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IHS Global : On Sinopec's offer for Addax Petroleum

Insight Perspective

Sinopec Agrees to Acquire Addax Petroleum for US$7.2 billion

China Petrochemical Corp. (Sinopec) has made an offer to pay C$8.27 billion (US$7.22 billion) for Swiss-based Addax Petroleum Corp. in one of the largest potential foreign acquisitions by China's NOCs to date.

Significance

The deal is reflects the aggressive global acquisition strategy launched by China's NOCs in the wake of the financial crisis, designed to boost their oil reserves and production and consolidate their global asset portfolio in high potential markets.

Implications

The offer promises to give Sinopec a 36% stake in Iraqi Kurdistan's prolific Taq Taq field as well as the prized Joint Development Zone (JDZ) offshore Nigeria and Sao Tome and Principe, which will help Sinopec strengthen its upstream presence and allow it to better integrate its operations and reducing its vulnerability to crude oil price volatility.

Outlook

With lock-up agreements for 38% of outstanding shares in place and a 47% premium on Addax's market price remaining, shareholders are likely to approve the deal. Over the longer term acquisitions of personnel and assets from Addax promise to develop Sinopec's deepwater capabilities, in line with the growing global shift towards exploration for hydrocarbons in these regions.

Sinopec Pounces

China Petrochemical Corp. (Sinopec) has made an offer to pay US$7.22 billion for Swiss-based Addax Petroleum Corp., which has a diverse range of assets in Africa and the Kurdistan region of Iraq. Sinopec has agreed to acquire Addax for C$52.80 a share in cash, a 47% premium on the closing market price on the TSX of the Addax common shares on 5 June 2009, the day before Addax announced it was in preliminary discussions over a possible transaction. In connection with the offer, AOG Holdings BV (a subsidiary of Addax and Oryx Group) and Jean Claude Gandur, president and CEO of Addax have agreed to tender their common shares to the offer. Other senior officers and directors have also entered into lock-up agreements, which represent a total of 38% of outstanding shares calculated on a fully diluted basis, according to IHS Herold. The Addax transaction surpasses China National Petroleum Corp.'s (CNPC) US$4.18-billion takeover of PetroKazakhstan Inc. in 2005 and is one of the largest acquisitions abroad by China's NOCs to date. What does the deal mean for Sinopec and for China's energy policy more broadly?

The Addax offer is representative of a broader aggressive acquisition strategy by China's NOCs that are seeking to take advantage of the fall in asset valuations and crude oil prices following the global financial crisis in order to expand their global asset portfolio's and boost control over foreign oil and gas reserves to enhance China's long-term energy supply security. With access to significant capital reserves and promises of tax breaks from the government China's NOCs are formidable competitors, routinely bidding 30% over the market value for companies they seek to acquire. The 47% premium for Addax will likely prove irresistible to the company's senior management and shareholders alike and was probably a key factor allowing Sinopec to outmanoeuvre rival competitor Korea National Oil Corp. (KNOC), which was also interested in the company.

A Risky Iraqi Move

Sinopec's acquisition of Addax will give it a 36% working interest in Iraqi Kurdistan's prolific Taq Taq field, making it a joint operator of about half of the region's crude production and exports, with a significant upside. The Taq Taq field's production is currently being ramped up to 50,000 b/d, with production levels of 100-150,000 b/d being targeted within one year's time and possible peak output from the field now thought likely to reach 180,000 b/d in a few years time.

Sinopec's entry into the highly promising Iraqi Kurdistan play, however, comes with significant political ramifications. Due to the conflict between the autonomous region and Iraq proper over control of the region's resources and the level of its autonomy, Iraq's Oil Minister Hussein al-Shahristani has been clear in his condemnation of companies investing directly in its upstream sector and has black-listed them from business opportunities in the rest of the country. Given that Sinopec has voiced its interest in participating in Iraq's imminent first licensing round—reportedly having created a consortium with Shell and fellow Chinese player CNPC with the aim of winning the giant northern Kirkuk oilfield—the timing of the acquisition of Iraqi Kurdistan acreage might seem a bit awkward.

Diversified Strategy

With the Chinese NOCs' strategy generally being seen as the extension of Chinese foreign and energy policy, it is however likely that China is pursuing a strategy of placing one egg in each basket by investing both in Iraqi Kurdistan—where the business climate has been significantly better and production is set to rise rapidly—and in Iraq proper, where the opportunities are huge but the political uncertainties remain and current investment terms are tight.

Sinopec and China are also likely to want to secure their good relations with the Iraqi Kurds, given that the giant Kirkuk field lies in disputed territory and that Kurdish officials as late as this week threatened that oil companies signing contracts with the Iraqi Oil Ministry for oilfields in the disputed Kirkuk governorate could face problems—a threat especially worrying given that the Kurdish defence forces are guaranteeing security throughout the whole northern area. With Chinese state interest on both sides of the border however, the Kurdish forces would be unlikely to want to cause a partly Chinese Kirkuk consortium any troubles, while al-Shahristani would be unable to punish CNPC for Sinopec's entry into Iraqi Kurdistan.

While the deal will primarily focus on the Chinese entry into Iraqi Kurdistan it should not be forgotten that a very attractive reason for the takeover is the acquisition of Addax's oil producing assets in West Africa, which will secure future fuel supplies for Sinopec's refineries and increase China's energy security.

Addax has made a reputation for itself in the past few years as a strong niche player in the Gulf of Guinea, with attractive assets in Nigeria, Gabon, and Cameroon. Despite the West African region being dominated by the supermajors, the company has proved itself there, and has a number of exciting prospects set for development. However, the potential prized asset is the acreage in the shared Joint Development Zone (JDZ) offshore Nigeria and Sao Tome and Principe. Addax holds a 14.33% interest in Block 2, where it has reached an agreement to work with the block operator, Sinopec. It also has a 15 % stake in Block 3, while it is the operator of Block 4 and holds a 38.3% participation interest. It also acquired ExxonMobil's 40% interest in Block 1 in September 2007. Exploration has been slow, with only one well drilled in the JDZ. This was in 2006 by Chevron; the well did not meet expectations, although it did discover hydrocarbons.

Outlook and Implications

The clear loser from this deal—which has allowed a large Chinese NOC into Iraqi Kurdistan—is Iraq's oil minister, who now has to see Iraqi Kurdistan's unilaterally passed and implemented oil law gain even more international credibility, despite his protests that all upstream investment not going through his ministry is illegal. Although he might be inclined to punish Sinopec and expel it from the licensing round in order to prove he is serious, it is also likely that other members of the Cabinet will be less enthusiastic to stand up to China, further weakening his position. Addax has been able to cash in on taking the initial risk and venturing into a legal no-mans land as one of the first IOCs after the 2003 U.S.-led Iraqi invasion, just as it has been allowed to commence exports but before the still unclear payment structure has been tested in practice.

The acquisition of Addax by Sinopec should speed up exploration in the JDZ in the offshore Sao Tome & Principe waters. The frontier acreage in the Gulf of Guinea will require significant investment and is therefore more suited to development by a state-owned company with deep pockets. Sinopec has made recent progress in the JDZ by securing the TransOcean SEDCO-702 deepwater rig, which is due to arrive in Block 2 around 1 July and drilling operations should commence immediately. Once the acquisition is complete Sinopec will hold a 43% stake in Block 2 of the JDZ and will immediately becomes the dominant player in Sao Tome and Principe's oil sector. If commercial reserves are discovered then Sinopec will have considerable influence on how they are developed.

The Chinese government now has until 24 August to approve Sinopec's offer. It is almost certain to meet the deadline, considering how the deal serves China's wider energy policy objectives and given that the company could have to pay hefty termination fees if the deal does not go through. For Sinopec, acquisition of Addax will provide a major boost to oil reserves and production, helping the company in its strategy of strengthening its upstream asset portfolio. Indeed, last year Addax produced on average 136,500 b/d and output is due to rise significantly following the launch of production from the Taq Taq field in Iraq's Kurdistan region. The core of Sinopec's operations is its large downstream refining base in China and the company is over 70% dependent on crude oil imports from abroad, which makes it extremely vulnerable to crude oil price volatility as well as dependent on other companies for supplies. Acquiring Addax will allow the company to better integrate operations, while increasing its foothold in a number of high-potential markets in the Middle East and West Africa that could potentially source Chinese demand. It also promises greater financial security for Sinopec as crude sales from operations abroad can offset feedstock purchases for its downstream operations, if oil prices rise which is expected by the Chinese government. By taking on personnel and operations from Addax Sinopec can also develop its deepwater expertise, which will be key in consolidating a long-term position in the world oil market where there is a growing shift towards exploration of deepwater areas as more readily accessible reserves become more difficult to locate. Indeed, Sinopec is planning to drill its first deepwater well in the South China Sea in 2010 and the experience provided by Addax could help the company in other deepwater ventures across the globe

By IHS Global Insight's Middle East energy analyst Samuel Ciszuk and China energy analyst Tom Grieder. Petroleumworld not necessarily share these views.

Editor's Note: IHS Global is a global leader in economic and financial analysis, forecastin and market intelligence for more than 40 years. Petroleumworld does not necessarily share these view.

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Petroleumworld News 06/26/09

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