At three minutes to midnight on Friday, October 19, 2012, Industry Minister Christian Paradis advised Malaysian state-owned PETRONAS that it had not demonstrated that its proposed acquisition of Calgary-based Progress Energy Resources Corp would be of “net benefit” to Canada. “Net benefit” is the standard that must be met under the Investment Canada Act (ICA) in order to receive government approval of a reviewable transaction.
This announcement caught many observers by surprise and appears to be inconsistent with recent approvals of investments involving state-owned enterprises (SOEs) in the energy sector, as well as statements and actions by the Canadian federal government.
SUMMARY OF IMPLICATIONS
Although the PETRONAS/Progress deal is the third disapproval in the last four years, it represents the first time that Canada has turned down a proposal by an SOE in the oil and gas sector. If the PETRONAS decision stands, and truly reflects current federal policy, it could have a significant chilling effect on foreign investors (especially SOEs) that may be contemplating investments and acquisitions in the Canadian resource sector. Ultimately this could affect the flow of much needed foreign capital into the capital intensive resource sector.
PETRONAS has thirty days in which to make representations and submit undertakings in order to convince the Minister to change his mind. The Minister has to respond with a final decision “within a reasonable time”. The Minister is obliged to give reasons only for a final negative decision. Since the ICA approval process is confidential, and no reasons for the Minister’s decision were released, we do not know the basis for the decision of October 19. There may well be factors underlying Minister Paradis’ decision that are unique to the situation and may limit its application to other transactions. However, for the moment, it would be prudent to assume that the ICA approval process is becoming more difficult.
CANADIAN INVESTMENT POLICY
Despite the existence of the ICA, Canada is a jurisdiction that has historically enjoyed a reputation of being open to foreign investment. In recent months, the federal government has been particularly active in courting such investment. Government officials, such as Prime Minister Harper and federal Minister of Natural Resources, Joe Oliver, as well as Alberta Premier, Alison Redford, have made numerous public statements in support of foreign investment in the resource sector, including Premier Redford’s statement in Beijing that “foreign investment has assisted us in growing our economy so we are encouraging that.” Further, federal and provincial officials have participated in numerous trade missions in the last few months, many of which have focused on Asia. Some of these efforts culminated in the signing of the Canada-China Foreign Investment Promotion and Protection Agreement in September of this year. Such initiatives are intended to assist the resource sector in accessing the capital it requires to fully realize the potential of Canada’s resources as well as expanding Canadian export markets for resource products. The federal government has stated publicly that further development of the Canadian resource sector can be the “catalyst for a new era of jobs, growth and prosperity for Canadians”. In this respect, the PETRONAS/Progress transaction is emblematic of the type of investment Canada is trying to foster.
BACKGROUND: THE PETRONAS/PROGRESS TRANSACTION
On June 28,2012, PETRONAS announced that it had reached agreement to acquire Progress for approximately C$5.5 billion by way of plan of arrangement. Completion of the transaction is subject to receipt of certain approvals such as Progress shareholder approval (which was received on August 28th), court approval (received on August 29th) and approval under the ICA.
Progress is a Calgary-based energy exploration and development company with a focus on unconventional resources. To date, Progress’ activities have focused primarily on the exploration and development of shale gas assets in the Montney formation in the Foothills region of northeast British Columbia. Its securities are listed on the Toronto Stock Exchange. PETRONAS is Malaysia’s national oil and gas company. PETRONAS has a significant focus on LNG projects.
In 2011, PETRONAS and Progress formed a joint venture to develop shale gas assets in the North Montney formation in British Columbia. Subsequent to its formation, PETRONAS and Progress discussed expanding the scope of the joint venture as well as the possible participation of third parties. In this regard, the PETRONAS – Progress joint venture announced plans to develop an LNG export facility in Prince Rupert, British Columbia.
Ultimately, PETRONAS determined to acquire Progress and commenced acquisition discussions in May of this year. Those discussions led to the June 28th announcement. PETRONAS filed its application for review under the ICA in mid-July. On October 5, 2012, Progress announced that PETRONAS and the Minister had agreed that the review period for the acquisition would be extended until October 19, 2012.
INVESTMENT CANADA PROCESS
Under the ICA, a foreign investor must obtain approval of the Minister of Industry before directly acquiring control of a Canadian business with at least C$330 million book value of assets. The test under the ICA is whether the investment is likely to be of net benefit to Canada, considering various factors including employment, resource processing, exports, Canadian participation and productivity. In addition, SOE investors must satisfy the Minister that their governance and commercial orientation is compatible with certain published criteria.
Many observers have criticized the net benefit test as being too vague, and subject to political interpretations which do not provide investors with sufficient guidance as to what is required to demonstrate “net benefit to Canada”. The process itself is not transparent. There are no public hearings. In addition, no published reasons are required for net benefit determinations (except a final negative determination).
Once an investor has applied for review, there is an initial review period of up to 45 days, which may be extended by the Minister for an additional 30 days. Further extensions may be negotiated between the Minister and the investor; significantly there is no limit on the number or duration of such extensions. Before the end of the review period (or agreed extension) the Minister makes a decision on whether the investment is likely to be of net benefit.
POTENTIAL IMPLICATIONS OF THE PETRONAS/PROGRESS DECISION
It is difficult to draw general conclusions from this decision based on the limited information available, or to interpret the decision as a shift in policy having negative implications for future foreign investment. In light of different facts, it also not possible to say at present whether the PETRONAS decision makes it more or less likely that the government will approve the CNOOC/Nexen transaction which is also being reviewed under the ICA. Nevertheless, the PETRONAS/Progress Energy case is notable in a number of respects:
PETRONAS’ initial commitments were considered insufficient to establish net benefit.
We do not know the nature of these commitments. On deal announcement, PETRONAS announced its intention to retain Progress employees, but no other proposed commitments. No new commitments in relation to its existing joint ventures with Progress were announced beyond the LNG project, noted above, and nothing was said with respect to governance. The SOE guidelines published under the ICA set out special commitments that should be addressed by SOEs concerning transparency and disclosure such as independent members of the board of directors and independent audit committees, as well as commercial orientation factors such as Canadian participation in the operations in Canada and elsewhere, capital expenditures, etc. Whether these factors were addressed in the review process is unknown. (In contrast, on announcement of the Nexen transaction, CNOOC outlined a number of proposed commitments, including making Calgary one of its international headquarters, which will manage Nexen's global operations and CNOOC's existing operations for North and Central America (comprising approximately US$8 billion of CNOOC’s existing assets); retention of Nexen's current management team and employees; maintaining and enhancing capital expenditures on Nexen's assets; and intending to list CNOOC Limited shares on the TSX.)
PETRONAS was unable to obtain approval within a relatively short review period of approximately 90 days.
A review period in excess of 90 days is not unusual, particularly for an SOE investment. However, PETRONAS apparently was unable or unwilling to extend the review period further. A longer review period might have given PETRONAS the opportunity to establish a positive net benefit case.
In addition to the parties involved, the Minister’s decision sends a message to other foreign investors, and may influence the commitments they are prepared to give in order to obtain approval.
The Minister’s decision may reflect a more difficult approval hurdle for SOEs without a public float.
Meeting the governance and transparency criteria of the SOE guidelines is simpler where an SOE has securities that are publicly traded.
The PETRONAS/Progress arrangement agreement set out a relatively low standard for obtaining ICA approval.
Pursuant to the arrangement agreement entered into with Progress, PETRONAS is not required to provide any undertakings to the Minister, or to meet any requirements “that are not as to commercial matters and, in any case, are not commercially reasonable” to PETRONAS. Moreover, PETRONAS cannot extend the October 31, 2012 outside date for closing the transaction if it fails to cooperate in obtaining a regulatory approval.
Until the PETRONAS/Progress decision is clarified by way of further efforts by PETRONAS to obtain approval and/or the release of Ministerial reasons for a final negative decision, it would be prudent to assume that the ICA approval process is becoming more difficult. The ultimate outcome of the PETRONAS case and the pending CNOOC/Nexen transaction could well provide material guidance to foreign investors on obtaining ICA approval. In the meantime, however, investors should expect to commit to substantial undertakings, allow adequate time for the process to unfold and, if they are not prepared to do so (or to run the risk of a negative decision by the Minister), consider a minority investment that is not an acquisition of control under the ICA.