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Motorists pump petrol at a Petroliam Nasional Bhd (Petronas) petrol station in Putrajaya outside Kuala Lumpur June 7, 2006.BAZUKI MUHAMMAD/Reuters

Malaysia's Petronas refused a last-minute request by the federal government for more time to consider the state-owned energy producer's proposed $6-billion acquisition of Canada's Progress Energy Resources, forcing Ottawa to block the deal just minutes before a deadline elapsed midnight Friday.

Petronas was frustrated after weeks of already-extended negotiations with the government over concessions needed to meet the "net benefit" test in the Investment Canada rules on foreign takeovers, and so declined when the government asked to keep negotiations going, said three people familiar with the discussions.

After a long stretch when the deal seemed to be on track, the transaction "came unglued" quite suddenly Friday after the federal government unexpectedly sought to extend talks, said one of the people. Behind the scenes, Petronas had made offers of concessions but was getting little feedback on what it would take to get the de al done, the person said, and was out of patience.

The government had already used up its chance to unilaterally extend talks, and by law could only continue the negotiations with Petronas beyond the deadline with the agreement of the Malaysian company. Petronas did not want to continue talking "indefinitely," so it took the risk of demanding the federal government make a call, said a second person with knowledge of the situation.

That left the government with no choice but to make a ruling, and Industry Minister Christian Paradis announced the decision to block the deal at three minutes before midnight. He gave no reasons other than saying the deal did not provide a "net benefit," and noted that the Investment Canada Act barred him from commenting further.

It's unclear what happens now. Petronas has 30 days to try to change the government's mind, though that period too can be extended if both sides agree to do so. Progress said in a statement it is "disappointed" with the government's stand. "Progress will be working over the next 30 days to determine the nature of the issues and the potential remedies," Michael Culbert, Progress' chief executive, said in a statement issued Saturday afternoon. "The long-term health of the natural gas industry in Canada and the development of a new LNG export business are dependent on international investments such as Petronas."

The ruling came as a surprise to investors, and to those involved in the negotiations, who expected no real challenge for Petronas in its quest to buy the natural gas producer. Progress is a growing company whose fields are well positioned to ship gas to Asia, but it far from one of the country's largest energy producers.

The ruling also casts further uncertainty over a far larger transaction that Ottawa is studying, the proposed $15.1-billion purchase of Canada's Nexen Inc. by China's state-controlled oil producer CNOOC Ltd.

"To say that this is unexpected would be the understatement of the year," said Eric Nuttall, portfolio manager for the Sprott Energy Fund. If Ottawa is signalling a broader discomfort with investment from state-owned oil companies, "imagine the potential money that has just been taken off the table," Mr. Nuttall said. "Staggering."

This is the third deal the Harper government has blocked using the Investment Canada Act's net benefit test since taking office in 2006 and the first in the energy patch, which depends on a flow of foreign capital for investment. The decision is fuelling yet more intense debate over the country's stance on foreign investment and the inscrutability of the rules on "net benefit," which the government has never clarified despite saying it would do so. Even those negotiating with the government say they have no real idea what it requires to meet the threshold.

The federal Conservatives stamped out BHP Billiton Ltd.'s hopes of capturing Potash Corp. of Saskatchewan using the Investment Canada Act in November, 2010. The government rejected that deal in part because it considered potash a "strategic resource" in the global food supply, Agriculture Minister Gerry Ritz said in the House of Commons at the time.

The government rejected a plan by Alliant Techsystems Inc. of the U.S. to buy part of MacDonald Dettwiler and Associates Ltd. for $1.3-billion in 2008.

The Petronas/Progress decision comes as the Harper government, which has gone to enormous lengths to convince outsiders Canada is open to foreign investment, faces a wave of foreign investment interest in the energy industry.

A takeover of Nexen by CNOOC would mark China's largest investment in Canada, and critics argue Ottawa is ceding control of the country's natural resources to foreigners. On the flip side, it will take hundreds of billions of dollars to develop Alberta's bitumen reserves, and energy proponents argue it cannot be done without overseas investors and buyers like CNOOC.

One challenging issue for Petronas, which is wholly owned by the government of Malaysia, is Ottawa's set of guidelines for approving deals involving state-owned enterprises. As part of its net benefit test, Ottawa requires such national oil companies to operate as commercial entities, with transparent governance structures, independent directors on their boards and Canadian standards of accounting and auditing.

Industry Canada says non-Canadian acquirers are "encouraged" to submit specific undertakings to provide benefits that include appointment of Canadians to as directors, listing of shares on a Canadian stock exchange, and employment of Canadians in senior management positions.

Because of the confidential nature of the Investment Canada review, it is unclear what level of commitments Petronas made. In contrast, CNOOC – which is traded on New York and Hong Kong stock exchanges – made public commitments on several of the recommended undertakings in its proposed acquisition of Nexen.

Even as the government rejected the takeover, it painted itself as a friend of outside investors.

"Canada has a long standing reputation for welcoming foreign investment," Mr. Paradis said. "The government of Canada remains committed to maintaining an open climate for investment."

Alberta, which does not have the power to block transactions, reiterated its support for foreign investment.

"We respect the federal net benefit test as a good and thorough process. We must also respect the appeal period," Mark Cooper, a spokesman for spokesperson for Alberta's International and Intergovernmental Relations Minister Cal Dallas, said in an interview Saturday. "In general we are supportive of foreign investment and the overall benefits it can bring to Alberta's economy."

Laura Lau, a fund manager at Toronto's Brompton Funds, said she thinks the Progress deal was squashed because of the politics surrounding CNOOC and Nexen.

"If it wasn't for Nexen, the deal might have gone through," she said Saturday.

The market believed the tie-up between Petronas and Progress would go through because the pair could make a strong case when facing the net benefit test. While Petronas can appeal, Friday's midnight decision is "not a good sign," she said.

Nexen, Ms. Lau believes, will have an even tougher challenge.

Investors are already bracing for a market rout Monday, arguing the scotched deal means potential takeovers of other companies are unlikely.

Mr. Nuttall of Sprott suggested Nexen, Encana Corp., Celtic Exploration Ltd. and other natural gas companies could be affected. Exxon Mobil Corp. on Wednesday offered $2.6-billion for Celtic. – a deal that will also need approval from Investment Canada before it can be consummated.

Hardest hit, of course, will be Progress.

"Progress will likely fall by at least 30 per cent," he said.

With a report from Nathan VanderKlippe in Calgary