What Red Menace?

The Chinese are stalking American companies…and some
Americans resent the trend. We investors, however, cannot
afford to indulge in such nationalistic urges. Identifying
the winners and losers of the global economy is far more
advantageous than identifying their nationalities.

The recent CNOOC-Chevron-Unocal affair is a good case in
point. The Chinese National Offshore Oil Company, dubbed
CNOOC, is competing with Chevron for ownership of Unocal,
the pride of El Segundo, CA. Even though CNOOC’s bid is at
least 10% higher than Chevron’s, many Americans consider
the Chinese suitors to be predators – a kind of "Red
Menace."

But the Chinese executives who oversee CNOOC seem to be
darn fine capitalists, which is the aspect of this saga
that interests us the most. Perhaps this particular menace
is also a worthy investment. But first, let’s dispense with
a few misconceptions.

This entire affair has perpetuated a number of myths, as I
recently discovered while conducting several radio
interviews. Invariably, the radio hosts portray CNOOC as a
big, red menace that is threatening to swipe U.S. oil
supplies for itself. The facts show a very different
picture.

For starters, CNOOC is not very menacing. Very few people
realize that the company is actually SMALLER than either
Chevron or Unocal. Chevron’s $151 billion in annual
revenues are more than 20 times larger than CNOOC’s $6.7
billion in revenues. Even little old Unocal generated
revenues of $8.2 billion, or 22% more than CNOOC’s.

Secondly, Unocal is little, which is another fact that gets
lost in the discussion. In terms of its U.S. production,
Unocal’s output is a pittance – only 57,000 barrels a day.
Compare that to the entire U.S. production of oil, which
comes in at over 7.3 million barrels a day. Unocal’s output
is less than 1% of total U.S. production. This seems hardly
worthy of the hysteria surrounding the potential
acquisition.

Even though Unocal is as an American enterprise, 70% of its
reserves lie close to the Asian markets they currently
serve, particularly in Indonesia. In this day and age, it
sometimes rings hollow to pin nationalistic badges on
global enterprises. This would seem to be one of those
cases.

The market for oil, especially, is a global market. Does
the fact that Chevron operates its headquarters in
California mean that American consumers will receive
preferred access to its oil? Doubtful. Chevron will sell
its oil to the highest bidder, just like every other oil
company would do.

The fact that a few Chinese companies are buying up
American companies stirs up nationalistic responses that
bear no connection to economic realities. For example, the
U.S. economy did not suffer for having sold innumerable
assets and companies to the Japanese during the 1980s. Our
economy is still here and it seems to be doing just fine,
thank you. Secondly, Chinese investment-to-date in U.S.
companies has been negligible.

In 2004, Chinese firms invested only $490 million directly
in U.S. companies and assets. Comparatively, U.S.
multinationals invested $15 billion in China. So again,
American fears of a Chinese takeover seem irrational in
light of the facts.

Another myth has also sprung from the flurry of recent
Chinese acquisitions of American companies. It is said that
the Chinese are interested in purchasing American brands
and securing outlets for their cheap goods. Chinese
appliance maker Haier has made a bid for Maytag, for
example. Yet, a fascinating piece in the Wall Street
Journal earlier in the month by two Boston Consulting Group
advisers based in Hong Kong argues convincingly to the
contrary.

The advisors note that Haier "has spent ten years building
its own brand in the U.S. and now has its name on 10% of
new U.S. refrigerators." Refrigerators are too large to be
made in China. They are made right here on U.S. soil.

What Chinese companies bring to the party, the Boston
Consulting duo argues, is management skill and savvy.
"Chinese management is an under-rated asset in American
discussions of China’s global strategy. Almost all large
successful companies in China are turnarounds of formerly
politically managed state-owned enterprises."

These management teams took the reigns in the 1980s and
learned the art of the turnaround specialist – they cut
costs, leveled corporate organizational charts, and pruned
losing businesses.  "The CEOs of Haier," the authors
continue, "all started and spent their entire careers on
the factory floor."

The CNOOC management team is no different. Fu Chengyu,
CNOOC’s CEO and Chairman, earned his master’s degree at the
University of Southern California and spent 13 years
working with international and U.S. oil companies. CNOOC
shareholders have enjoyed the benefits of Chinese
managerial skill.

Since its listing four years ago, CNOOC’s market cap has
grown four-fold amidst an energy boom. It maintains an
investment grade rating, with net cash on the balance sheet
and solid profits. As the chart below illustrates, CNOOC’s
earnings have nearly tripled over the last four years – or
more than twice the results that Chevron and Unocal
delivered over the same time frame.

Clearly, this team has accomplished much in a short period
of time. Perhaps it has not occurred to the protectionist
members of Congress, but maybe Unocal’s shareholders
DESERVE both CNOOC’s higher bid and the future leadership
of CNOOC’s management team.

The Chinese government owns 70% of CNOOC, with the rest in
the hands of public shareholders. Shares can be purchased
on the New York Stock Exchange (the ticker symbol is CEO)
at a modest 12 times trailing earnings and with a 3.4%
yield.

John Pomfret, the Washington Post’s former Beijing bureau
chief recently made a thought-provoking observation. He
wrote, "Too often, when people are writing about China,
they are actually using its successes as a way to mourn
perceived problems back home. American is becoming
complacent, uneducated, slow and bureaucratic, they say.
Look at China; it’s got all the answers. It’s the future.
But is it?"

Our guess: The Chinese do not have all the answers, but
many Chinese companies certainly have the right ideas,
capitalistically speaking. CNOOC may be one of them.

Did You Notice…?
By Eric J. Fry

Yesterday, the American Petroleum Institute (API) surprised
many investors by reporting a "smaller than expected"
drawdown in crude oil inventories. Immediately after the
news crossed the wires, the price of crude oil tumbled more
than $2 a barrel. Most oil stocks also dropped sharply.

Interestingly, however, oil-shipping stocks bucked the
trend. Teekay Shipping (NYSE: TK), a core holding of the
Outstanding Investments portfolio, jumped more than 2% on
four times the stock’s average daily trading volume. Other
industry bellwethers, like Frontline Ltd. (NYSE: FRO) and
General Maritime (NYSE: GMR), also chalked up nice gains.

Why the renewed interest in shipping stocks? The "Imports"
component of the API report may provide a partial answer;
production trends in the Middle East may provide the rest
of the answer.

Yesterday’s API report revealed that US crude oil imports
last week totaled a near-record 11.1 million barrels per
day, continuing a years-long trend of rising imports. Oil
product shipments also continue to increase, as the chart
below illustrates.

Elsewhere around the globe – and much to the delight of
oil-shipping companies – the thirst for imported oil cannot
seem to quench itself.

"Supertanker bookings for oil exports from the Middle East
reached their highest monthly level this year in July, as
OPEC increased output," Bloomberg News reports.

These vessels, known as very large crude carriers, or
VLCCs, carry about 80% of the Persian Gulf exports. Since,
therefore, VLCC shipping rates are rebounding, Middle
Eastern oil production must be picking up. And if Middle
Eastern oil production is rising, global oil demand must be
holding steady, if not rising somewhat. Shipping rates for
voyages to Asia have doubled in the past three weeks. So
somebody over there must want the stuff.

"With today’s oil price, all producers and refiners have an
incentive to pump and refine as much as possible," explains
Ole-Rikard Hammer, managing director of Oslo-based
shipbroker P.F. Bassoe AS. "This is very promising for the
tanker market."

We deduce, therefore, that what may be a bad thing for the
oil price – rising supplies – might not be bad thing for
oil shippers, especially if those rising supplies are
arriving in an oil tanker.