-Nexen affair until the public receives some clarity regarding the list of undertakings that CNOOC has promised the federal government. And when those undertakings are made public, it's going to be pretty interesting to see what kind of measures the government required of CNOOC, a Chinese state-owned enterprise, in order to create a net benefit for Canada.

It's going to be interesting because the feds can ask for some very meaningful concessions and a recent federal court decision on the Investment Canada Act ("ICA") has indicated that whatever undertakings the parties agree to are enforceable.

The only court action that the ICA has seen since its inception in 1984 was settled one year ago after treatment by the Federal Court. U.S. Steel settled a lawsuit with the Canadian government over undertakings it gave Industry Canada when it bought Stelco in the summer of 2007.

The transaction was caught under the same ICA that applies to the CNOOC-Nexen deal and to satisfy then-Minister of Industry Tony Clement's net benefit test, U.S. Steel agreed to several intrusive undertakings. Specifically, U.S. Steel agreed to a three-year commitment to increase production by 10 per cent and to maintain employment at roughly Stelco's pre-insolvency levels. If those targets were not hit, fines of $10,000 a day per infraction could be levied by Industry Canada.

Being 2007, these undertakings were made in the rose-coloured light of a seemingly endless commodity boom and liquid, speculative capital markets. When the rubber hit the road in 2008 and auto-manufacturers required significant assistance, those Industry Canada undertakings became a distant memory for U.S. Steel.

Surely, they thought, in those times of financial meltdown Industry Canada would be compassionate to the plight of the steel industry. The federal government had gone so far as to buy a piece of Detroit. And those targets were set assuming growth and stability.

Even if a steel company could raise steel production 10% with banks essentially frozen, who would want to? Why build Orwellian stacks of cold rolled steel? The company laid off 2,200 workers from its Stelco operations and shut down the Nanticoke plant. Industry Canada wrote shortly thereafter seeking full compliance and fines.

A Federal Court decision determined the penalties and the undertakings to be entirely enforceable in 2010. After more legal skirmishing at the appellate level, the parties settled in December of 2011.

In the cold light of 2012, the undertakings made above seem weird and intrusive to any company with an appreciation for the vicissitudes of economic growth. I suppose that, when U.S. Steel made its commitments, the company had no prior evidence suggesting any willingness of Industry Canada to play hardball to achieve compliance.

After all, U.S. Steel probably saw itself as a white knight, saving the operations of a once-great Canadian steel-manufacturer with the intention to return Canadian steelmaking to its former glory. They were the good guys! So what if they can't live up to promises that were incredibly intrusive to their business judgment -- THEY CAN SAVE HAMILTON! The only question left for them must have been, "Where do we sign?!"

Which brings us, again, to the sobering light of 2012 and CNOOC. The Minister of Industry, Christian Paradis, has indicated that the primary undertakings that enabled CNOOC to achieve an ICA happy ending involved matters of transparency and corporate governance.

And I suppose this makes sense. CNOOC, being essentially a state-owned enterprise, needed to ensure Canada of their ability to abide by Canadian corporate law and securities regulation and not simply act as a Chinese enclave. Perhaps the minister required a greater percentage of the board will have to be resident Canadian (it's always helpful to maintain a few locals to deal with any criminal liability), or that CNOOC will have to reincorporate as a Canadian company and create a headquarters in Canada to do its CNOOC's Nexen-related business.

These concessions seem to be in line with what the Minister indicated. But at the same time, these don't veer too far beyond what Canada already requires. We have corporate law and securities regulation to ensure compliance with Canadian law and standards. Perhaps an extra director or two would be required to be Canadian or CNOOC would be forced to be traded on the TSX.

But really, what could be requested of CNOOC regarding transparency and corporate governance that isn't already being produced by merit of its listing on the NYSE and conducting business in North America over the past 30 years? And, if these softball undertakings are the only ones received by Industry Canada, how could they possibly turn the deal into a net benefit for Canada?

This is where it could get interesting. Because most undertakings in the corporate governance and transparency realm are relatively banal -- already required by our domestic laws -- it is possible there have been some real zingers thrown into the mix to make the deal a true net benefit for Canada. Maybe there are invasive undertakings regarding the core business.

Maybe Paradis managed to get CNOOC to promise not to drink the rest of the oil sands' milkshake. It could be that CNOOC's Nexen-related books may have to be wide open at all times to determine to whom oil is being sold and at what cost. Maybe it agreed to a federal royalty scheme, or to hire 100 Canadians for every dollar above $100 for a barrel of oil. It is entirely possible that Paradis negotiated some real gems.

The problem -- and the primary distinction of this case from the U.S. Steel example -- is that CNOOC is considered a state-owned enterprise, and the treatment of its Canadian portfolio by our government becomes a matter of foreign affairs.

Whereas traditionally Canada could tell a group of shareholders to stick it without much reverberation in the world of foreign affairs, possible WTO/NAFTA grumbling aside, CNOOC presents a more singular stakeholder with near limitless agency and worldwide reach. I can only presume that this state-based ownership was felt through the Nexen negotiation process, which was contemporaneous with the two governments negotiating the Canada-China Foreign Investment Promotion and Protection Agreement. So while the undertakings that Paradis negotiated will be enforceable at Canadian law, it may not be desirable to do so.

Much like giving the boss' son some high heat at the corporate softball tournament, enforcing CNOOC undertakings under the ICA may feel good in the short term but strain longer-term possibilities, leaving Canadians to wonder whether the undertakings are worth anything at all...