CNOOC Creates Biggest China-U.S. Oil Deal For Stake in Shale Gas Industry

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China's state-owned energy company China National Offshore Oil Corp. (CNOOC) (NYSE ADR: CEO) late Sunday announced it would invest $2.16 billion in U.S.-based Chesapeake Energy Corp. (NYSE:CHK) to increase China's stake in unconventional gas resources like shale gas. It is the largest ever China-U.S. oil and gas deal.

CNOOC initially will pay $1.08 billion for a 33% stake in Chesapeake's Eagle Ford shale acreage in Southern Texas. China's third-largest oil company will invest an additional $1.08 billion by paying 75% of Chesapeake's drilling and completion costs in coming years, allowing Chesapeake to tap hard-to-extract shale gas deposits and boosting its weak balance sheet.

The deal highlights China's need to develop its shale-gas extraction techniques. The country has 26 trillion cubic meters of shale gas reserves that are largely unexplored due to a lack of drilling ability - and Chesapeake is a pioneer in the shale gas industry.

"This is the one area that [China] seriously wants to get into, Gordon Kwan, an analyst at Mirae Asset Securities, told the Financial Times. "They don't have the technical expertise and Chesapeake is the market leader in shale oil and gas. So they are teaming up with the world's best player in a sector in which they previously had no exposure.

Extracting from its natural gas deposits also will help China reduce its carbon footprint. The Chinese government wants to increase natural gas consumption to 8% of total energy consumption by 2015 from just 4% now.

Chesapeake plans to grow to 40 rigs from 10 by the end of 2012 with the CNOOC investment, and the project is set to reach peak production of 400,000 to 500,000 barrels of oil equivalent a day in the next decade.

Kwan told The Wall Street Journal that the deal is a "win-win, as it fulfills Chesapeake's need to finance expensive natural gas extraction projects, and provide resources for CNOOC's "supernormal production growth.

"This deal is completely consistent with what U.S. government has said they would like to see Chinese energy companies do, which is to provide capital into America to acquire minority interests and for American companies to use that capital to go out and develop American oil fields and to reduce oil imports, Chesapeake Chief Executive Officer Aubrey McClendon told Bloomberg.

The deal also marks China's first step into the U.S. oil and gas market after political tensions killed an $18.5 billion deal for CNOOC to acquire Union Oil Company of California (Unocal) in 2005. Since the Chesapeake agreement involves a minority stake, the regulatory concerns are not as severe as in the Unocal deal.

Unconventional Gas Sources Perfect Target for Hungry China

Shale gas constitutes about 15%-20% of U.S. gas production, but that is expected to quadruple in coming years - and the Eagle Ford shale area is a key to that growth.

"Eagle Ford is hot, said analysts at Tudor Pickering Holt & Co., the Houston-based energy research firm that worked on the CNOOC deal. "Eagle Ford M&A activity remains on fire.

These deals confirm the value of Eagle Ford's reserves. Experts expected a rise in Chesapeake stock as well other companies with large holdings in that area, including EOG Resources Inc. (NYSE: EOG), Pioneer Natural Resources (NYSE: PXD), SM Energy Co. (NYSE: SM) and Petrohawk Energy Corp. (NYSE: HK)

India's Reliance Industries Ltd. since April has spent $3.4 billion investing in U.S. shale gas projects, including $1.3 billion for a 45% stake of Pioneer Natural Resources Co.'s Eagle Ford assets.

But China's need to meet the energy demands of the world's fastest growing economy has pushed it into making even bigger global moves to gain stakes in unconventional oil and gas projects, which include shale gas, tar sands and coal bed methane.

China's surging energy demand will rise to 46 million metric tons of imported liquefied natural gas a year in 2020, up from 5.5 million tons imported last year, according to industry consultants Wood Mackenzie. Chinese gas demand will rise to 444 billion cubic meters annually in 2030 from 93 billion cubic meters in 2009.

In March, Royal Dutch Shell PLC (NYSE ADR: RDS.A) and PetroChina Co. Ltd. (NYSE ADR: PTR) paid $3.4 billion for Australia's Arrow Energy Ltd., which specializes in coal bed methane. In April, China Petroleum & Chemical Corp. (Sinopec) (NYSE ADR: SNP) bought a $4.65 billion stake in Syncrude Canada Ltd., a Canadian oil sands producer.

The benefits of China's energy shopping spree are two-fold for the Asian giant. Besides stockpiling commodities to meet its increasing demand, the country is able to gain physical assets that the rest of the world needs - putting it in a very powerful position.

"While companies in the United States, Great Britain and Europe are being forced to shed promising assets in order to compensate for massive losses or to pay down debt, cash-rich China has been able to operate as a buyer in a buyer's market, wrote Money Morning Chief Investment Strategist Keith Fitz-Gerald in May 2009. "While the rest of the world has interpreted this as a sign that China's interested in buying the things it needs to grow, what they have not understood is that China's also interested in using physical assets as a source of 'currency' that offsets an increasingly eviscerated U.S. dollar.

"This is actually a double-whammy of sorts, for while the rest of the world has been grappling with the global slowdown, China has been locking up supplies of commodities that are only going to become more scarce (and more valuable) as global demand escalates, said Fitz-Gerald.

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