INSIGHT-Security fears dogged Canada debate on China energy bid

* Canada's spy agency warned about Chinese takeovers

* US intervention made approval of CNOOC deal more difficult

* CSIS seen satisfied with new foreign investment rules

OTTAWA, Dec 23 (Reuters) - In September, two months after

China's state-owned CNOOC Ltd made an unexpected $15.1

billion bid for Canadian energy company Nexen Inc,

Canada's spy agency told ministers that takeovers by Chinese

companies may threaten national security.

The rare warning from the Canadian Security Intelligence

Service (CSIS), which was disclosed to Reuters by intelligence

sources, did not stop the takeover. That was approved by

Canadian authorities earlier this month.

But the intervention and an influential U.S. lawmaker's

warning in October that Canadian companies should be careful

about doing business with Chinese telecom equipment companies

Huawei Technologies Co and ZTE Corp

made the approval process for the deal more

difficult than initially expected.

"CSIS did not like the Nexen bid and thought it was a bad

idea for Chinese firms to be investing in the oil sands. It all

played into their greater fears about firms like Huawei," said

one person familiar with the agency's concerns. "They do not

want to wake up one day and realize a crucial sector of the

economy is under the control of foreign interests."

And after listening to the spy service, which usually keeps

a low profile, Canada drew up surprisingly tough foreign

investment rules that were unveiled when approving the Nexen

deal, China's biggest-ever successful foreign takeover. In a

clampdown on companies it deems influenced by foreign

governments, Canada will block similar purchases in the future.

CSIS has been silent about what it said to Ottawa on the

Nexen transaction, and it declined to comment for this story. It

didn't specifically recommend the CNOOC deal be blocked, but

rather warned more generally about such deals with Chinese

entities, the person said.

In reality, the government was unlikely to want to block the

CNOOC bid, given a high-profile push by Prime Minister Stephen

Harper earlier in the year to boost ties with China, and given

that a lot of Nexen's assets are outside Canada, and it has

underperformed other energy companies.

SPECIFIC WORRIES

By pushing back aggressively, CSIS ensured that it got

foreign investment policy tightened significantly to deter

similar such takeovers by companies under the sway of foreign

governments.

"I think people at CSIS and elsewhere are going 'Good. That

was a very good response by the government'," said Ray Boisvert,

a former CSIS assistant director of intelligence, who retired

this year after almost three decades at the agency.

"It did reflect some of those deep strategic concerns that

practitioners have had about this kind of investment."

Specific worries include theft of Canadian intellectual

property, espionage, computer hacking and foreign companies

gaining too much influence over crucial sectors of the economy,

said the person familiar with the agency's views.

The government could, in theory, nationalize assets if it

thought foreign control was problematic. But the pro-business

Conservatives would likely find it politically unpalatable to

take such a step.

"To be blunt, Canadians have not spent years reducing the

ownership of sectors of the economy by our own governments, only

to see them bought and controlled by foreign governments

instead," Harper said as he announced the new investment rules.

In October, the U.S. House of Representatives' Intelligence

Committee urged U.S. firms to stop doing business with Huawei

and another Chinese telecom equipment company ZTE on

the grounds that Beijing could use products made by the two

companies to spy.

The House Intelligence Committee's chairman, Rep. Mike

Rogers, a Michigan Republican, urged Canada to take a similar

stance, and two days later, the Canadian government indicated it

would not let Huawei help build a secure government

communications network because of possible security

risks.

"The Huawei business caused a lot of political complications

for the CNOOC bid," another person familiar with the CNOOC deal

said of the U.S. committee's report.

Both Huawei and ZTE have repeatedly denied the allegations

in the report, [ID: nL1E8L800L] [ID: nL1E8L86T5] and China's

foreign ministry dismissed as "baseless" the idea that security

concerns could impede commercial ties.

"We hope that the relevant party can objectively and justly

treat Chinese companies' overseas investment and cooperation

plans, and stop actions which harm Chinese companies' image and

do more to benefit the promotion of bilateral trade and business

cooperation," said ministry spokeswoman Hua Chunying.

CLANDESTINE SUPPORT

In its annual report, released in September, CSIS noted

risks that included espionage and illegal technology transfers,

and said some foreign state-owned enterprises had "pursued

opaque agendas or received clandestine intelligence support for

their pursuits" in Canada.

The agency did not give details, but added: "When foreign

companies with ties to foreign intelligence agencies or hostile

governments seek to acquire control over strategic sectors of

the Canadian economy, it can represent a threat to Canadian

security interests."

CSIS, hit by controversy in 2010 after its head suggested

China had too much influence over some Canadian provincial

politicians, did not mention any country or firm in its report.

It is unclear how much, if any, influence the United States

had on the Canadian authorities' foreign investment policy.

Fen Hampson, head of the global security program at the

Centre for International Governance Innovation in Waterloo,

Ontario, said he had learned that a U.S. official visited Ottawa

in the last few months to discuss mutual concerns about foreign

state-owned enterprises.

U.S. Ambassador David Jacobson told Reuters he was not aware

of such a meeting, but he noted that officials from the two

countries met constantly. "I would be surprised if almost any

issue you could think of has not come up in one or more of those

conversations," he said. "The United States has not sought to

influence Canada's decision with respect to that (CNOOC's

bid)... We respect that decision."

The Canadian government did not respond to a request for a

comment.

Chinese companies have bought up smaller Canadian energy

firms before, but the July 23 bid for Nexen was their first

attempt to buy one of the larger players.

Nexen has assets in Canada, the North Sea, Nigeria and the

Gulf of Mexico. Technology that Nexen and its partners use for

deep sea drilling could interest CNOOC.

Asked about the CSIS concerns, a spokeswoman for Industry

Minister Christian Paradis replied: "The government has the

authority to take any measures it considers necessary to protect

national security."

Yet two people close to the deal noted that the Canadian

government did not exercise its option to do a separate review

of the potential security risks of the CNOOC-Nexen bid, again

signaling its concerns were tied to overall Chinese investment

rather than to this particular deal.

Under the new rules, which Paradis is responsible for

enforcing, foreign state-owned enterprises can no longer buy

controlling stakes in assets in the oil sands, the biggest

reserve of crude oil outside Saudi Arabia and Venezuela.

Such enterprises can buy minority stakes in the oil sands,

or majority stakes in companies outside the oil sands. Companies

deemed to have strong government links will be treated with

particular caution wherever they propose to invest.

"When it comes to our security and intelligence services,

they would rather pull up the drawbridge than let it down," said

Hampson, co-author of a report on trade ties between Canada and

emerging nations that he discussed with Harper in June.

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