Crisis on the China Rim: An Economic, Crude Oil, and Military Analysis

"There is a crisis rising on the China Rim, a crisis made of economic imbalances, energy insecurities, ancient hatreds, and unsettled scores. The catalyst for this crisis is success itself, the success of the People’s Republic of China in its de facto rejection of a failed experiment in communism and its rapid transformation into a thriving market economy. The inseparable companion of this success, though, is an insatiable hunger and thirst for precious resources... most important among these, crude oil."

2005.04.14 | 85 pages | download

Canadian-owned PetroKazakhstan Inc. (PetroKaz) announced today that it has accepted an acquisition bid from CNPC International Ltd., a wholly-owned subsidiary of China National Petroleum Corp. (CNPC).   CNPC is China's largest and the world's 10th largest oil company.

CNPC's offer for PetroKaz amounts to US$55.00 per share, US$4.18 billion in total, and CDN$5.06 billion in total.

PetroKaz's Board of Directors has asked CNPC to consider a spin off from PetroKaz to pre-merger PetroKazakhstan shareholders a new oil and gas company capitalized at roughly US$76 million.  If such a transaction is executed, pre-merger PetroKaz shareholders might receive US$54.00 per share plus one share of the newly created oil and gas company.

Today's agreement calls for a $125 million break fee.   Further, today's agreement allows PetroKaz's Board of Directors to review unsolicited competing offers, but bars PetroKaz from actively seeking competing offers.

In the view of Laguna Research Partners, a counter-bid from India's ONGC-Mittal Energy, a venture between India's state-owned ONGC Limited and Mittal Steel Company NV, the world’s largest steel producer, remains a possibility.  ONGC-Mittal Energy was party to the original round of bidding for PetroKaz.

In our 2005.04.14 "Crisis on the China Rim..." (CCR) analysis, Laguna Research Partners emphasized the critical importance of Kazakhstan to China.  Here's an excerpt from page 42 of CCR:

"Within the China Rim 14 [the fourteen countries that share land borders with China], there are three countries that Laguna Research Partners believes deserve special attention.  These three, Pakistan, Burma, and Kazakhstan, provide critical land links directly from China to huge oil reserves (Kazakhstan to the Caspian Sea) or to important shipping lanes (Pakistan to the Arabian Sea and Burma to the Bay of Bengal).  The significance of these "land bridges" cannot be overestimated given that China is land-locked to its north, west, and south."

In sum, we view Kazakhstan as having tremendous strategic appeal to the Chinese.  (Please see our China and the China Rim map).  Prior to today's announcement, China's economic and political involvement in Kazakhstan was already deep.  Here are the details.

China and Kazakhstan are both members of the Shanghai Cooperation Organization (SCO), a six-country security group led by China and Russia that was ostensibly established for the purpose of combating Islamic extremism in Central Asia.  (In addition to China and Russia, SCO's member states include Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan.)

In recent months, SCO's agenda has clearly shifted away from combating terrorism towards countering and, if possible, eliminating the US's presence in Central Asia.  In July 2005, the SCO called for the US to establish a date for its departure from military bases in Central Asia.  In effect, the SCO provides China and Russia with a diplomatic channel by which both countries can challenge the US's sharply-increased post-9/11 presence in the region without confronting the US directly.

The SCO's four smaller members have been invited guests monitoring first-ever bilateral China-Russia war games currently taking place in the east China Rim region.

As discussed in our firm's CCR, construction began on the 3,040-kilometer Atasu-Alashankou pipeline linking western Kazakhstan with China’s Xinjiang Uygur Autonomous Region in October 2004.  In March 2005, construction commenced on the pipeline’s 240-kilometer Chinese section.   This pipeline is expected to have a capacity of 75 to 80 million barrels of oil annually, with planned expansion to 150 million barrels at a later date.   Construction costs for the entire project are expected to reach US$3 billion.   China has also expressed interest in building a 390-kilometer pipeline through Iran to that country’s frontier at the southern shore of the Caspian Sea.   Ultimately, that pipeline could be connected to the Atasu-Alashankou pipeline, boosting the potential strategic value of the Atasu-Alashankou pipeline even further.

Kazakhstan aims to boost its annual crude oil production from the 2003 figure of 437 million barrels to 740 million barrels by 2010.  This target implies compound annual growth in production of 7.8%.  Further, Kazakhstan is expected to grow into one of the world's largest producers of crude oil over the next ten years.

Posted by:
Kevin B. Skislock
Partner and CEO
Laguna Research Partners
[bio] [disclaimer]

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