China doesn't seem to see an end to commodities boom

China Changes Rules
of the Resource Game

By Julian Hewitt
The Mail & Guardian, Johannesburg
Tuesday, February 13, 2007

http://www.mg.co.za/articlePage.aspx?articleid=298761&area=/insight/insi...

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 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 and 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. This is purported to be the largest untapped iron-ore reserves in the world, and 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 560-kilometers 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 spiralling trade 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-percent 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.

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Julian Hewitt is a Shanghai-based consultant.

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