From Sandton to Shanghai

China changes rules of resource game

Julian Hewitt: COMMENT
13 February 2007

When I left South Africa, a talk by Clem Sunter titled “China’s Game” was ringing in
my ears. Clem talked about the rules of the game China is playing in its
unprecedented drive to industrialise a 1,3-billion strong population. What struck me
was China’s dependence on natural resources to continue its impressive growth
trajectory. One of the major rules of China’s game requires it to establish massive
and sustainable supply lines to secure resources that fuel its vast factory-floor
economic model.

Of course, this is the major pillar behind African-Chinese trade. Africa has the
undeveloped resources China so desperately wants. In testimony to this growing
trade and development cooperation, Chinese President Hu Jintao has visited Africa
five times since 1999 and Premier Wen Jiabao has already toured the continent on
three separate occasions. Depending on which side of the fence you sit on, much
has been said about China’s new “colonial” role in Africa or the massive development
opportunity for the continent to dovetail on China’s great economic ambitions.

There are a couple of interesting factors that make up China’s drive to secure
mineral resources and energy assets. The first is the sheer scale of the undertaking.
China has a massive population and burgeoning economy to support. The other is
the role of the state in securing these resources. This is a national prerogative, which
is not unique in itself. However, the fundamental difference is that the Chinese
government plays a prominent role in meeting these strategic requirements, while
most other governments rely largely on the invisible hand to meet a rising supply and
demand needs.

At China’s disposal is an army of state operated enterprises (SOEs). Long a
backbone of a previous, more socialistically inclined, era, the more effective SOEs
have subsequently embraced a world of initial public offerings (IPOs), international
acquisitions and foreign contracts.

China’s ruling party has entrusted them with a mandate to pursue resources deemed
to be of strategic national interest — iron ore, nickel, zinc, oil and gas and copper,
among others. The SOEs have political backing, massive credit lines from local
banking institutions and increasing international business acumen.

A sign of things to come is the Belinga Project in Gabon. Purported to be the largest
untapped iron-ore reserves in the world, a Chinese consortium came head to head in
the contract bidding with Brazil’s CVRD — the world’s largest iron-ore producer.
Because Gabon’s iron-ore reserves are situated deep in equatorial forests, massive
infrastructural costs have excluded previous iron-ore suitors. Enter the Chinese
consortium, which offered to a) build a new railway line 560km into the jungle, b)
construct a deep-water harbour from which to export the iron ore, c) develop a
hydro-electric dam to supply electricity to the project, d) finance the initiative, e) bring
in Chinese labourers to build it and f) offer to buy the entire mined output.

Not surprisingly, CVRD got blown out of the water in the bidding process — few
companies on Earth would be able to compete with such a comprehensive undertaking.

A recent “secret” meeting at the World Economic Forum in Davos, Switzerland, was
held between the heads of more than a dozen of the world’s largest mining
companies. The six-hour think tank highlighted what a growing concern Chinese
encroachment in Africa was becoming. The group — ironically given the
colonialesque title of “the governors” — sought to find ways of curtailing China’s
immense interest in Africa, which is rapidly displacing their exposure on the
continent. They are considering appealing to the World Bank and United Nations for
help. What “the governors” are rapidly realising is that competing with
government-backed Chinese companies is beyond their capacity. The World Bank
estimates that, last year alone, China spent more than $10-billion on infrastructural
projects in Africa as part of its capacity for-resources exchange.

There is a flip-side to China’s foreign mining exploits. The debate started in earnest
when in 2005 China’s Minmetals made an audacious takeover bid to acquire
Canadian miner Noranda — then the world’s ninth-largest copper and third-largest
zinc producer. A strong nationalistic Canadian backlash revolved around the
argument that Minmetals was a state-owned company and local officials were not
comfortable with a foreign SOE acquiring an important industry on home turf. The
deal was eventually scuppered and other Chinese SOEs have faced many similar
subsequent acquisition challenges.

Bear in mind that China has more than a trillion dollars in foreign reserves from
spiralingtrade surpluses. One of the reasons it is reluctant to completely open its
currency to market forces is the inevitable appreciation of the Chinese yuan against
major currencies such as the United States dollar. Even a “small” 10% depreciation
will wipe off $100-billion from Chinese reserves — enough to finance the estimated
project costs of Gabon’s Belinga Project 169 times over. It has to be tempting for
China to reduce currency exposure on its monolithic foreign reserves by investing in
foreign resources, killing the proverbial two birds with one stone.

Whatever the future holds for China’s quest to build its resource supplies, the rules of
the game will definitely be different from those of the corporate game being played at
present.

And Africa will be a key part of the playing field making us all rather interested
participants or observers.