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SINO – FOREIGN
OIL AND GAS INDUSTRY
LEGAL RISK COMPARATIVE ANALYSIS
November 2005
PREPARED BY
LOVELLS INTERNATIONAL LAW FIRM
IN COOPERATION WITH
ASSOCIATION OF CORPORATE COUNSEL
LETTER FROM THE EDITOR OF THE REPORT
In March of this year, Lovells International Law Firm issued Conquering Legal Risk: Report on the
Legal Risk Exposure of the China Top 100 Enterprises ("Legal Risk Ranking Report"). The
response by Chinese media, academics, government officials, business leaders and legal
professionals exceeded all expectations. SASAC leaders circulated a summary of the Legal Risk
Ranking Report to senior managers at central-level SOEs, and scores of traditional and internet
publications dedicated nearly 300,000 words to the Legal Risk Ranking Report and related legal
risk topics over the following weeks and months. Legal risk management has gained tremendous
currency as an important topic of discussion and analysis in China, and the Legal Risk Ranking
Report has contributed in part to that development.
In order to build on the foundation laid by the Legal Risk Ranking Report, we at Lovells decided to
prepare some follow-up reports highlighting certain legal risk findings and conclusions on an
industry-specific basis. Our initial ambitions were modest: we envisioned a short three or four
page comparative analysis of legal risk scores for Chinese and foreign companies in particular
industries (see Section 4.1 of this Report).
However, as we developed this concept, we determined that an industry-specific focus provides a
perfect platform on which to illustrate legal risks in a concrete business context. This, then, was
the genesis of the current Sino-Foreign Oil and Gas Industry Legal Risk Comparative Analysis
Report (this "Report"). It is intended to be the first of a series of industry-specific and topical legal
risk reports.
In preparing this Report, we have been most fortunate to draw upon both internal and external
experts in the oil and gas industry (see list of contributors in Annex A to this Report). Through our
long-standing cooperation with the Association of Corporate Counsel ("ACC"), the world's largest
in-house legal counsel association, we have been able to supplement our own global oil and gas
industry experience and expertise with that of senior in-house lawyers from leading companies in
the oil and gas industry.
Thus, this Report is unique not only in China but also anywhere in the world both in respect of its
content and also in respect of the quality and experience of its panel of contributors. Collectively,
the core contributors to this Report have nearly 150 years of experience in managing legal risks in
the international oil and gas industry.
One of these expert contributors, Ted Frois, General Counsel of Upstream Businesses of
ExxonMobil, expressed the following view on the Report, stating that it "accurately describes the
range and types of legal risk exposures faced by international oil companies and provides a
framework under which to evaluate those risks [and] tak[es] what is usually a subjective exercise
and attempt[s] to provide an objective process for comparing relative legal risk exposures."
Lovells is honoured to be able to cooperate with the ACC and this outstanding panel of experts.
We sincerely hope that this Report will prove to be useful to Chinese companies in this critical
industry sector in both theory and practice.
Robert Lewis
Managing Partner
Lovells Beijing
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SINO – FOREIGN
OIL AND GAS INDUSTRY
LEGAL RISK COMPARATIVE ANALYSIS
LETTER FROM THE EDITOR OF THE REPORT i
1. INTRODUCTION 1
1.1 Legal Risk Generally 1
1.2 Legal Risk Industry Reports 1
1.3 Introduction to Legal Risk in the Oil and Gas Industry 2
2. INTERNATIONAL OIL AND GAS INDUSTRY 2
2.1 Overview of the Oil and Gas Industry in the United States 2
2.2 International Trends 3
2.3 Overview of Legal Risks Specific to the International Oil and Gas
Industry 4
2.4 Case Study One: Miscategorization of Oil Reserves by Shell 8
2.5 Other International Oil Company Case Studies 10
3. CHINESE OIL AND GAS INDUSTRY 11
3.1 Overview of the Chinese Oil and Gas Industry 11
3.2 Areas of Potential Legal Risk Exposure for Chinese Oil and Gas
Companies 13
3.3 Case Study Two: Analysis of CNOOC's bid for Unocal 15
3.4 Case Study Three: CNPC Bid for Petrokazakhstan 18
3.5 Case Study Four: China Aviation Oil's US$ 550 million Derivatives
Disaster 18
3.6 Other Chinese Oil Company Case Studies 23
4. LEGAL RISK COMPARISONS FOR THE OIL INDUSTRY 23
4.1 Comparison of Legal Risk Exposure of Chinese and International Oil
Companies 23
4.2 Comparison of Legal Affairs Management Resources of Chinese and
Foreign Oil Companies 27
5. LOOKING TO THE FUTURE 29
5.1 Predictions 29
5.2 Solutions 30
5.3 The Value of the In-house Legal Team 30
5.4 Investing in the Future 31
6. CONCLUSION 32
ANNEX A Biographies of Key Individual Contributors and Acknowledgements 33
ANNEX B Introductions to Sponsoring Organizations 33
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SINO – FOREIGN
OIL AND GAS INDUSTRY
LEGAL RISK COMPARATIVE ANALYSIS
PREPARED BY
LOVELLS INTERNATIONAL LAW FIRM
ASSOCIATION OF CORPORATE COUNSEL
NOVEMBER 2005
1. INTRODUCTION
1.1 Legal Risk Generally
In March 2005, Lovells International Law Firm published Conquering Legal Risk: Report on the
Legal Risk Exposure of the China Top 100 Enterprises ("Legal Risk Rankings Report") in
order to help Chinese companies understand the importance of assessing and managing legal
risk. The Legal Risk Ranking Report discussed the legal risks that the Chinese top 100
companies confront generally, highlighting selected categories of heightened legal risk. As a
general matter, because legal risks are higher outside China than inside China, the more
internationalized the operations of a Chinese company are, the higher the legal risk score will
be.
The central conclusion of the Legal Risk Ranking Report was that the median legal risk
exposure of major Chinese companies was approximately 40% of their foreign counterparts in
the Fortune 100, but that Chinese companies typically spend roughly only 2% of what major
foreign companies do on legal risk prevention and legal affairs management generally. This
suggests that leading Chinese corporations with international operations or which are listed on
stock exchanges outside of China do not devote nearly enough resources to managing their
legal risks, which in turn increases the likelihood that Chinese enterprises will suffer serious
economic losses arising from legal problems as they continue to expand internationally.
1.2 Legal Risk Industry Reports
This Oil and Gas Industry Sino-Foreign Comparative Legal Risk Report ("Report") is the first of
a series of ten follow-up reports focusing on the legal risks for Chinese companies in particular
industry sectors as they expand internationally. This Report focuses on legal risks facing
Chinese oil companies. Subsequent follow-up reports, to be issued serially over the next
several months, will compare legal risks faced by Chinese companies in the context of the
following industries (listed in no particular order): telecommunications, computers and
electronics, insurance, banking, construction, heavy equipment manufacturing, automobiles,
pharmaceuticals and mining and minerals.
The purpose of these industry-specific legal risk reports is to highlight particular categories of
legal risks within the business context of each industry. While these legal risk industry reports
cannot be exhaustive in scope, they do provide a more concrete basis for senior management
and senior enterprise legal counsel in major Chinese companies with international operations
or which are listed on stock exchanges outside of China or which expect to undertake such
operations or listings to identify the categories of legal risks common to their particular industry
and, more importantly, to take appropriate measures to mitigate and, where possible, prevent
these legal risks before they cause serious, even perhaps devastating, economic damage to
the companies they are responsible to manage.
In order to highlight these industry-specific legal risks, this Report provides a comparative
industry overview for the international oil industry (with particular emphasis on the oil and gas
industry in the United States of America (US), the leading energy producer and consumer in
the world) and the Chinese oil and gas industry. Because Chinese oil companies likely are to
invest primarily in jurisdictions other than the US, this report also identifies certain key risk
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categories which apply in various countries around the world. Case studies are used liberally
for both the international oil and gas industry and the Chinese oil and gas industry to
underscore the potential risks in more practical terms1.
In preparing these follow-up reports, Lovells International Law Firm, one of the 10 largest law
firms in the world, with more than 1,600 lawyers in 27 offices in Europe, Asia and the US, has
cooperated with the Association of Corporate Counsel (ACC), the largest association for
enterprise legal counsel in the world, with more than 17,000 corporate legal counsel members.
Key contributors to this Report include Lovells oil and gas experts in Europe and Asia and
former and current general counsel of foreign oil companies (current and former members of
ACC). In addition, a team of more than 20 researchers has assisted with the preparation and
drafting of this report.
1.3 Introduction to Legal Risk in the Oil and Gas Industry
Several aspects of the oil and gas industry—e.g. the capital-intensive nature of the industry,
market price volatility, geographic scope of assets and operations, the high-risk nature of
exploration and exploitation of natural resources, technology requirements, environmental
concerns, downstream brand promotion and protection issues, political sensitivities, scale and
diversity of employee base, etc.—give rise to particularly high levels of legal risk for
international oil and gas companies.
The ability of a Chinese company in the oil and gas industry with operations or stock exchange
listings outside of China to effectively manage its legal risk will increasingly be a factor in
determining whether or not that company prospers or, in some cases, even survives. This is
in large part due to the internationalization of Chinese companies following the government's
recent directive to expand internationally ("走出国门"), and the increasing independence given
to state-owned enterprises in this sector. The value of Chinese state-owned enterprises that
are listed on foreign stock exchanges may be closely estimated by the number of shares listed
multiplied by the per share stock price which is often referred to as the market capitalization of
the stock. For example on September 25, 2005 SinoPec’s New York Stock Exchange listing
(NYSE) reflected 72 million shares of stock issued and outstanding at a market price of
US$34.08 per share (market price) which results in a market capitalization of US$2.45 billion.
Should the market price per share decrease it may be said that the value of the state-owned
portion of SinoPec also declines by the same amount. Accordingly the investors in SinoPec
(including SASAC) have a very real interest in the management of the value of such listed
companies.
As the widely reported legal problems faced by China Aviation Oil in Singapore demonstrate
(see Case Study Four, page 20), as Chinese oil and gas companies expand outside of China,
any deficiencies in internal management control systems in the company will render the
company less able to address properly the heightened legal risks outside of China. This may
result not only in potentially severe fines and penalties for the company, but also can seriously
damage the company's image and reputation in the international industry, which can damage
the overall business performance of the company. In addition, the value of a listed company
as reflected in the its market capitalization may be seriously reduced by such deficiencies.
Moreover, also as demonstrated by the China Aviation Oil case, senior managers inside and
outside of China can face personal civil and even criminal liability.
2. INTERNATIONAL OIL AND GAS INDUSTRY
2.1 Overview of the Oil and Gas Industry in the United States
BASIC INDUSTRY FACTS
The US is the world's largest producer, consumer and net importer. It also ranks eleventh
worldwide in oil reserves, and sixth in natural gas reserves.2
1
Please note that Lovells has acted as legal advisor for certain companies mentioned in this Report, but the
contents of this Report are based solely on publicly available information and press reports.
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According to the Oil and Gas Journal, as of January 2005 the US claimed 21.9 billion barrels
of proved oil reserves. Eighty percent of these reserves are concentrated in Texas, Louisiana,
Alaska and California. Oil accounts for approximately 40 percent of energy consumption in
North America (comprising the US, Canada and Mexico).
Natural gas—the use of which requires extensive pipeline systems—represents 24 percent of
total energy consumption in the US. As of January 2005, the US had estimated proven natural
gas reserves of 187 trillion cubic feet, or 3.1 percent of world reserves.3 More than 80 percent
of US natural gas imports are from Canada.4
CHALLENGING REGULATORY ENVIRONMENT
Corporate governance and risk management are ranked among the highest priorities for oil
and gas companies. The reporting of operational results of oil and gas companies listed on the
New York Stock Exchange are subject to the Sarbanes-Oxley Act of 2002, which requires
increased rigor in financial reporting, as well as greater transparency of company conduct.
Credit risk ratings and cost of capital are directly affected by the level of transparency of
corporate governance. It is commonly accepted in the West that good corporate governance is
reflected in the market capitalization of listed companies with those companies perceived to
have good governance trading at a premium to companies that are perceived to have less
stringent standards of performance. As a result of this perception, the investors in a company
have a real interest in a listed company maintaining high levels of corporate governance.
SIZE
Fortune 2005 rankings place oil and gas companies in the first tier of the world's largest
companies, with six of the twelve largest companies in the world being oil and gas companies,
namely, British Petroleum, Exxon Mobil, Royal Dutch/Shell Group, Total, Chevron and
ConocoPhillips. Moreover, Exxon Mobil is ranked as the most profitable company in the world
in 2005, with US$25.3 billion in profits. BP ranks second in profits with US$15.3 billion against
total revenue of US$285 billion.5
2.2 International Trends
GROWING ENERGY DEMAND
Recent trends indicate robust growth in demand for crude oil, natural gas and petroleum
products. In particular, demand in many developing countries is increasing much more rapidly
than domestic production. This anticipated growth has attracted increased capital into the
industry and has resulted in both the formation of new companies and international expansion.
OPERATING ENVIRONMENT
The operating environment remains competitive, and there is pressure to manage costs, meet
growth targets, and improve performance. This in turn results in an increased level of mergers,
acquisitions, divestments, and the selling of "non-core" assets. Internationally, many state-
owned companies are now investing outside their home countries for the first time, resulting in
increased competition for investment opportunities and capital.
INTERNATIONALIZATION AND DIVERSIFICATION
Certain oil companies are looking to internationalize their operations either to spread risk or to
respond to market factors. For example, Japanese oil companies are seeking to acquire
interests in exploration assets in the North Sea, and a significant number of international oil
2
Official Energy Statistics from the US Government (January 2005) Energy information
administration website : http://www.eia.doe.gov/emeu/cabs/usa.html
3
North American Natural Gas Vision (http://www.pi.energy.gov/pdf/library/NAEWGGasVision2005.pdf)
4
Official Energy Statistics from the US Government (January 2005) Energy information
administration website (http://www.eia.doe.gov/emeu/cabs/usa.html)
5
www.fortune.com/fortune/global500
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companies are looking to invest in Algeria, and companies in markets with surplus supply
(such as Middle Eastern, Russian and CIS companies) are expanding to markets of increasing
demand (such as the US and India). At the same time, many international oil companies are
diversifying their assets and operations by acquiring production assets to balance their
exploration assets.
MERGERS AND ACQUISITIONS
Many high-profile mergers have taken place in the oil industry in the last few years as oil
companies seek to achieve economies of scale and balance and expand their asset portfolios.
The most notable transactions have been mergers between major oil companies, such as the
Exxon-Mobil, Chevron-Texaco and Conoco-Philips mergers, and the earlier BP acquisition of
ARCO.
However, while the oil and gas industry is often characterized as being comprised of a
relatively small group of major oil companies, the industry also includes a large number of
smaller to medium-sized players, which are often referred to as independents. Some of these
independents are likely to be important acquisition targets for Chinese oil companies in the
future. It is also likely that the majors, independents and Chinese oil companies will
increasingly compete for the same assets in the global market place.
PUBLIC-PRIVATE COOPERATION
Since a significant amount of oil and gas resources are controlled by national governments,
state-owned oil companies are important players in oil and gas projects around the world.
While a certain degree of standardization of terms of exploration contracts exists around the
world, local governments also can dictate many deal terms. Dealing with state-owned oil
companies in various jurisdictions introduces additional risk, complexity and political sensitivity
to these transactions.
2.3 Overview of Legal Risks Specific to the International Oil and Gas Industry
While certain legal risks are common across all industries (e.g. legal risks arising in respect of
contract management, securities regulations, labour laws, etc.), companies in each specific
industry face certain risks unique to that industry. Accordingly, companies in a particular
industry commonly adopt certain customs and practices on an industry-wide basis to allocate
those risks in a generally accepted manner. This is particularly true in the oil and gas industry,
which is highly specialized and composed of a relatively small number of key players. In this
environment, it is important for Chinese oil and gas companies to be aware of the nature of
these legal risks that are specific to this industry and to address them in a manner that is
commercially acceptable in the global marketplace.
In the oil and gas industry, as in all other industries, legal risks arise by reference to
relationships between the company and other players in the market. There are three general
relationships that all legal risks can be categorized under: the relationship between the
corporation and regulators (representing the interests of public shareholders, consumers, etc.
as well as the interests of the State in respect of revenues in the form of royalties and taxes),
between the corporation and other companies, and between the corporation and individuals
(including employees) and other societal stakeholders. In the context of the oil and gas
industry, these relationship categories give rise to a range of legal risks, some of which are
described below.
RELATIONSHIP TO REGULATORS
Politics. Governments consider a secure supply of oil and gas products to be a matter of
national security. CNOOC's recent bid to purchase Unocal demonstrates the importance that
governments attach to the industry, as government administrations on both sides of the Pacific
made various efforts to influence the outcome, directly and indirectly, to ensure that national
interests were not compromised (see Case Study Two, page 15). While political risk itself is
separate and distinct from legal risk, they are often connected. As seen in the CNOOC-Unocal
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case, political issues can give rise to additional legal requirements, and as can be seen from
other case studies in this Report, legal problems can give rise to political responses.
Heavy regulation. While the oil and gas industry itself is not one of the most heavily regulated
industries, in terms of industry-specific regulations, the operations of oil companies are subject
to a wide array of regulations such as environmental, labour, regulations, securities, tax, trade,
distribution and transportation. International projects, whether or not involving state-owned oil
companies of the host country, can also be subject to foreign investment and other country-
specific rules regulations. As such, oil and gas companies devote substantial resources to
ensure regulatory compliance. They also pay close attention to the processes involved in the
conduct of business (for example, the processes involved in obtaining and maintaining
licenses, in transferring licenses and participations, etc.) and to the impact of changes in
applicable legislation.
Anti-trust. Approximately 80 countries around the world have enacted some form of anti-trust
or competition laws. Those regulatory regimes often have somewhat conflicting requirements
and procedures regarding notice of acquisitions, pre-clearance of acquisitions, etc. Those
risks must be examined in detail by competent legal counsel, often located in more than one
jurisdiction, in order to assess the risks involved in acquiring significant assets. Compliance
with anti-trust notification and clearance regulations can be quite costly and time consuming.
Those uncertainties can place a significant amount of pressure on the stock price of both the
acquirer and the target regardless of whether the target is the stock of a company or simply a
significant asset. Governments in various parts of the world also apply anti-trust laws to
certain other operational aspects of the oil and gas industry. For example, the EU recently
announced an enquiry into North Sea gas pricing, which has led some commentators to
suggest that the EU intends to try to avoid the creation of an "OPEC of gas". Thus, oil and gas
companies need to assess the competition law implications not only of mergers and
acquisitions but also of pricing arrangements.
Expropriation of Assets. Government expropriation of oil and gas assets (including indirect
expropriation through changes in the tax regime) are risks in certain jurisdictions. While these
in and of themselves are not directly legal risks, they can have legal implications. Parties
should assess these risks and evaluate what legal and political recourse would be available in
the event of appropriation, for example, under the Energy Charter Treaty, which provides for,
among other things, fair and equitable treatment, constant protection and security, non-
discriminatory treatment and prohibition of expropriation. The question of what is fair and
equitable treatment often depends on the political atmosphere surrounding an expropriation.
The experience of international oil companies that had oil and gas related assets expropriated
in the last century indicates that the company which has its assets taken in this process is
likely to feel that its long term value has been reduced by an amount that exceeds the
compensation that is offered by the expropriating government.
Multiple jurisdictions. Not only must oil companies comply with a voluminous body of
complex regulations, they must do so across numerous jurisdictions. Some oil and gas
companies list their shares on multiple stock exchanges in more than one jurisdiction, while all
of the largest global oil and gas companies engage in cross-border upstream and downstream
operations and manage international supply and distribution networks in scores of different
countries. Because the business activities of oil companies fall under the jurisdiction of
multiple government authorities, each with their own unique sets of regulations, oil companies
must often adopt separate compliance systems in each jurisdiction. Violations of applicable
laws in one jurisdiction may give rise to potential legal liability in other jurisdictions as well.
RELATIONSHIP TO OTHER COMPANIES
Size and Scale. Oil and gas companies constitute some of the world's largest corporations.
Such size and scale introduces additional challenges in managing legal risks. In order to
manage legal risks arising out of operations of a global scale on a uniform basis, international
oil and gas companies adopt comprehensive and rigorously enforced internal policies and
practices to ensure compliance with applicable laws. The capital-intensive nature of oil
company projects also gives rise to unusually high legal risks. Given the scope and scale of oil
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company investments around the world, failure to secure critical legal rights or approvals, or
delays in obtaining the same, can cause commercial losses in the form of increased costs or
lost or delayed revenues in amounts of tens or even hundreds of millions of US dollars.
Interdependence. Companies within the oil industry are simultaneously partners and
competitors. Oil companies must often work with other oil companies in order to prevent
overlap and to make major projects economically and logistically feasible. Such cooperation
requires complex negotiations and contracts, and can lead to conflicting interests. For
example, as Chevron and CNOOC competed to acquire Unocal, they were at the same time
negotiating a deal to cooperate in a natural gas project in Australia. However, this
interdependence does create a framework where co-operation rather than adversarial
approaches is the order of the day.
Intellectual property. In both upstream exploration and extraction and downstream
production of oil products, technology plays a pivotal role. While some processes are
commonly known and used throughout the industry, others are patented or proprietary
(intellectual property rights or “IPR”) and are the source of important competitive advantage.
In the course of joint exploration or production projects with partners/competitors, the IPR of
one party may be exposed to the other party. Secondments of personnel from one oil
company to another for project-specific operations can also expose proprietary information to
the seconded personnel. Accordingly, in all of these situations, oil companies negotiate
comprehensive contract provisions to protect their IPR and impose strict operational
guidelines for access to and use of such technology. When pursuing individual exploration or
production projects in certain markets, oil companies take equal care to prevent leakage of
sensitive IPR to employees or third parties, again consisting of both contractual rights and
obligations and rigorous security measures. In the context of the downstream distribution of
products and services in certain markets, oil companies must take aggressive measures to
protect trademarks and sales channels. Counterfeit products not only take away potential
sales revenue, but inferior counterfeit products sold under the brand of a major oil company
can also seriously damage that company's reputation in the marketplace.
Contractual obligations. Because of the size and scale of the projects oil companies
engage in, both in terms of resources and investment, and given the fact that many projects
are undertaken in conjunction with a competitor, contracts within the industry are often long
and complex. The majority of oil and gas projects involve a series of inter-locking contracts
and in many cases may involve external commercial debt financing. As such, contracts in the
oil and gas industry require a high level of expertise not only in respect of general international
contract drafting and negotiation skills, but also specialized expertise in international oil
industry customs and practices as well as specialized areas of international law and practice,
e.g. environmental law, construction law, real estate law, international commercial finance,
transportation and shipping, boundary delimitation issues, host government agreements,
international arbitration, consumer protection, etc. Disputes under these contracts can involve
tens or even hundreds of millions of US dollars and will typically be adjudicated in foreign
courts or international arbitration fora in accordance with complex local rules. This explains
why major foreign oil companies employ hundreds of experienced in-house legal counsel with,
in many cases, 15-20 years of international contract negotiation experience. By comparison,
Chinese oil companies have far fewer experienced in-house lawyers.
Market volatility. Historically, global oil market has been extremely volatile and market prices
have been subject to a large number of events outside of the control of oil companies.
Supplies can be limited by such events as labour disputes, civil unrest, court injunctions,
terrorist attacks, war, mechanical breakdowns in extraction or refining equipment, an
unforeseen change in government policy, extreme weather (witness the devastating effects of
Hurricane Katrina in the US Gulf coast), etc. Demand can be greatly altered by a sudden
change of weather, adoption of new technology, change in government policy, terrorist attacks,
speculation, etc. This historic volatility has increased the difficulty of managing the legal risks
arising from contracts and regulations. For example, an oil company that contracts to supply a
certain amount of oil to a refinery does not always have complete control over the amount it
may extract due to the national policy of or political unrest in a particular country. Increasing
international demand has fuelled spiralling oil prices over the last year leading many to
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suggest that the world has entered a new era of high oil prices which may stabilize in a range
much higher than historical levels, but certain factors enumerated above may still combine to
change the market paradigm again to return the market to lower pricing levels. Thus, these
continuing commercial risks must still be addressed in respect of management of related legal
undertakings. For example, the damage inflicted by Hurricanes Katrina and Rita in the US Gulf
of Mexico on drill rigs, production platforms, pipelines and refineries significantly impacted
world prices for crude oil, not just regional prices in the US.
RELATIONSHIP TO OTHERS
Operational risks. Day-to-day operations create numerous legal risks for oil and gas
companies. Even companies that strictly comply with all applicable regulations are not
immune from liability for damages to third parties in the course of the company's operations.
For instance, if a fire erupts at a refinery, and the resulting explosion injures or kills employees
or other individuals and causes damage to neighbouring private property owned by third
parties, depending on the particular facts and the requirements of applicable law, in some
jurisdictions even if the company was not negligent and was fully compliant with all applicable
regulations, the oil company may still be obligated to clean up the physical damage,
compensate the injured persons for damages and, before resuming operation, repair the
damage to the refinery and/or take remedial actions to ensure, to the satisfaction of the
applicable regulatory authorities, that similar events do not occur again during normal
operations. This liability is not unique to the oil and gas sector but the size and scope of
operations and the inherent risks in dealing with oil and gas products makes this a more
serious concern than in many other sectors. Although the legal liability for such events in
China may give rise to only modest damages under current conditions, outside of China the
legal liability for such events can result in damages in the tens or even hundreds of millions of
US dollars. The legal effects of such operational disasters may extend for 10 years or even
longer and oil company senior executives personally may be liable for civil and even criminal
penalties in certain cases and be subject to arrest if they were to enter the host jurisdiction
following certain serious disasters (as reportedly was the case with the Union Carbide
accident in Bhopal, India). Although oil companies cannot completely prevent such accidents
from occurring, they must take precautions to limit the number of such incidences, and employ
sufficient legal resources to effectively handle these claims and liabilities when they do arise.
Environment. Extracting, refining, and transporting oil products can all create potential
environmental problems. In developed countries, and increasingly in developing countries,
environmental laws are strictly enforced with potentially severe civil and, in some cases,
criminal penalties. Moreover, non-compliance with environmental regulations, with or without
accompanying actual environmental damage, generally will result in aggressive responses by
environmental protection advocacy groups. Recent high-profile environmental disasters have
greatly changed the operating environment in the industry. First, regulators now more closely
supervise the industry's actions to protect the environment. Second, oil companies have had
to adopt proactive earth-friendly policies in their business operations to avoid negative
repercussions among the consuming public. Thus, failure to implement appropriate pro-active
compliance measures or public relations programmes, can have a serious negative impact on
an oil company's operations and financial results.
Human rights. The impact of the actions of oil companies upon local populations has
recently become a matter of major concern in the industry. The policies and actions of
government officials in some resource-rich developing countries may result in gross human
rights violations, and to the extent that oil companies are alleged to have facilitated or even
only to have only been complicit in such activities, they may face liability inside (and, in some
cases, outside) the host jurisdiction. Many oil companies are currently facing such charges in
courts in various parts of the world. Even for those oil companies exonerated from such
claims, the allegations of human rights abuse can inflict damage to the company's reputation
and market capitalization.
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2.4 Case Study One: Miscategorization of Oil Reserves by Shell
This section highlights some of the problems faced by the Royal Dutch/Shell Group of
Companies ("Shell"), the world's third largest oil company, in respect of the mis-categorisation
of reserves.
FACTS
On 9 January 2004, Shell announced that it was recategorizing 3.9 billion barrels of oil
equivalent ("BOE") of "proved" reserves, to the more speculative category of "probable". In
some cases, BOE reportedly were no longer capable of categorisation as proved because
local litigation over political, environmental, or commercial issues called into question the
certainty of being able to extract oil. In other cases, Shell apparently no longer considered it
likely that it would be able to extract all of the oil it booked as proved before its lease on the
land expired.
With the recategorization, Shell's reported reserves dropped over 20 percent6, and within one
week the value of Shell's stock fell over 10 percent, representing over US$6 billion in market
capitalization—the equivalent of nearly two years of Shell's total profits.
In the aftermath of the recategorization, Shell was fined record amounts by both British and
American regulators, agreeing to pay a total of US$151 million in civil penalties to the UK
Financial Services Authority and the US Securities & Exchange Commission, 7 narrowly
escaped criminal prosecution by the US government, dismissed three senior executives,8 and
caused serious damage its reputation.
In addition, Shell paid US$90 million to settle a three class action lawsuit filed by members of
various Shell pension schemes in the US. Shell also settled a shareholders derivative lawsuit
relating to the recategorization by the payment of over US$9 million in legal fees incurred by
the plaintiffs and by agreeing to adopt corporate governance changes. One other class action
is still pending, pursuant to which, according to reports, shareholders are asserting claims for
losses to share-based savings schemes of more than US$1.8 billion.
EXPLANATION
As an NYSE-listed company, Shell is subject to SEC Reg. § 210.4-10, which requires oil
companies to report the size of their "proved" oil reserves, so investors can have access to
accurate information on the company's Reserves Replacement Ratio (RRR), a key
performance indicator. If an oil company has an RRR of less than 100 (i.e., it extracts oil faster
than it finds new reserves) this may raise concerns about the company's future ability to
continue to extract at the same rate, which will have an impact on perceived value. Under Rule
4-10, the SEC defines proved reserves as those which with "reasonable certainty [will] be
recoverable in future years from known reservoirs under existing economic and operating
conditions." The SEC has clarified this to mean that a firm cannot claim reserves until
commercially viable oil is flowing. While the SEC rule is very detailed, judgment must still be
6
Oil giant Shell's investors shocked, BBC News (http://news.bbc.co.uk/1/hi/business/3890045.stm)
7
ReguLetter No 16. 2004 (http://cuts-international.org/reguletterpdf/reguletter16.pdf)
8
The Plain Dealer http://www.cleveland.com/business/plaindealer/index.ssf?/base/business/
1125664442196210.xml&coll=2
-9-
exercised in the categorization of reserves as "proved". According to published reports, Shell
had a comprehensive internal policy to manage reporting of reserves but this reportedly did
not conform in all particulars with the detailed requirements of the SEC rule.
Shell's Response to the Recategorization Crisis
After the announcement of the recategorization, Shell commissioned a major US law firm to
conduct a comprehensive independent investigation of its compliance systems. It conducted a
full scale public relations campaign to demonstrate that it took the problems seriously and to
reassure investors and other public stakeholders of its commitment to openness and
transparency in the process of effecting necessary internal structural reforms.
Shell then completely restructured its original dual Anglo-Dutch ownership structure and
adopted more streamlined corporate governance systems. As a part of this overall
restructuring, Shell has created a new senior management position of senior compliance
officer to report directly to the chief legal officer. This new senior compliance officer will be
vested with substantial independence and authority and will be responsible to create,
implement and oversee an independent regulatory compliance system. The overall role of the
in-house legal department has also been strengthened.
This aggressive action on the part of Shell to address fundamental structural issues in its
corporate governance and regulatory compliance systems has ameliorated much of the
damage inflicted in the initial period following the recategorization. Public confidence is being
restored, and as a result of Shell's restructuring efforts and spiralling oil prices, Shell's stock
price has rebounded to levels well above the pre-recategorization period.
LESSONS FOR CHINESE OIL COMPANIES
Shell is one of the most profitable and highly-respected companies in the world. It has
dedicated substantial resources to the development of comprehensive internal policies and
guidelines to ensure compliance with applicable regulatory requirements. Yet Shell still
experienced very substantial compliance-related problems.
By comparison, Chinese oil companies overall have less well-developed internal management
control systems, and investment in regulatory and legal compliance programmes and
resources has been very low by international standards. Thus, it is more likely that the Chinese
oil companies operating or listed on stock exchanges outside of China will encounter legal risk
events of serious magnitude across a wide range of legal compliance risk categories. In
particular, since each of the "Big Three" major Chinese oil companies are listed on the NYSE,
they are to the same detailed reporting requirements as Shell and thus face the same risks in
the event of mis-categorization. It will be important for Chinese oil companies to evaluate their
own internal compliance systems and make necessary investments in ensuring that they are
sufficiently robust and effective.
Shell's response to the crisis is also instructive for Chinese oil and gas companies. The fact
that Shell implemented a comprehensive and well-coordinated effort to address the
fundamental problems in a substantive and public way helped stem the reputational and
financial damage. The openness and transparency of Shell's internal management reform
process was of critical importance.
Chinese oil companies may not be able to respond in the same public, transparent and
immediate manner. In a crisis of this nature, delay and lack of openness will only exacerbate
the concerns of investors and other public stakeholders and deepen the crisis. In general the
existing internal management controls and compliance systems in Chinese companies are not
as well developed as those of western companies. In a situation such as that faced by Shell,
Chinese companies will face even more significant challenges in adopting reforms to corporate
governance and regulatory compliance systems as quickly and effectively as Shell was able to
do. This creates potentially higher risks of damage for Chinese companies in the event of such
legal crises in the future.
- 10 -
2.5 Other International Oil Company Case Studies
Type of Risk Example Result/consequences
The Exxon Valdez ran
• In this highly-publicized case, Exxon, the
aground on a charted reef,
world's largest public company, sustained
spilling 11 million gallons of
US$4bil. in punitive damages
crude oil (1989)
• This case was filed in Ecuador,
increasing concerns that Chevron will be
Group of Ecuadorians filed found liable (but no decision issued to
US$1bil. suit in Ecuador date)
against Chevron for alleged • This case, which has been closely
dumping of toxic wastewater watched by lawyers, multinational
(2003) corporations and the international human
rights community, subjects the reputation
of Chevron to public scrutiny
Environment
Shell, Nigeria's largest
investor, fined US$1.5bil. by • In addition to payment of the US$1.5
Nigerian government for billion fine, Shell is to pay for clean-up
alleged environmental and equipment upgrade costs to prevent
damage to the Niger delta further damage
(2004)
South Coast Air Quality
Management District filed • Case created substantial adverse
US$319mil. suit against BP publicity
because one of BP's • BP has had to pay substantial additional
California refineries amounts to bring its facilities into
allegedly did not meet compliance
environmental regulations
(2003)
Occidental Petroleum sued
for $12mil. in a US court for
allegedly aiding the
• Not yet decided
Colombian government in a
bombing that killed 17
civilians in a Colombian
village (2003)
Human Rights
Unocal was sued by
Myanmar peasants in US • Unocal settled for an undisclosed amount
court for over $1bil. for • Case confirms the validity of the Alien
allegedly assisting the Tort Claims Act, a once obsolete civil
government in human rights procedure rule, allowing foreign citizens
abuses during a pipeline to sue in the US
construction project (2003)
• Motiva officials pleaded guilty to
US government sued Shell negligently endangering workers and to
and its Saudi JV (Motiva knowingly discharging pollutants into the
Operational Risks Enterprises) following a tank air and water in connection with a fatal
explosion that killed 1 and explosion at a Delaware refinery in 2001.
injured 8 others (2001) Motiva Enterprises was fined US$10
million
- 11 -
3. CHINESE OIL AND GAS INDUSTRY
3.1 Overview of the Chinese Oil and Gas Industry
BASIC INDUSTRY FACTS
After the US and Russia, China is the world's third largest energy producer. It is also the
second largest energy consumer after the US.9 As such, China's share in the global energy
production and consumption market is significant: it produces 9.5 percent of the world's total
annual energy, and consumes roughly 10 percent. China's energy demand has been greatly
increasing and is expected to grow at about 5.5 percent per year through the year 2020. The
International Energy Agency 10 predicts that by 2030 China will account for one-fifth of the
world's total energy demand.
Since 1993 China has been a net oil importer as China's growing demand for oil and gas has
greatly outstripped its domestic production capabilities. It became the second largest oil
importer in 2003, when it imported 30 percent of its oil needs. That percentage is projected to
increase to 50 percent by 2010, and by the year 2030, China is expected to import more than
80 percent of the oil it consumes. With regard to gas supply, offshore basins are becoming
increasingly important, even though China has substantial proven gas reserves.
RESTRUCTURING OF THE ENERGY INDUSTRY
Until the mid-1990's, China's energy sector was dominated by a small number of very large
state-owned enterprises directly administered by the relevant government ministry.
In 1998, China began a major restructuring of most state-owned oil and gas assets into two
vertically integrated firms—China National Petroleum Corporation (CNPC) and China
Petrochemical Corporation (Sinopec). This created two regionally focused firms, with CNPC in
the north and west, and Sinopec in the south. Other major state sector firms in China include
China National Offshore Oil Corporation (CNOOC), which handles offshore exploration and
production and accounts for more than 10% of China's domestic crude production, and China
National Star Petroleum, a company created in 1997.
Through its Tenth Five-Year Plan (2001-2005) the Chinese government undertook a strategic
reorganization of the energy industry aimed at securing a sustainable oil and gas supply in the
long term. Anticipating China's increased energy demand, the guiding principles of this
reorganization are focused on the domestic market, tapping the international market and
enhancing exploration efforts.
GOING GLOBAL
With China's expectation of future dependence on oil imports, China's "Big Three" oil
companies Sinopec, CNOOC and CNPC (and its subsidiary Petrochina), have in recent years
spent billions of US dollars on oil and gas production projects around the world, and have
acquired interests in exploration and production assets abroad.
Iran is China's largest source of foreign oil, providing 13 percent of China's total annual
imports.
CNPC holds oil concessions in Kazakhstan, Venezuela, Sudan, Iraq, Iran, Peru and
Azerbaijan. CNPC deals also include the acquisition of a 60 percent stake in a Kazakh oil firm
(Aktobemunaigaz) and expanded oil production in Sudan. It also signed a deal with the
Brazilian state oil firm Petrobras to cooperate on refining, pipeline, exploration and oil
production projects.
9
http://www.traveldocs.com/cn/economy.htm
10
Energy Overview of China (www.fe.doe.gov/international/EastAsia_and_Oceania/chinover.html)
- 12 -
Sinopec has also begun seeking to purchase overseas upstream assets, purchasing a 50
percent interest in an oil field in Angola. Other agreements involve exploration and
development of natural gas and oil in Saudi Arabia.
In Myanmar, CNOOC and Sinopec started large-scale oil development projects, following in
the footsteps of CNPC, which had entered natural gas production a decade ago. In Indonesia,
PetroChina and CNOOC purchased large stakes in Indonesian oil and gas fields. In Australia
CNOOC purchased a stake in the North West Shelf liquefied natural gas project, co-operated
by Chevron.
Chinese companies are also active in Canada and the United States. In Canada, PetroChina,
Sinopec and CNOOC signed deals for shares of Alberta's oil sands and for a pipeline to export
crude oil extracted from Alberta to the Pacific coast and then via tanker to China. Most
recently CNOOC unsuccessfully bid to buy Unocal in the US (see Case Study Two on page 15)
and CNPC has bid successfully (albeit not without difficulty) for Petrokazakhstan (see Case
Study Three on page 18).
CONCLUSION
As the second largest energy consumer in the world, China's rate of increase of demand is
four to five times the world average.11 To secure energy sources essential for its future growth,
Chinese oil companies are aggressively expanding internationally. However, global operations
are complex and demand consistent and flexible strategies as well as an appropriate level of
risk management, including legal risk management.
Top World Oil Consumers,
2004*(Non-OPEC Fact Sheet)12 Top World Oil Net Importers, 2004*
Total Oil Consumption Net Oil Imports
Country (million barrels per day) Country (million barrels per day)
1) United States 20.5 1) United States 11.8
2) China 6.5 2) Japan 5.3
3) Japan 5.4 3) China 2.9
4) Germany 2.6 4) Germany 2.5
5) Russia 2.6 5) South Korea 2.1
6) India 2.3 6) France 2.0
7) Canada 2.3 7) Italy 1.7
8) Brazil 2.2 8) Spain 1.6
9) South Korea 2.1 9) India 1.5
10) France 2.0 10) Taiwan 1.0
11) Mexico 2.0 *Table includes all countries that imported more than 1
*Table includes all countries that consumed more million bbl/d net in 2004.
than 2 million bbl/d in 2004.
11
China’s Energy Woes: Running on Empty, Far Eastern Economic Review June 2005
(http://www.feer.com/articles1/2005/0506/free/p013.html)
12
Energy Information Administration (http://www.eia.doe.gov/emeu/cabs/topworldtables3_4.html)
- 13 -
Map of proved oil reserves at end 2004 13
3.2 Areas of Potential Legal Risk Exposure for Chinese Oil and Gas Companies
In their day-to-day business activities, Chinese oil and gas companies are confronted with a
variety of legal risks. As they expand and grow their operations overseas, these risks are
compounded. It is essential for Chinese oil and gas companies to be aware of such risks,
analyze how these risks might affect their operations, and take the appropriate actions to
mitigate such risks. Chinese companies that ignore the industry's inherent legal risks leave
themselves exposed to potentially serious consequences. Some of these legal risks are
described below (using the same relationship categories used above).
RELATIONSHIP TO REGULATORS
Foreign law exposure. Chinese oil companies that operate or are listed on stock exchanges
in foreign markets must comply with the applicable laws of that jurisdiction. Although China's
legal system is developing rapidly, by comparison with the legal systems of many foreign
jurisdictions, the Chinese legal system is less well developed. This is especially true of the
regulatory regime in the oil and gas industry in China, which traditionally has been dominated
by only a few SOEs. Thus, Chinese companies that operate without incident in the Chinese
legal environment are not necessarily adequately prepared for the demands of operating
abroad under more rigorous foreign regulatory schemes. The requirements of foreign laws not
only may result in fines, penalties and lawsuits, but as either a legal or a practical matter also
may prevent the intended commercial activities contemplated in the foreign jurisdiction. Thus,
if a Chinese company is not familiar with the local legal requirements in a particular foreign
jurisdiction, this may undermine the entire commercial purpose of the investment in that
foreign market.
Corporate governance. Chinese oil companies listed abroad must ensure their internal
governance structure and systems are consistent with the corporate governance demands of
the applicable stock exchange and securities regulatory authorities. In the aftermath of the
recent Enron and Worldcom scandals, corporate governance has become an issue of critical
importance in the US and across the world. To prevent similar legal and financial disasters in
the future, governments and regulators have tightened corporate governance requirements
and increased enforcement. Under the Sarbanes-Oxley Act of 2002, senior management of
companies listed in the US that do not fully comply with applicable reporting requirements face
possible criminal charges. As the experience of China Aviation Oil (Singapore) demonstrates,
other markets are increasingly adopting similar laws.
Dual nature of SOEs. China's major oil companies remain majority-owned by the PRC
government. At the same time, Chinese oil companies are responsible to operate
independently and are also responsible to their public shareholders. This dual status of
13
Proven Oil Reserves on BP website( http://www.bp.com/sectiongenericarticle.do?categoryId
=9003054&contentId=7005895 )
- 14 -
Chinese oil companies often presents tensions which can be manifested in the form of legal
and political risk. For example, the Chinese government's 70 percent ownership of CNOOC
was perceived by some to be an obstacle to its proposed acquisition of Unocal.
Political risk. There is a great deal of pressure upon Chinese oil companies to expand
abroad and secure sufficient natural resources assets to sustain the continued unprecedented
growth and acceleration of China's economic engine. This has spurred Chinese oil companies
to look to cooperation with governments such as Iran and the Sudan for access to the
necessary resources. At the same time, Chinese oil companies have taken advantage of soft
loans from Chinese state-controlled banks to secure loan terms not available to international
competitors. Since the oil industry operates on a truly global basis, Chinese oil companies
should recognize that some such arrangements may give rise to political repercussions which
may present obstacles to other potential commercial arrangements (again, CNOOC's reported
reliance on government-supported soft loans in connection with the proposed acquisition of
Unocal was cited by some as grounds for opposing that transaction). These risks should be
assessed and addressed on a global basis.
RELATIONSHIP TO OTHER COMPANIES
Contract management. As noted above, contracts used in the international oil and gas
industry are often lengthy and complex. Many Chinese oil companies have negotiated joint
cooperation agreements with major foreign oil companies primarily only in respect of projects
based in China, where Chinese oil companies were in a position to dictate more of the terms
and conditions of the contract. As Chinese oil companies expand abroad, they will need to
adopt industry-standard contracts which are highly specialized and can be very technical in
nature. Chinese oil companies at present still have relatively little experience in the
negotiation of such complex contracts and therefore will find themselves at a disadvantage in
comparison with their more experienced foreign counterparts. Subtle changes in the drafting
of highly technical provisions of such contracts can shift risks having a value in the range of
several millions to several hundreds of millions of US dollars from one party to the other. Thus,
Chinese oil companies will need to invest heavily and quickly to bring their levels of
international contract negotiation up to international standards.
Interdependence. The interdependent nature of the oil industry poses unique challenges for
Chinese oil companies. A positive reputation for transparency, performing commitments, and
cooperation is an important and valuable asset for oil and gas companies, while a perceived
reputation to the contrary will foreclose certain commercial opportunities. Chinese oil
companies, accustomed to operating in their home environment where their status as SOEs
has given them additional commercial leverage, have been perceived (correctly or incorrectly)
by some foreign competitors within the industry as uncooperative because of a reported track
record of breaching or renegotiating contracts for China-based projects. While the position of
Chinese oil companies in China may have shielded them from potential claims or liabilities in
the past, this perceived track record in China may limit future business opportunities outside of
China, and if similar tactics are employed outside of China these may result in legal action. As
Chinese oil companies acquire assets outside of China these risks will increase.
RELATIONSHIP TO OTHERS
Labour laws. The risk of non-compliance with foreign labour laws is one of the areas of
greatest potential legal risk for Chinese companies as they expand abroad. For example,
whereas labour unions and strikes are illegal in China, in many foreign countries it is illegal for
employers to prevent such activities. In addition, although China has become a major
economic force in the global economy in large part because of its supply of inexpensive labour
resources willing to work long hours under varying conditions, foreign jurisdictions often have
much more stringent wage and work environment requirements under a wide range of
environmental health and safety laws. According to Lovells' research, one of the most
common legal problems faced by Asian companies as they expand into the US and Europe is
non-compliance with labour laws. Penalties for labour law violations can be quite severe,
including administrative penalties, class-action awards and even punitive damages. Labour
matters are also very politically sensitive, and violations may give rise to public protests and
- 15 -
boycotts, resulting in economic losses to the company greatly in excess of the underlying
violation of law. Consequently, Chinese oil companies expanding abroad must set up
systems to ensure compliance with applicable local labour laws. Chinese companies will also
need to also be aware of the difficulty in obtaining visas for workers that are required to
operate assets in foreign countries. Many countries around the globe are seeking to require
increased use of nationals of the country of operation. Such efforts may take many forms such
as quotas, training requirements and bid preferences.
Environmental laws. Developed countries uniformly have much stricter laws in place to
protect the environment than developing countries. Environmental issues are highly politicized
outside of China, and all oil and gas companies, Chinese or foreign, are especially vulnerable
to public protests led by environmental protection advocates. Chinese oil companies that
expand their operations abroad while maintaining only the comparatively less rigorous
environmental standards of China likely will find themselves in continuing violation of the
applicable environmental laws of the foreign jurisdiction. Compliance with foreign
environmental standards can be very expensive; however, the legal penalties for violations of
environmental laws in most jurisdictions can be extremely severe and harsh, including both
significant civil fines or civil judgments of up to several hundreds of millions of US dollars or
even in excess of US$1 billion (see selected case studies in section 2.5 above) as well as
potential criminal liability for key managers. Negative public reaction to non-compliance with
environmental laws can also result in lawsuits and boycotts, inflicting even greater economic
damage to the company. By any measure, the cost of compliance is cheaper than the cost of
non-compliance.
3.3 Case Study Two: Analysis of CNOOC's bid for Unocal
On 23 June of this year, CNOOC announced that it had made an unsolicited, all-cash bid of
US$18.5 billion for Unocal, based in the US state of California. This announcement shook the
industry and created a firestorm of controversy in the US. Ultimately, on 2 August, CNOOC
withdrew its bid in the face of what it described in it press release as "unprecedented",
"regrettable and unjustified" political opposition. This paved the way for Chevron to complete
its acquisition of Unocal for a mixed cash-and-shares offer of approximately US$17 billion.
Extensive media reports inside and outside China have analyzed the reasons for the failure of
CNOOC's bid for Unocal. In this Report, we analyze the legal and related risks encountered
by CNOOC in the bid process and then discuss what additional risks CNOOC would have
faced had its bid been successful. This will serve to illustrate many of the industry-specific
legal risks outlined above.
Political Risk
CNOOC's bid for Unocal sparked an unprecedented level of political opposition in the US. US
government approvals would be required in any event for such an acquisition, but US
politicians demanded a more stringent review than otherwise may have been required.
Although from an objective point of view these obstacles appear to have been capable of
being surmounted eventually, in the end the political pressures were certainly a factor; in the
words of the CNOOC press release, these pressures "create[ed] a level of uncertainty that
present[ed] an unacceptable level of risk" that the deal could be closed.
As a general matter, in addition to shareholder approvals, such a bid would have to be cleared
by the US justice department following a determination that the acquisition would not
significantly reduce competition. Since Unocal accounts for less than 1% of global oil
production, it is anticipated that despite the political issues this transaction would have passed
the standard US competition law tests, although perhaps with some minor modifications to the
deal structure. The pressure that the bid put on the market capitalization of the Unocal as the
target and Chevron also should not be lightly dismissed.
In addition, US law provides in certain cases for review of proposed foreign acquisitions of US
companies by a federal inter-agency panel by the name of Committee on Foreign Investments
in the United States (CFIUS). This review is triggered when there is "credible evidence" that a
- 16 -
proposed acquisition might pose a threat to US national security. The US Congress passed a
resolution on June 30 declaring that CNOOC's proposed acquisition could threaten America's
national security interests and required CFIUS to subject the CNOOC bid to a thorough review.
CFIUS had approved the recent Lenovo acquisition of IBM's global PC business only a few
months earlier, and many analysts believe that CFIUS would ultimately have approved the
CNOOC acquisition of Unocal as well, but the prospect of further delays in the review process
appear to have been a decisive factor in the decision of Unocal's board to accept Chevron's
lower bid.
This response in the US to CNOOC's bid illustrates the politically sensitive nature of the oil
and gas business (however, it is interesting to consider what the response of the Chinese
government would have been had the situation been reversed, i.e. if Unocal had made an
unsolicited bid for CNOOC's listed shares). As global oil prices continue to rise, concerns
about protection of energy supplies naturally become intensified.
Even if such political concerns are not supported by objective facts, they are important factors
that give rise to actual political risks and must not be overlooked. Moreover, this case
illustrates that political opposition can be expressed through the imposition of additional legal
requirements. In this case, the response was taken at the legislative branch, but in other cases
the response could be taken through the judiciary or the administrative arms of the
government.
Acquisition Stage Risks
Had CNOOC's bid been accepted and US government approvals obtained, CNOOC and
Unocal would still have been required to negotiate detailed acquisition contracts. The legal
risks associated with an acquisition of a business or a company fall primarily on the purchaser.
This is particularly true in a cash offer for the purchase of shares of the target, as was the case
here.
In a share acquisition, the purchaser acquires the target, including all of its assets and all of its
liabilities. In a non-public share acquisition, extensive legal and financial due diligence is
required to confirm that the target has all legal rights in its assets and that there are no
undisclosed risks or liabilities (in a public share acquisition, much of the necessary information
is already public). In most cases, some of this due diligence exercise would have been
conducted at a high level prior to making the offer (which would be subject to certain standard
conditions, typically including completion of full due diligence and signing of comprehensive
and definitive acquisition contracts). Areas of particular concern in the proposed acquisition of
an oil and gas company would include issues of legal risks relating to environmental law
compliance, labour law compliance, intellectual property rights, litigation, operating permits,
etc.
But even following completion of full due diligence, there are still substantial areas of
uncertainty and risk for the purchaser. In order to address these risks, the definitive
acquisition agreements in a non-public share acquisition will, depending on the nature of the
transaction, include contractual assurances (known as representations and warranties) from
the seller to the buyer covering all key aspects of the business and operations of the target
company. In essence, this is a detailed description of the condition of the target company that
forms the basis on which the purchaser agrees to pay the agreed acquisition price. If it turns
out that these assurances are not correct in any material respect, then the seller will be
required to indemnify the purchaser by refunding an appropriate portion of the purchase price
(subject in most cases to minimum thresholds and individual and aggregate caps).
This is a highly complex exercise that gives rise to significant legal risks to the parties to an
acquisition transaction. In this case, this was a public share acquisition and CNOOC was
represented by experienced international legal counsel who would be in a position to guide
CNOOC through this process to reduce these legal risks to the extent possible.
- 17 -
Post-Acquisition Operation Risks
However, the primary area of legal risk exposure for CNOOC and other prospective Chinese
purchasers of companies or businesses in more developed countries likely would arise in
respect of the post-acquisition operational period. The following factors contribute to this
increased risk:
• Scope of Risk. The differences in the risk profile inherent in the acquisition stage
and in the post-acquisition operational period can be understood in the context of the
following analogy: the acquisition stage itself takes places in a compressed period of
time and can be likened to a snapshot or a short video clip, while the post-acquisition
operational period is of indefinite duration and can be likened to a continuing series of
full-length motion pictures. In respect of the acquisition stage, the legal risks are
intense but limited in time and scope, while the legal risks arising in respect of
continuing operations are unlimited in scope and duration and can include individual
legal risk categories and events as serious as those encountered during the
acquisition process itself. Another way to express this same concept it as follows:
while the acquisition process is intended to address in part future operational risks,
the focus is on confirming the pre-acquisition operational status so as to avoid legacy
problems going forward; on the other hand, in the post-acquisition stage, new
ownership and management is responsible for its own operational decisions, and
since this is of indefinite duration, the legal risks generated by new management
operational decision can be infinite in number. Thus, over time, in the aggregate the
operation period poses a higher level of legal risk overall.
• Continuing Investment in Legal Risk Management. Chinese companies in general
recognize the legal risks inherent in a major off-shore acquisition of a foreign target
company and so will engage experienced international legal counsel to assist with
such transaction. However, Chinese senior management has not yet demonstrated
that it fully appreciates the need to continue to invest in international-standard internal
and external legal affairs management systems and resources in connection with
day-to-day operations of the business. In this case it can be assumed that Unocal's
existing legal affairs management systems and resources would remain in place
following the acquisition, but it is less clear whether CNOOC's senior management
would be willing to continue to invest in maintaining such systems and resources. As
set out in section 4.2 below, the larger international oil companies invest up to several
hundreds of millions of US dollars each year for internal and external legal services to
ensure continuing legal compliance and to manage the full range of legal matters. If,
for any reason, CNOOC management did not continue to make these high levels of
investments in legal affairs management, this would increase the likelihood that
Unocal would experience significant legal problems following CNOOC's acquisition. It
is commonly estimated that over 70% of Western stock acquisition fail to deliver the
expected value to the acquiror. Managing the risks of the transaction as well as the
integration of Unocal into CNOOC would have been critical to the success of the
proposed acquisition.
• Possible Erosion of Culture of Compliance. Similarly, without strong, clear
leadership from senior management in respect of the critical importance of legal
compliance, existing internal legal compliance policies likely would be ignored and
become ineffectual, giving rise to potentially severe legal problems. Consequently,
even if the existing Unocal legal affairs infrastructure remained in place following the
proposed CNOOC acquisition, if new CNOOC management emphasized short-term
financial performance and de-emphasized regulatory compliance, Unocal employees
may have followed that lead and engaged in conduct which may have given rise to
increased legal risks.
• Continuing Political Risks. In the case of CNOOC's proposed acquisition of Unocal,
if US government approvals in fact could have been obtained, this would not
necessarily change the overall negative political response to the deal in the US. This
continuing negative political sentiment possibly could, for example, have manifested
- 18 -
itself in the form of heightened scrutiny of Unocal's activities following the CNOOC
acquisition. In particular, strong negative public sentiments would be kindled if
Unocal, under new CNOOC ownership and management, were to be accused of
violations of environmental regulations, non-compliance with labour laws or
infringement of IPR. All of these matters are highly politically sensitive in the US, and
given the apparent suspicion of Chinese companies among many members of the US
public, even small legal infractions in these areas could generate a disproportionate
political response, possibly including public protests and boycotts which could inflict
severe financial damage on Unocal and CNOOC.
• Multiple Jurisdictions. Unocal was a particularly attractive target for CNOOC
because of its extensive reserves in Asia and the Caspian region, and following the
acquisition CNOOC would have had assets and operations in a total of 12 countries.
This would have a multiplier effect on the legal risks faced by CNOOC in the same
manner described above in respect of international oil companies generally.
• Increased Legal Risks in China. Chinese companies with assets and
operations only in China are relatively insulated from external legal risks since
foreign court judgments are not enforceable in China as a practical matter.
However, once a Chinese company acquires significant assets and operations
outside of China, particularly in more developed countries such as the US, the
Chinese company becomes exposed to the risk of lawsuits outside of China. So,
for example, if CNOOC were alleged to be infringing third-party IPR in China,
following CNOOC's acquisition of Unocal the foreign owner of such IPR would in
certain cases be able to bring the legal action outside of China. Similarly, had the
CNOOC acquisition of Unocal gone forward, under certain circumstances
CNOOC could be exposed to legal liability for activities outside of China which
violate certain US laws with extra-territorial application, e.g. the US Foreign
Corrupt Practices Act (FCPA) and US technology export rules. Violation of these
legal requirements can carry stiff civil penalties and in certain cases, criminal
liability.
3.4 Case Study Three: CNPC's Bid for Petrokazakhstan
On 22 August 2005, three weeks after CNOOC withdrew its bid for Unocal, the board of
Petrokazakhstan Inc. recommended to it shareholders that they approve acceptance of a
US$4.18 billion bid from China National Petroleum Corporation (CNPC), through its wholly-
owned subsidiary China National Petroleum Corporation International (CNPCI).
A PROMISING BEGINNING
After the political pressures brought to bear against CNOOC in the US, many observers
predicted smoother sailing for CNPC's bid for Canadian-registered Petrokazakhstan, given the
general perception of excellent relations between Beijing and Astana. The fact that CNPC's
bid price reflected a 21% premium over the closing market price for Petrokazakhstan's shares
on the day prior to the bid also pointed toward an expectation of a positive response from the
target's shareholders when the bid came up for a vote on 18 October (and, in fact, the
shareholders did so vote overwhelmingly to approve the sale to CNPC).
SUBSEQUENT CHALLENGES
But, instead, CNPC has found its bid buffeted in the turbulent waters of an international
political and legal contest featuring players from India, Kazakhstan and Russia. Even with the
approval of the Petrokazakhstan shareholders in hand, CNPC has continued to face a certain
level of continuing uncertainty as to the extent of its management control over
Petrokazakhstan (as a result of the political requirement to sell an interest in Petrokazakhstan
to state-owned KazMunaiGaz) and given the Lukoil legal challenge even as to whether the
deal can proceed as a practical matter (apparently now resolved in CNPC's favor).
- 19 -
A POTENTIAL RIVALRY WITH INDIA
CNPC competed with an Indian consortium in the bid for Petrokazakhstan. The Indian
consortium of Oil and Natural Gas Corporation (ONGC) and India steal-maker Mittal group,
called ONCG Mittal Energy (OME), actually submitted a higher initial bid, but CNPC re-
submitted a higher bid, and OME reportedly was not given an opportunity to re-bid to match or
beat the CNPC offer.14 While CNPC was able to bested OME in this bid, many observers
expect that Chinese and Indian oil companies are likely to compete head-to head for other oil
assets on a regular basis going forward.
POLITICAL MANOEUVRES IN KAZAKHSTAN
With this hurdle cleared, the next (and probably most significant) challenge came from within
Kazakhstan itself. It had been understood from the beginning that the Kazakh government had
the legal right to pre-empt the sale of any oil property in the country. Early indications were
that this would not present a problem, in part because the law reportedly applied only to sales
of domestically-held interests (and this was a foreign-owned company registered in Canada),
and because of the apparently positive status of Sino-Kazakh diplomatic and trade relations.
However, this expectation had to be balanced against the fact that in 2003, Kazakhstan
blocked Sinopec's bid to acquire a stake in the Kashagan oilfield in the Caspian continental
shelf, permitting Kazakhstan's KazMunaiGaz company to pre-empt Sinopec's bid and acquire
the stake instead.15
However, on 5 October 2005 Kazakhstan's lower house of Parliament voted unanimously to
permit the state to intervene in the sale of foreign-held stakes in Kazakh oil companies.16
Although this bill still required upper-house and presidential approval, it signalled a potential
shift in the political and legal environment. The Kazakh energy minister at the same time
stated that Kazakhstan wanted to maintain "strategic control" over Petrokazakhstan's assets,
and indicated that state oil company KazMunaiGaz was in talks to obtain a stake in
Petrokazakhstan.
Subsequently, CNPC in fact signed a binding agreement to sell a 33% stake in
Petrokazakhstan to KazMunaiGaz for US$1.4 billion.17 According to some analysts this could
adversely impact CNPC's ability to direct the sale of Petrokazakhstan's production back to
China on terms and at prices set by CNPC (as it could do as sole owner). Thus, the legal
steps taken by the Kazakh government may have undermined to an extent some (but likely
not all) of CNPC's key commercial objectives for the acquisition.
THE RUSSIAN CHALLENGE
In the midst of the foregoing political and legal manoeuvres in Kazakhstan, Russia's Lukoil
commenced an international arbitration action in Stockholm on 5 October 2005 in an effort to
block the indirect sale of a 50 per cent stake in its Kazakh joint venture with Petrokazakhstan.
Lukoil and Petrokazakhstan are 50-50 partners in a joint venture called Turgai Petroleum that
involves developing part of the Kumkol oil field in central Kazakhstan.18 Lukoil reportedly is
asserting that the change in ownership of Petrokazakhstan would trigger its pre-emptive right
to acquire Petrokazakhstan's 50% interest in the joint venture. Lukoil's action appears to be
directed at CNPC--Lukoil's regional manager in Kazakhstan was quoted as saying that Lukoil
would have "no objections" if KazMunaiGaz acquired the Petrokazakhstan stake in the joint
venture.19
14
"Kazakh oil coup for China, India cries foul", Asian Times Online (August 25 2005)
15
Vladimir Socor, "Implications of China's takeover of Petrokazakhstan", Euro-Asia Daily Monitor
(September 7 2005) Website : http://jamestown.org/edm/article.php?article_id=2370186
16
"Kazakh Bill Could Hinder Bid By China for PetroKazakhstan", Wall Street Journal (October 8 2005)
17
Asian Wall Street Journal
18
Isabel Gorst, "Lukoil sues to block joint venture sale" (October 6 2005)
http://www.businessmoscow.com/
19
Isabel Gorst, "Lukoil sues to block joint venture sale" (October 6 2005)
- 20 -
Lukoil subsequently brought a legal action in a court in Alberta, Canada to temporarily ban the
approval of the acquisition of Petrokazakhstan by CNPC pending resolution of the Stockholm
arbitration case. At the late stages of the Alberta court proceedings, Lukoil indicated a
willingness to match CNPC's bid for PetroKazakhstan if the court blocked the sale,20 but on 25
October 2005 CNPC reported that the Alberta court approved the CNPC deal. Even though at
the time this Report went to print, Lukoil's effort apparently has proven to be unsuccessful, this
still illustrates how legal levers often are used to advance commercial interests and, in some
cases, possibly to impede the commercial activities of competitors.
LESSONS ILLUSTRATED
This experience illustrates that there are no "safe harbours" when it comes to political or legal
risks in the global oil and gas industry.
As was also demonstrated in the case of the CNOOC bid for Unocal, political risk can be
expressed in terms of legal actions. In this case, in addition to legislative action, CNPC has
found that its bid also has been affected by a truly international legal action: an arbitration
case filed in Stockholm by a Russian company in respect of interests in a Kazakh joint venture
together with a related court case initiated in Canada could have affected the interests of
CNPC.
In order to survive in this world of global legal risk, Chinese oil and gas companies will need to
have an internal and external legal team of true international qualification and experience, as
well as a senior management team that understands and appreciates the fundamental
importance of managing these global legal risks in a sophisticated manner.
3.5 Case Study Four: China Aviation Oil's US$ 550 million Derivatives Disaster
BACKGROUND
A number of Chinese SOEs began overseas futures trading in the late 1970's. However, the
business was suspended in the mid 1990's, reportedly after speculation led to a substantial
flow of funds out of China and heavy losses for many Chinese companies. From late 2001, the
Chinese government gradually again started to allow a small number of qualified overseas-
based subsidiaries of Chinese companies to trade in oil, grain and non-ferrous metals.
According to reports, the companies were permitted to invest in futures contracts to hedge the
risks of price fluctuations in the international marketplace but they were strictly barred from
speculative trading activities.
FACTS
China Aviation Oil Singapore Co. Ltd (CAO) is one of the companies permitted to engage in
offshore futures trading for hedging purposes, specifically in the aviation fuel sector. CAO's
parent company has established an aviation oil filling network covering nearly 100 domestic
airports and provides oil-filling service for 108 domestic and international airlines. CAO
Singapore is listed on the Singapore Stock Exchange.
For years, CAO Singapore had traded futures for hedging purposes, but according to
published reports, it began trading riskier derivative option contracts starting in March 2002.
According to the published reports of the findings of PricewaterhouseCoopers (PWC), CAO
Singapore's risk-management manual did not contain any guidelines to govern options trading.
Reportedly, CAO Singapore initially incorrectly predicted the direction of the movement fuel
prices starting in the fourth quarter of 2003, incurring significant trading losses on derivative
option deals. The company restructured its derivative contracts in January 2004, and again in
http://www.businessmoscow.com/
20
Financial Times, "CNPC bid for Petrokazachstan win court approval" (October 26 2005)
- 21 -
June, moved into higher risk option instruments that left CAO Singapore exposed to potentially
unlimited losses.
CAO Holding subsequently sold a 15% stake in CAO Singapore to outside investors for
approximately US$100 million on 20 October 2004. Neither CAO Holding nor CAO Singapore
disclosed the Singapore unit's financial position at the time of the sale. CAO Singapore also
hid its losses from investors and its audit committee when it released third-quarter results in
November of 2004.
On November 30, 2004, CAO announced that CAO Singapore had suffered significant losses
from speculative oil derivative contracts trading. As of 29 November 2004, CAO Singapore
estimated that the total cumulative losses (both realized and unrealized) incurred by it were
approximately US$550 million. On this news, trading in CAO Singapore's shares was
suspended after the shares dropped to below S$1.00 per share, compared to prices as high
as S$1.70 per share,21 at which the shares traded during the period between March 27, 2003
and November 30, 2004 inclusive.
21
Shareholder Class Action Filed Against China Aviation Oil (Singapore) Corporation Ltd. by the Law Firm
of Schiffrin & Barroway, LLP http://press.arrivenet.com/bus/article.php/579281.html
- 22 -
CONSEQUENCES
(a) Criminal Charges
According to published reports, Chen Jiulin, CAO Singapore's ex-CEO, is facing 15
criminal charges including forgery, making false financial statements and conspiring to
deceive Deutsche Bank AG into handling the sale of 15% of CAO Singapore's stock in
October 2004. Peter Lim, CAO's finance director has been charged with five criminal
offenses, including issuing false financial statements. Both are charged with failing to
disclose losses to the board and failing to notify the Singapore Exchange of CAO
Singapore's losses.
(b) Civil Settlement for Insider Trading.
The Monetary Authority of Singapore (MAS) has entered a civil settlement with the
Beijing-based parent company, CAO Holding for insider trading. CAO Holding will pay
MAS a civil penalty of US$ 4.8 million and will additionally transfer CAO shares to the
Singapore unit's minority shareholders which it will obtain under a debt-for-equity swap
agreement. The civil settlement means CAO Holding will not be subject to criminal
sanctions. However, the deal is separate from current charges of insider trading
against various individuals. As such, criminal charges against former CAO Singapore
CEO Chen Juilin and four other CAO officials will not be dropped as the result of the
MAS settlement.
(c) Shareholder Class Action Suit
In February 2005 a shareholder class action suit was filed in New York on behalf of all
purchasers of securities of CAO Singapore between 27 March 2003 and 30 November
2004. The complaint alleges that CAO Singapore failed to disclose and
misrepresented the following material adverse facts which were known to defendants
or recklessly disregarded by them: (1) that the Company lacked adequate internal
controls and risk management procedures; (2) that as a consequence the Company
engaged in speculative derivative trading, forcing controlling shareholders to raise
funds to cover margin calls on massive derivative losses; and (3) that CAO Singapore
kept US$550 million in derivative losses off the books, thereby artificially inflating its
financial results.
LESSONS ILLUSTRATED
CAO's case yields specific lessons applicable to all Chinese companies, in particular the
State-owned enterprises who list their subsidiaries abroad.
(a) Align standards of corporate governance in Chinese enterprises with
international corporate governance standards
CAO's problems are a reminder that a publicly listed foreign subsidiary of a Chinese
company must achieve international standards for transparency, corporate governance
and internal management controls.
(b) Implement and enforce an appropriate compliance system
According to reports, CAO did have a high-level risk control policy in place but it lacked
detailed and concrete implementation measures. A proper compliance system will
ensure compliance with minimum legal requirements (including in this case, Chinese
government restrictions on speculative trading and Singapore securities disclosure
requirements). In addition, specific training and monitoring mechanisms must be put in
place.
(c) Create a Culture of Compliance
Senior management must demonstrate leadership in respect of legal compliance.
Management must establish an environment where everyone in the company,
- 23 -
including senior management, understands his or her legal responsibilities and is
accountable for compliance.
3.6 Other Chinese Oil Company Case Studies
Case studies of Chinese companies primarily illustrate the general point that legal risks in
China are in fact lower than outside of China.
For example, Longchang Petro Ltd. (a CNPC subsidiary) allegedly concealed material
information and made false statements in its annual report. This resulted in a fine of RMB
300,000 by the China Securities Regulatory Commission on the company. Fines were also
imposed on the president and CEO.
A December 2003 explosion at a CNPC subsidiary in Chongqing Municipality resulted in the
deaths of scores of people from exposure to toxic fumes. The general manager of CNPC
resigned. No civil fines or damage awards were reported.
Most China-based projects involving Sino-foreign cooperation typically would be expected to
be immune from legal action outside of China or, if subject to legal action outside of China
then primarily only in the form of international arbitration. However, in June 2000 Apache
China Corp. filed a US$100 million lawsuit against the three largest Chinese oil companies
alleging that the three Chinese oil companies had unlawfully impeded Apache's oil
development projects in China. A court in the US issued a temporary restraining order against
the three Chinese oil companies. Although it would appear that enforcement of any US court
judgment in China would be problematic, the parties settled the case within 10 days after the
lawsuit was filed, permitting Apache to resume the project in China.
While our research identified no foreign legal actions against Chinese oil companies alleging
human rights violations (presumably in part because no jurisdiction could be established in the
US, where many of these claims tend to be brought), the International League for Human
Rights did publicly accuse CNPC was accused of being complicit in human rights violations in
Sudan. Even though no law suit was filed, the allegation was made at a particularly sensitive
time, during the period prior to the IPO of CNPC's subsidiary, PetroChina. This again
demonstrates that even in the absence of direct legal recourse for claimed violations of
international law, political pressure may still be applied.
4. LEGAL RISK COMPARISONS FOR THE OIL INDUSTRY
4.1 Comparison of Legal Risk Exposure of Chinese and International Oil Companies
(a) Introduction to Oil and Gas Industry Comparison
In the Legal Risk Ranking Report issued by Lovells International Law Firm in April 2005,22
legal risk exposure scores for the China top 100 enterprises were listed. However, key factors
contributing to the legal risk exposure scores were set out only in respect of the five Chinese
companies with the highest legal risk exposure scores, namely Lenovo, TCL, Haier, CNOOC
and COFCO. In the April 2005 Legal Risk Exposure Rankings Report, high, low and median
legal risk exposure scores were provided for the Fortune 100 companies included in the
survey, but actual legal risk exposure scores and contributing factors were provided only for
the five Fortune 100 companies with the highest legal risk exposure scores according to
Lovells' analysis, namely Microsoft, HP, Disney, Lockhead Martin and Cisco.
In this Report, Lovells provides for the first time more detailed information on the actual scores
and contributing factors for selected Chinese and international companies in the oil and gas
industry (see Chart A below). A brief explanation and analysis of the comparative scores and
factors is set out following the Chart.
22
Note that the analysis set out in the Legal Risk Ranking Report and this section of this Report was
prepared independently by the Beijing Office of Lovells under the direction of Robert Lewis, who
assumes sole responsibility for the related methodology and conclusions subject to the caveats
and limitations set out herein and therein.
- 24 -
First, some notes and caveats:
• The Lovells' study was based only on publicly-available information, which by its
nature is incomplete. Consequently, certain assumptions had to be made as to the
relative weighting and importance of several factors considered in the analysis.
However, to the fullest extent possible, assumptions were made on an objective and
consistent basis across all companies included in the study in order to provide a
reasonable basis for comparison.
• The study focused on only a handful of key categories of legal risk (see explanation of
factors set out in subsection 4.1(b) below). There are other legal risk factors which
may affect individual companies included in the study which have not been factored
into this analysis. However, the legal risk categories highlighted in the study do reflect
the key categories of legal risk common to nearly all companies in virtually all
industries and thus provide an appropriate basis for comparative analysis across
industries and jurisdictions.
• While the legal risk exposure scores in the Legal Risk Rankings Report were designed
to establish a correlation between levels of legal risk exposure and legal affairs
management spending as a percentage of total revenues, (i.e. the median legal risk
exposure score of 100 for the Fortune 100 companies was intended to correlate to
median legal affairs spending by US companies of 1.0% of total revenues as derived
from various published international survey results (see Legal Risk Ranking Report for
more details as to the basis for this correlation)), it is not appropriate to conclude that
a legal risk exposure score of 42 (the median score for the China top 100 enterprises)
means that the company must spend 0.42% of its total revenue on legal affairs
management. The overall legal risk exposure score is intended only to provide a
reasonably objective basis for assessing the relative legal risk exposure of the top 100
Chinese companies in comparison with other companies in China and abroad
irrespective of industry. The actual level of legal spending for a particular company
may need to be lower or higher and will depend on various factors specific to that
company, including business strategies and priorities.
• Finally, a higher legal risk exposure score is not in and of itself negative. The legal risk
scores are intended merely to describe the environment in which the company
operates, and generally, at least in the case of Chinese companies, the more
internationalized the business operations, the higher the legal risk score. Accordingly,
a higher legal risk score can be seen as a positive indicator of the success of
commercial operations as a higher score likely is indicative of a larger scope of
operations. These legal risk scores are designed to assess legal risk exposure at a
general level and on a comparative basis to highlight the factors which contribute to
legal risks. This in turn is designed to keep senior management of Chinese companies
assess and address particular legal risks.
- 25 -
CHART A
China Top 100 Fortune 100
Top Legal Top Legal
Company Name Company Name
100 Risk 100 Risk
and Legal Risk Factors and Legal Risk Factors
Rank Score Rank Score
China National Offshore Oil Exxon Mobil Corp.
Corp. (CNOOC) (中国海样石油总 NYSE
公司) Domestic and int'l subsidiaries
NYSE, SEHK, SSE Non-US investments
Overseas investments and 1 2 JVs with major competitors 119
cooperative drilling Shell (among others)
1 29 Domestic and foreign 71 World-wide oil exploration
suppliers/buyers Domestic and int'l distribution;
Own and joint R&D extensive int'l sales network
Own and 3rd party patents Chevron Texaco Corp.
On-shore, Off-shore NYSE
subsidiaries Domestic and int'l subsidiaries
Sales agents Non-US investments
SinoPec (中国石油化工集团公司) World-wide oil and gas
2 6 115
NYSE, LSE, SEHK, SSE exploration
Overseas investments Domestic and int'l distribution;
2 3 62 extensive int'l sales network
Domestic and foreign suppliers
Own and 3rd party patents Finance, real estate, insurance
Sales agents and franchisees operations
PetroChina (石油天然气集团) Marathon Oil Corp.
NYSE
NYSE and SEHK
Domestic and int'l subsidiaries
Overseas investment
3 2 60 Non-US investments
Domestic and foreign suppliers
3 35 World-wide oil exploration 112
Own and 3rd party patents
Domestic and int'l distribution;
Sales agents and franchisees
extensive int'l sales network
SinoChem (中国中化集团公司) 50% ownership in travel ctr.
SEHK and SSE PTC
Financial services subsidiary Conoco Phillips
4 8 Overseas investments 58 NYSE
Domestic and foreign suppliers Domestic and int'l subsidiaries
Own and 3rd party patents 4 7 Non-US investments 106
Sales agents and franchisees World-wide oil exploration
China Aviation Oil (中国航空油料 Domestic and int'l distribution;
集团公司) extensive int'l sales network
SingSE Valero Energy Corp.
5 76 On-shore, Off-shore 58 NYSE
subsidiaries Domestic and int'l subsidiaries
Domestic and foreign suppliers 5 34 Some non-US investment 95
Diversified non-core industry Extensive int'l sales network
investments Heavy reliance on 3rd party
distribution and pipelines
The Williams Companies
NYSE
6 98 Domestic and int'l subsidiaries 92
Own interstate utilities
distribution
• This study addressed only legal risk exposure and not the level of investment in (or
effectiveness of) legal risk prevention and legal affairs management measures
adopted or implemented by an individual company. Data regarding such categories of
investment of company resources is not publicly available, and the effectiveness of
legal affairs management measures is not always subject to objective analysis.
However, there are some general points of comparison that can be drawn, as
described briefly in section 4.2 below.
(b) Explanation and Analysis
As shown in Chart A above, the average legal risk exposure score of the Chinese oil
companies included in the survey is 61 compared to an average legal risk exposure
score of 106 for the foreign companies included in the survey. This is in line with
expectations given that Chinese oil and gas companies typically have the great
- 26 -
majority of their business operations and assets in China and given that legal risk
generally is lower in China than outside China.
But it is also important to note that all of the Chinese oil and gas companies ranked in
the top quartile of all of the China top 100 included in the survey. This reflects that in
comparison with other Chinese companies, the leading Chinese oil and gas
companies are more internationalized and thus have higher legal risk.
However, the key conclusion to be drawn from this comparison is that as Chinese oil
companies continue their global expansion their legal risk exposure will continue to
increase correspondingly and eventually will be nearly as high as the legal risk
exposure scores of their international competitors. Consequently, it is of critical
importance for Chinese oil companies to invest now in development of appropriate
legal risk prevention and legal affairs management so that they will be prepared to
address the increasing legal risks to be faced as they expand globally.
In order to do so, senior management of Chinese oil and gas companies must
understand the basic principles of legal risk and be able to identify the key categories
of legal risk faced by their company. To this end, Chart A above is instructive not only
in comparing the legal risk exposure of Chinese and international oil and gas
companies but also in respect of demonstrating how legal risk is analyzed generally
together with the relative weighting of individual factors.
Lovells conducted this analysis by examining differences in the general categories of
legal risk: industry, form of entity, intellectual property rights, procurement and sales
activities, and jurisdiction of establishment. Below, we compare some of the individual
factors that contribute to this risk exposure in the oil and gas industry.
The first element of legal risk exposure is industry. The oil industry carries inherent
legal risk, and that risk is factored into a company's individual risk score. Interestingly,
although the oil industry itself does not carry the highest inherent legal risk, as noted
above the legal risk exposure scores for all oil companies in the China Top 100 fall in
the top quartile. These high rankings are not solely a function of inherent industry risk
but a composite function of other factors, as detailed below.
Form of entity is another element that affects a company's legal risk exposure. All of
the companies on these two charts are listed enterprises, meaning their legal risk is
higher than that of privately financed companies or state-owned enterprises. But the
particular stock exchange on which a company lists greatly influences its legal risk. In
addition to all of the international oil companies, CNOOC, SinoPec and PetroChina,
are listed on the New York Stock Exchange (NYSE) and thus have the highest legal
risk exposure in this category; however, SinoChem and China Aviation Oil are listed
only regionally and thus have somewhat lower risk exposure in this regard.
A company's stock exchange listing is not the only element of entity form that is
important to a discussion of legal risk; joint-ventures and subsidiaries can also
influence a company's legal risk exposure. Of particular note is the effect of non-core
industry subsidiaries. Though SinoChem and China Aviation Oil are not listed on the
NYSE, their total legal risk scores are close to those of SinoPec and PetroChina, in
part because both SinoChem and China Aviation Oil have non-core industry
investments and subsidiaries. Because each industry sector gives rise to separate
categories of legal risks, operations in multiple industry sectors requires additional
compliance and legal risk management systems and resources in order to address
these additional risk categories. Thus, in this analysis the industry and form of entity
factors combine to generate higher legal risk exposure scores.
Additionally, IPR can also add considerable legal risk. Most Chinese oil companies
utilize their own and third-party patents, which increases their legal risk exposure in
comparison to other industries that do not rely so heavily on IPR. Joint research and
development and shared IPR increases legal risk even more, and the reported level of
- 27 -
CNOOC's joint R&D and cooperative drilling activities outside of China makes their
legal risk exposure much higher than other Chinese oil companies.
Procurement and sales becomes an issue of legal risk primarily when these activities
take place out of the home jurisdiction. All of these Chinese oil companies have both
domestic and foreign suppliers, which increases their legal risk, and CNOOC in
particular has both domestic and foreign customers. Most of the Fortune 100 oil
companies not only utilize foreign suppliers, but also have extensive international
sales networks to distribute their product globally. As described in more detail in the
main body of this Report above, the breadth of such business activities creates higher
legal risk.
Jurisdiction is an element of legal risk that affects the way all of the other factors
impact a company's total legal risk score. Home jurisdiction establishes a base legal
risk, with US/EU-based companies, or companies with substantial US/EU business
presence, having a higher base legal risk exposure score than Chinese companies.
This home jurisdiction score partially accounts for the divergence between the legal
risks scores on the two lists, but this is only part of the story. The Fortune 100
companies generally conduct their business operations in numerous international
jurisdictions, and several are involved in world-wide oil exploration. Operating in
several jurisdictions affects the legal risk associated with any of the other factors, even
with factors common to both the Chinese and US companies. For example, Chevron
Texaco's finance operations would generate higher legal risk than SinoChem's
financial services subsidiary, because Chevron Texaco operates in the US and in a
variety of other jurisdictions, while SinoChem operates primarily in China.
In sum, all enterprises are exposed to some amount of legal risk, though the
proportions generated by each of these factors may vary among companies. No one
element is dominant, though jurisdiction affects them all. The application of these
principles to the particular circumstances of the international oil and gas industry is
demonstrated in the industry-specific analysis contained in this Report. As Chinese oil
companies expand their business operations, it is important for senior managers to
understand the basics of the legal risk factors discussed in this analysis and to
recognize how their business decisions affect their legal risk exposure and then take
appropriate measures to address these risks.
4.2 Comparison of Legal Affairs Management Resources of Chinese and Foreign Oil
Companies
Once we understand the relative legal risk exposure profiles of Chinese and international oil
companies, the next step is to evaluate how Chinese oil companies compare with their foreign
counterparts in respect of investment in legal affairs management resources. While much of
this information in respect of a particular company is not publicly available, there are some
important data points that are public and there are some standard practices common
throughout the industry which we can reference.
One key reference point is the number and qualifications of in-house legal counsel employed
by international and Chinese oil companies. The largest of the major foreign oil companies
employ globally anywhere from 300 to 600+ in-house lawyers. By reference solely only to the
number of in-house lawyers, some Chinese oil companies compare reasonably favourably,
having in some cases in the range of 400 in-house legal counsel.
However, in order to compare on an apples-to-apples basis, other reference points must be
taken into consideration. For example, international surveys typically analyze the numbers of
in-house legal counsel in comparison to total revenues and total number of employees. Based
on Lovells' research, the leading international oil companies typically employ roughly 2 in-
house lawyers per each US$1 billion of revenue (this is lower than the global average across
all industries of more than 5 in-house lawyers per each US$1 billion of revenue) and nearly 5
in-house lawyers per every 1,000 employees (compared to a global average of 1.4). Chinese
- 28 -
oil companies, by comparison, may have up to 5 in-house lawyers per each US$1 billion of
revenue but typically will have far less than 1 in-house lawyer per each 1,000 employees.
This data points to some interesting conclusions. First of all, international oil companies have
fewer lawyers as a percentage of total revenue than other foreign companies. This likely
reflects the fact that oil companies proportionately generate more revenue than companies in
other industries, and in the current market conditions where world oil prices continue to
escalate to record levels, oil company revenues far outstrip those of other companies.
This also demonstrates that legal risk scores cannot be viewed as having a direct one-to-one
relationship with legal spending as a percentage of total revenues. The fact that the average
levels of legal risk exposure of the international oil companies included in our survey are only
slightly higher than the median legal risk score for the Fortune 100 is intended to provide a
relative ranking among the other Fortune 100 companies. The actual amount of money in real
dollar terms to be invested to address these legal risks may be commensurate with other
companies in other industries with similar levels of legal risk exposure; however, because the
total revenue levels of the international oil companies is so much higher than many other
companies in other industries, international oil companies may in fact spend less than other
companies in other industries as a percentage of total revenues.
A rough indication of total spending on legal affairs management matters can be derived by
the following simple formula:
Legal Spend Calculation Formula
# of in-house counsel
multiplied by US$500,000
multiplied by 2
equals approximate total legal spending
The US$500,000 figure is the mid-point between various international survey results for total
legal spending per in-house lawyer (which covers salary and benefits plus all related overhead
for the in-house law department, including non-lawyer staff, IT systems, training budgets, etc.).
This figure is multiplied by a factor of 2 to reflect a 50-50 split in internal and external legal
spending (again, representing the mid-point in various survey results). Based on this very
rough calculation formula, which is applicable only to companies with core operations situated
outside of China, we can estimate that foreign oil companies are spending in the range of
US$300 million up to in excess of US$600 million on both internal legal affairs management
resources (principally consisting of a large team of experienced legal professionals) and
external legal services, representing somewhere in the range of 0.20-0.25% of total revenues.
Again, this is only a rough approximation. Actual spending may be higher or lower than this,
but no matter the actual figure, it is clear that these amounts represent a significant investment
by foreign oil companies in real dollar terms.
Based on the overview of legal risks inherent in the legal industry as described above in this
Report, it is clear that the legal risks faced by international oil companies can create severe
negative economic consequences for these companies. This level of legal spending as
estimated in this section reflects that these international oil companies are keenly aware of
these risks and make a substantial continuing investment in internal and external legal
resources and services in order to mitigate and manage these risks.
At these levels of investments, what kinds of resources will major foreign oil companies have
at their disposal to address the legal risks they face? These resources include:
• Experienced In-house Legal Team: According to sources in the industry, in-house
legal counsel in major foreign oil companies have an average of up to 15-20 years of
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professional experience in the industry. (In fact, based on published CVs for BP and
Chevron in-house lawyers, the average years of experience is closer to 20 years.)
This means that in-house legal teams in major foreign oil companies consisting of
300 in-house lawyers with an average of 15 years of experience will have in the
range of 4,500 years of collective experience in managing international legal matters
in the oil and gas industry. Within a given law department, the in-house lawyers will
have developed a wide range of different categories of specialized legal expertise
and capability that can be deployed on projects around the world at any given time.
Increasingly in-house legal teams in the international oil industry employ a diverse
staff of legal specialists that are licensed in many of the jurisdictions that they
operate in. Over the next few years as those experienced lawyers and staff retire the
competition for that expertise will intensify and it will become increasingly difficult to
find and hire legal professionals of comparable experience and expertise.
• Extensive Legal Affairs Know-how Resources: The typical major foreign oil
company law department will have extensive on-line precedents, templates, policies,
guidelines, data bases, etc. that members of the in-house law department can
access to provide assistance in connection with virtually any type of project that may
arise anywhere in the world within the scope of the company's operations. This is
the embodiment of the collective experience of not only the current in-house legal
team but also all those who have preceded them over several decades of time.
Major foreign oil companies continuously invest in the further development of these
important know-how resources.
• External Resources: Industry experts estimate that major international oil
companies spend as much on external legal counsel as they do on internal counsel
and related in-house legal affairs resources. Major areas of external legal spending
will include litigation, administrative claims and appeals processes, specialist
external legal advice for matters in foreign jurisdictions or relating to other legal
matters outside of the core competency of the internal legal team. In all cases, the
internal legal team will take the lead on management of external legal resources, and
the combined internal and external resources provide a formidable infrastructure to
protect the assets and stable business operations of the company.
So how do Chinese oil companies measure up against foreign oil companies in this regard?
While no concrete data is available, industry sources indicate that Chinese oil companies lag
far behind in every category. The in-house legal teams of Chinese oil companies typically
are comprised mostly of younger legal professionals, most of whom have little if any
experience in negotiating sophisticated international contracts outside of China.
Similarly, Chinese oil companies have comparatively little in the way of know-how resources
and underutilize external legal counsel. No public data is available on the amount of the
budget for legal affairs management in Chinese oil companies, but anecdotal evidence
suggests it is extremely low in comparison with their foreign counterparts both in terms of
spending in actual dollar terms as well as in terms of percentage of total revenue.
5. LOOKING TO THE FUTURE
5.1 Predictions
As Chinese oil companies expand internationally and as Chinese regulatory requirements
become increasingly stringent, their legal risk exposure will continue to increase.
In particular, if CNOOC were to have been the successful bidder for Unocal, CNOOC's overall
legal risk score would have jumped dramatically, possibly to exceed the legal risk score of
Lenovo, which currently tops the legal risk rankings for Chinese companies in Lovells Legal
Risk Rankings Report. Following such an acquisition, CNOOC's legal risk exposure would
have increased across the board as it would be exposed to legal risks in the much more
aggressive legal risk environment of the United States. As noted above in Case Study Two,
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likely areas of potential legal issues would be in respect of compliance with environmental,
labour and IPR laws. The risk of legal action would be much higher as well.
Overall, so long as Chinese oil companies focus on unilateral acquisition of resources in less
developed countries, operational legal risks may remain relatively modest (but still significantly
higher than in China), but as Chinese oil companies increase their collaborations with oil
company competitor/partners from more developed countries (e.g. Canada, the US, Australia,
Europe), and particularly as Chinese oil companies make investments in or acquisitions of
foreign oil companies in such more developed countries, the attendant legal risks will increase
dramatically.
As demonstrated above, although some Chinese oil companies have now begun to recognize
the importance of legal risk management and have started to develop related legal risk
management systems and resources, overall they have not developed legal risk prevention
measures to the same level as their international counterparts. The leading global oil
companies have a tremendous lead in terms of resources and experience in managing the
legal risks in the international oil and gas industry and continue to invest heavily on a
continuing basis. Without very high levels of investment in internal and external legal
resources over a very short and compressed period of time over the next few years, it is very
likely that Chinese oil companies will experience a disproportionately high number of severe
legal problems outside of China as their business activities outside of China continue to
outpace their development of necessary legal risk prevention and mitigation systems and
resources.
Since the major Chinese oil companies are all listed outside China, such legal problems likely
also will have serious adverse impact on stock prices for these companies. More ominously, if
any of the leading Chinese oil and gas companies experience severe legal problems, it could
disrupt oil and gas supplies, creating a potentially disastrous knock-on effect for the entire
Chinese economy.
5.2 Solutions
In order to survive and prosper in the international oil and gas industry, Chinese oil companies
will need to invest in developing additional international-quality in-house legal resources and
legal compliance systems. Specifically, investments must be made in the development and
implementation of an appropriate legal affairs management infrastructure (know-how data
bases, templates, checklists, training programs, audit functions, etc.), development of
international-standard in-house legal professionals through internal and external practical legal
training programs and related professional development incentive programs, and
implementation of rigorous and comprehensive legal compliance systems for all critical
business operations of the company.
The traditional model of uncoordinated management of legal risks by overlapping in-house
legal teams at different levels of Chinese group companies both increases costs and
increases risk. Moreover, as demonstrated by the problems experienced by China Aviation Oil
in Singapore, failure to implement appropriate internal control systems can lead to devastating
consequences. Chinese oil companies thus should implement a centralized system of
management of key legal matters, e.g. IPR, corporate securities regulatory compliance,
international transactions, investment, dispute resolution, labour law compliance, etc. All in-
house lawyers in all group companies should report up through an independent reporting line
ultimately to the general counsel at the HQ level, just as the finance function reports on an
independent line up to the HQ CFO. Virtual teams of internal legal and non-legal personnel
from both HQ and key subsidiaries can be set up to address key legal risk issues in a uniform
manner with the support of appropriate external experts.
5.3 The Value of the In-house Legal Team
In major foreign oil companies the lawyers interact with management to identify and mitigate
legal risks. Representative examples include:
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• A lawyer with requisite expertise is assigned to work directly with the Human
Resources Department to advise on labour laws and regulations affecting the
enterprise's employees and contractors and to help that department devise
appropriate policies. That same lawyer is available to management when specific
issues arise under those policies. This experience provides a foundation for future
advice and mitigation measures.
• A lawyer with broad commercial background is assigned to the negotiation team for a
major commercial transaction. While management directs and leads the negotiations,
the lawyer's intimate knowledge of the transaction and knowledge of the business
allows the lawyer to proactively identify key legal risks and suggest possible
mitigation measures for management's consideration. This close involvement also
insures that the final documents accurately reflect the agreement of the parties and
that management has been fully informed of key risk exposures presented by the
transaction. Management is then in a position to take appropriate mitigation measures,
such as purchasing additional insurance or increasing oversight of key activities.
• A lawyer who already has knowledge of the company's operations and decision-
making processes is in a much better position to defend a regulatory enforcement
action (or private lawsuit), as they can quickly locate key witnesses and documents,
evaluate the matter, and advise the appropriate management on strategies and
responses. Lessons learned from the experience can be effectively communicated to
prevent future violations or disputes.
In each of the main categories of legal risk management, lawyers play a key role in
identifying and helping management understand the legal constraints, issues, and
alternatives that the enterprise faces. Lawyers can develop and, with management
consent, implement effective strategies that protect the enterprise's interests. Key factors
that allow lawyers to effectively contribute to the enterprise's success include:
• Knowledge of the business and industry in which it operates. Lawyers that
understand the business objectives and have experience with the operations of a
company can provide legal advice promptly and in a useful context. They become
problem-solvers, rather than obstructionists.
• Familiarity with the decision-making processes. Large enterprises tend to have
processes that involve several individuals or departments. Understanding these is
critical to providing advice to the right person at the right time. Lawyers need to
understand how the enterprise makes its decision.
• Ready access to management. The ability to speak directly to all levels of
management insures that legal advice is correctly communicated and that it is
understood. It is also a powerful signal to the organization that management is
serious about complying with laws and its obligations.
• Ability to proactively identify and prevent issues from arising. Avoiding an issue
or problem is the most cost-effective approach to managing legal risks. Lawyers that
are well-integrated into the organization are uniquely suited to this role.
An appropriate mix of in-house and outside lawyers can provide the management of an
international enterprise with the needed expertise and assistance to effectively manage
legal risk exposures. The cost of an effective legal group is far outweighed by losses they
prevent, as well as the additional value they can add to the business.
5.4 Investing in the Future
If Chinese oil companies are to close the gap with their foreign counterparts in respect of legal
affairs management, this will require investment by Chinese oil companies of at least several
tens of millions of RMB each year over and above spending levels for day-to-day legal affairs
management matters in order to achieve international standards. This is a significant
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investment, but if this investment is not made, the risk of serious legal problems will be even
higher, resulting in potentially devastating economic losses to Chinese oil companies and
possible civil and criminal liability for senior management.
But this investment will also have an important upside benefit to the Chinese oil companies,
their shareholders (including SASAC) and senior management. A comprehensive centralized
legal affairs management system will promote centralized management of the overall business
operations of the entire group of companies. In major multinational companies, the finance
function and the legal function perform complementary roles. While the centralized
management of the finance function provides for financial reporting on a uniform basis, the
centralized management of the legal function across all subsidiaries and business divisions
increases operational management on a uniform basis through the entire group. Shareholders
reward operational transparency and efficiencies with higher valuations.
6. CONCLUSION
China's continued economic development is dependent on access to sufficient energy
resources, of which oil and gas will continue to comprise a critical part. China's economy is
like a pre-adolescent male--China's current voracious appetite for fuel for its economy will
explode exponentially in the coming period as China's economic growth curve takes a sharp
turn upwards. Consequently, Chinese oil and gas companies will be driven to expand ever
more aggressively outside of China to secure adequate supplies to meet this unprecedented
growth in domestic demand.
As demand grows, so will the scope and scale of the Chinese oil companies. SinoPec is
already ranked 31st on the Fortune global 500 list. CNPC/PetroChina is ranked 46th, and
SinoChem is ranked 287th on the same list. CNOOC is ranked number 254 in the Global 500
Financial Times rankings. With this heightened profile will come increased attention by
concerned parties around the world, and the Chinese oil companies increasingly will find
themselves targets of legal actions at home and abroad.
Chinese oil and gas companies must bring their levels of legal risk management up to
international standards commensurate with their growing importance in the global marketplace.
Failure to step up to this next level can have devastating consequences not only for the
companies themselves but also for their shareholders (including SASAC) and the entire
Chinese economy.
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ANNEX A
BIOGRAPHIES OF KEY INDIVIDUAL CONTRIBUTORS AND ACKNOWLEDGEMENT
Lovells ACC
Robert Lewis
Frederick Krebs
Managing Partner, Lovells Beijing
Member, ACC China Liaison Committee President and Chief Operating Officer of the
Foreign expert, All China Lawyers Association Association of Corporate Counsel
Legal Education Committee
Theodore Frois
John Cooper
General Counsel for the Upstream Companies
Partner, Lovells London
of Exxon Mobil Corporation
Head of Lovells global energy practice group
John Allen
David Moss Senior Vice President, Law, Halliburton Energy
Services Inc. (one of the largest oil field
Partner, Lovells London services, engineering and project management
Specialised in energy disputes, energy companies in the world)
projects, energy transactional work and M&A
Jack Foltz
James Higbee Former Chairman of ACC
Retired Vice President and General Counsel
Consultant, Lovells Beijing Sunoco Inc. (one of the largest independent
Specialized in oil and gas projects US petroleum refiner-marketers)
More than 15 years as in-house lawyer for
ARCO
Other members of Lovells Beijing Legal Risk Management Team:
Aaron Ward, Aiping Chen, Andrea Lewis, Benjamin James , Carrie Meyers , Dieter De Smet, Di Liu , Elizabeth Corrin,
Jennifer Liu, Jet Shao, Jordan Baggs, Mary Bai, May Bai, Michael Aldrich, Ma Xiaoran, Matthew Smith, Sooyeon Cho,
Richard Wigley, Sarah Zhang, Steven Zhang, Sandra Zhai, Terrence O'Donnell, Yang Chu.
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ANNEX B
INTRODUCTIONS TO SPONSORING ORGANIZATIONS
B-1: LOVELLS INTERNATIONAL LAW FIRM
Lovells is a leading international law firm with over 340 partners, 1,622 lawyers and a total staff of
more than 3,200 people across 27 offices worldwide. The firm has six offices in Asia, two offices in
the USA and 19 in Europe. It is the fifth largest law firm in Europe and seventh largest law firm
worldwide. The firm serves commercial, corporate, financial, industrial and property clients from its
worldwide offices.
Lovells is included in Global Counsel's ranking of the top 10 global law firms, taking 7th place in the
survey of the world's 5,000 leading companies. With respect to China, Lovells was ranked 3rd overall
in the most recent Global Counsel 3000 survey of all law firms in China.
Lovells has been advising clients on doing business in the People's Republic of China since China’s
opening to the West more than 25 years ago. The Lovells' Hong Kong office has been established for
more than 20 years. Lovells opened its first China office in Beijing in 1992, and was one of the first five
foreign law firms to be licensed to practice international law in Beijing. Lovells was again among the
first international law firms approved following China's entry into the World Trade Organization ("WTO")
to establish a second office in Shanghai in 2003.
Lovells is active in promoting the continued development of the local Chinese bar. The All China
Lawyers Association (ACLA) and Lovells have cooperated in the presentation of a highly-acclaimed
and innovative series of practical legal skills training courses for both licensed, Chinese lawyers and
in-house corporate legal counsel from Chinese corporations from all over China. Robert Lewis, the
managing partner of the Beijing office, has been appointed as the only foreign expert on the ACLA
Legal Education Committee.
Lovells also has a continuing cooperation with the Law and Policy Bureau of the State-owned Asset
Supervision and Administration Commission under the State Council of the PRC in respect of legal
risk management training. Lovells has also conducted legal risk management consulting and training
projects for several of the leading state-owned and private companies in China.
B-2: THE ASSOCIATION OF CORPORATE COUNSEL
The Association of Corporate Counsel (ACC), formerly the American Corporate Counsel Association,
is the in-house bar association, serving the professional needs of attorneys who practice in the legal
departments of corporations and other private sector organizations worldwide. The association
promotes the common interests of its members, contributes to their continuing education, seeks
to improve understanding of the role of in-house attorneys and encourages advancements in
standards of corporate legal practice. Since its founding in 1982, the association has grown to
more than 17,500 members in 53 countries who represent over 7800 organizations, with 43
chapters and 12 committees serving the membership. Its members represent 47 of the Fortune
50 companies and 97 of the Fortune 100 companies. Internationally, its members represent 42 of
the Global 50 and 75 of the Global 100 companies. For more information, please go to
www.acca.com.
