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China’s outbound investment into resource and energy assets is likely to undergo a shift in form, direction and scale during the next few years. Nationalist resistance to earlier high-profile acquisitions and tougher regulatory inspection in traditional target countries, as well as a shift in domestic priorities, will determine new strategies.
“Although Australia and North America will remain the most important destinations for acquisitive Chinese companies and state-owned enterprises (SOEs), other regions such as Africa and Central Asia should grow in prominence,” said Amy Cheng, vice-chairman of investment banking at Bank of China, in a panel discussion at this week’s Mines and Money conference in Hong Kong.
China’s outbound investment has risen at a spectacular rate. In 2005, it amounted to only $9.9 billion, but has increased at a compound annual growth rate of 33.4% to reach $79.7 billion up to the third quarter of 2012, according to Bank of China figures.
“M&A activity was explosive between 2008 and 2011 after declining briefly in 2007,” said Cheng. Although the number of deals has fallen, the size of individual transactions has grown substantially as Cnooc, Sinopec and other SOEs sought to secure the energy and natural resources for the country.
But, increasingly, Chinese firms are shifting their focus to Africa in particular, despite weaker legal regimes, because costs and regulations are less restrictive. China’s investment in the continent has expanded at an average annual rate of 24% a year during the past three years, yet still makes up below 1% of its total overseas investment.
There is enormous potential for growth, and it is likely to range across all poles of the continent. Yet, the presence of Chinese firms is evident, running copper mines in Zambia or oil wells in Sudan, and often funding infrastructure development as a condition of entry. Indeed, as this journalist saw during the middle years of the last decade, in (North) Sudan’s pariah regime, China had already replaced Libya’s Gaddafi and Al-Qaeda’s Osama bin Laden as principal benefactors.
However, rather than M&A deals, China is likely to pursue assets directly. Purchases of foreign firms too often face scrutiny and encounter controversy, despite recent regulatory approval of Cnooc’s record $15.1 billion bid for Canada’s Nexen.
This shift in strategy might seem strange when, as Keith Spence, president of Global Mining Capital, pointed out, there is a “perfect storm” that should encourage more M&A.
Many international resources companies are trading at low valuations, several need capital, demand for commodities and energy remains strong, new leaders have taken over the political levers in China and the country’s central bank is flush with trillions of dollars.
But, “Chinese companies have learned an important lesson since the 2008 crisis,” said Hongyu Chai, managing director, research department at China International Corporation. “High-profile acquisitions of listed firms attract too much publicity, so the focus will be on unlisted assets instead.”
However, they are likely to seek domestic partners because in the past they have suffered from a lack of local knowledge about cultural, social and environmental issues, and been forced to incur significant costs as a quid pro quo for their investments, she said.
Yet, operating costs in Chinese resources companies are increasing, caused by higher wages and a strong renminbi, according to Rohan Kendall, senior analyst at Wood Mackenzie. That provides them with an incentive to look overseas, and copper, iron and coal assets might become available from disposals by leading global firms, such as Rio and BHP Billiton, which now have new chief executives.
Large size and advanced stages of production are likely to remain key criteria for asset purchases, added Kendall, although smaller Chinese firms are becoming more sophisticated about spotting bargains, said Chai.
Nevertheless, the rate of overseas investment expansion should decline. China’s more moderate target of annual GDP growth of 7.5%, compared with 10% a year for the past decade will lead to a slower rate of demand for some raw materials, said Bank of China’s Cheng. Official focus on consumption rather than investment is also likely to cause a shift in the composition of that demand. For instance, as the population becomes richer, so will its aspirations for better quality products which should boost copper sales; and less spending on capital projects will reduce demand for iron and steel.
Clearly, China’s predatory role in the international commodities markets will not be tamed. But, competitors and prey should expect its targets and tactics to evolve.
