China’s search for resources – from oil and gas, minerals and metals, and now to farmland – is reaching all corners of the world. An appetite for energy resources drove China’s first outbound investments in the early decade of reform. In recent months, the intense volatility and inflation of global commodity prices, combined with China’s vast capital reserves, has re-energized the effort.
At the mega-size end of the spectrum, Aluminum Corporation of China continues to negotiate ways of expanding its relationship, if not equity, in Rio Tinto, following its initial US$14.5 billion buy-in. This initiative fits in with several of the key objectives for resources set out in the 11th Five-Year Plan: to assure access to steady and fairly priced supplies; to cooperate on a global basis to maintain stability in the markets; and to prevent excessive consolidation in resource ownership that would lead to monopoly distortions.
As the world seeks ways to address commodity inflation, Beijing is focused on the shifting leverage between resource buyers and sellers, and the risk of consolidation – if you are not among the consolidators.
Honing the approach
At more modest levels, China is pressing mining and refining companies to go abroad and buy. Most potential buyers are state-owned resource firms, so bosses are naturally aware of the political benefits of a good deal, but even more aware of the ramifications of a bad deal.
Resources should be an inherently less risky territory than sectors like financial services, simply because if the goods are there, no resource-based company can vanish in value. At the same time, such investments are slow to generate cash and often require additional spending on essential transportation, environmental and safety infrastructure. Risks of venturing overseas are far from negligible for companies that lack the scale and experience of China’s biggest state-owned enterprises, and that leads their bosses to certain kinds of approaches.
First of all, there is an inclination to under-diligence assets and over-negotiate price. Resource investments have complex risk profiles, while commodities securitization has attracted more investors and generally driven up futures prices. How sustainable current record prices will prove to be is anyone’s guess, and valuations of resource companies should move in close relationship to futures. But the current volatility is contrarily depressing values of certain listed firms. Against a backdrop of widely held belief that supplies of virtually everything will fail to meet rising global demand, minor news events trigger highly geared reactions in futures.
Robust diligence does not always produce a perfect result, but it can support good risk management decisions and an orderly negotiating process.
In the past, though, Chinese buyers have been criticized for not negotiating hard enough, especially where a transaction has ultimately proved to be a loser. Fear of this outcome pushes buyers to persist in price discussions to the point where the targets feel haggled to death. Many deals have died from a mismatch of infinitely patient Chinese negotiators and finitely patient foreigners.
Secondly, to manage risk, Chinese outbound investors look for positions in related pieces of the value chain – railroads, ports – that will profit from resource development. Not only does this keep those profits in the hands of the resource developers, it provides an opportunity to influence the competitiveness of the Chinese-owned assets.
Collateral infrastructure investments have been welcomed by some countries, but repelled by others, particularly those with enough capital to provide for themselves.
Looking back, China’s strategy in overseas resource acquisition has changed markedly as a result of increasing sophistication combined with increasing pressure to secure inputs for what are the world’s largest and hungriest factories and mills.
But what will be the future strategy, goals, and benchmarks that drive the State’s position on commodities and guide the behavior of Chinese buyers abroad? The question is an important one, because it involves not just outbound investment in resources. It also has implications for renminbi exchange-rate management, policy toward strategic reserves, and domestic market pricing of key energy and mineral materials that underpin China’s export competitiveness, and possibly the sustainability of its growth.
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