When Repsol, Spain’s largest oil and gas company, announced on October 1 that it had sealed an agreement with Sinopec, China’s largest petroleum and petrochemicals players, it marked a major turning point, and not just for the two firms. The aim of the agreement is to jointly develop exploration projects that Repsol already has under way in Brazil, with Sinopec injecting US$7.1 billion into Repsol Brasil and taking a 40% stake in the Brazilian business. That’s the vision Antonio Brufau, chairman of Madrid-based Repsol presented to the CNMV, Spain’s stock market regulator.

On the day the deal was sealed, Reuters reported that Repsol’s shares rose 5.6% to a two-year high of 20 euros. Consultants at Evaluate Energy say the deal, which is pending regulatory approval, will create the second-largest privately owned oil firm in Latin America, with a newly capitalized Repsol Brasil worth US$17.8 billion. The only company in the region larger than it is Brazil’s OGX Oil & Gas, worth US$31.8 billion.

"This is a very good strategic move for Repsol," states Rafael Pampillón, professor of economics and country analysis at IE Business School in Madrid. "China has paid a very good price, and has done so in cash." Meanwhile, he says, it gives the 49 billion euro (in annual revenue) Spanish firm an opportunity to "build up strength in other countries and markets, with the goal of diversifying risks."

Adalmir Marquetti, economics professor at Pontifical Catholic University of Rio Grande do Sul in Brazil, agrees. He notes that the deal reflects Repsol’s larger growth vision. Repsol is already the third-largest petroleum producer in Brazil, after state-owned Petrobrás and Britain’s BG. It is also the largest foreign owner of exploration blocks. "The company had plans to launch its shares on the São Paulo exchange to get the cash it needed to explore for oil in the ‘pre-salt’ [crude reserves discovered in southern Brazil in 2006] and participate in new rounds of bidding [for oil licenses]," he says. "In addition, this opens up the Chinese market for Repsol."

Repsol told regulators in Madrid that the funds from the deal would cover all its needs for financing the development of Repsol Brasil’s portfolio of assets. Among them, Repsol said in a press release, are "some of the most important discoveries made in the world in recent years." Brazil’s offshore reserves have been one of the world’s fastest-growing areas worldwide.

Esteban García Canal, professor of business management at University of Oviedo in Spain, downplays concerns expressed elsewhere that Repsol might lose clout with respect to the Chinese company as a result of the deal. Rather, he views it as "a consequence of [Repsol’s] need to capitalize itself in order to continue investing in Brazil." Garcia Canal notes that its focus is on ongoing hydrocarbon exploration in Brazil. That would have been difficult with Repsol Brasil’s balance sheet, which had 977 million real (US$580 million) of debt, says Reuters, which reports that the Brazilian division had 2.7 billion real of assets as of June and losses of 238 million real in the first six months of 2010, compared with a profit of 210 million real a year earlier. Operating revenue fell to 165 million real from 189 million real over the same period.

According to analysts at UBS, the Swiss bank, state-owned Sinopec paid a premium of 22%, but "the offer can be justified by starting with a more aggressive forecast about the price of oil" and Repsol’s recent success with exploration in the Campos region.

China‘s Strategic Move

In terms of China, the deal is another stepping stone in its recent strategy. As García Canal observes, "Controlling its sources of energy is becoming a priority for China, and this deal moves it in that direction. The premium it paid demonstrates its interest in guaranteeing that it [has that control]."

What’s more, Marquetti says it’s indicative of "the growing role China is playing in oil in Latin America, where it has more and more influence in numerous countries in the region." He adds, "Brazil is the Latin American country that has the greatest chance of expanding its production because of the pre-salt reserves, so it has been an object of China’s interest. There are also rumors that OGX is negotiating selling a portion of its shares to a company from [China]."

Pampillón notes that the agreement allows China to gain further influence in the global oil market. "They are going to continue to take such steps in coming years, and they’ll have more and more of a presence in this market." He says it would not surprise him if the collaboration between China and Repsol were to extend to other parts of Latin America, and he predicts that Chinese investors could take a stake in Repsol directly, albeit a minority one and without any intention of a takeover. That could happen if, say, Sacyr, a Spanish construction company, sold its 20% of Repsol. Sacyr "has shown its intention, on more than one occasion, to do just that," he notes. "If this occurred, it would be an opportunity for Repsol to gain the support of a financially strong partner, and that would open doors to important markets where Repsol does not yet have a presence, such as China."

In Brazil, Repsol owns shares in blocks of the maritime basins of Santos, Campos and Espirito Santo. It announced plans to invest as much as US$14 billion in the region through 2019. The deal is the second foreign acquisition that the Chinese company has made — and its largest one, now that the country is searching for crude deposits to satisfy its growing internal demand for fuel.

Sinopec’s latest investment is the largest oil agreement made by a Chinese firm in any foreign market since Sinopec purchased Switzerland-based Addax Petroleum for US$8 billion last year. The goal of that deal was to acquire oil reserves in Kurdistan, Iraq and West Africa.

The Latin American Impact

The deal has consequences for all of Latin America, say experts, and it demonstrates China’s influence on trade in the region. "China has established a pattern in international business in which Latin America exports primary products and materials to it and imports industrial products from it," says Marquetti. Such trade has a downside for the region. "The competitiveness of Chinese industrial products is based, for the most part, on the undervaluation of its currency," he observes. "Chinese investments are focused on the production of primary products, which means Latin America will continue to export commodities and import industrial products."

Meanwhile, Pampillón draws attention to the positive aspect of China’s presence in the region. "China and its investments are very important for Latin America, and they will continue to be in coming years," he says. "People saw how South American countries emerged rapidly from the global economic crisis thanks to the contribution of foreign investment, principally China."

But according to the United Nations’ Economic Commission of Latin America and the Caribbean (ECLAC), foreign direct investment (FDI) into Latin America and the Caribbean was US$76.7 billion in 2009, down 42% from a record 2008. With respect to where that FDI originated, the U.S. was the largest investor, accounting for 37% of the total, followed by Spain (9%) and Canada (7%). While China lags those investors, its cumulative investment in the region’s manufacturing sector was the second largest at US$32.2 billion, or 18% of the total, exceeded only by the U.S.

According to Marquetti, in 2009, China was Brazil’s principal trading partner, as it was for all of Latin America, "which means a loss of influence on the part of the U.S. and the European Union in the region." And while he says it is too early to predict what lasting impact China will have on Latin America’s economy, he wonders to what extent the region’s "deindustrialization" resulting from trade with the country will become a major problem.

Pampillón doesn’t ultimately foresee the U.S. and Spain losing influence in Latin America because of China’s investments in the region. "China only invests in order to have control of the primary products that it is interested in," he says. "But everything depends in the future on the prices of the products over which they have control."