The China Effect: The story of how Chinese demand for natural resources transformed emerging markets

Twenty years ago Zambian copper mines were facing ruin, low prices, failing companies and ancient infrastructure had condemned the industry to a bleak future and with it the miners that depended on the metal for their livelihood. In Sudan conflict between Northern and Southern regions had frightened off all but the most intrepid investors, particularly in its nascent oil industry, but now despite the nation’s formal division and continued fighting it has not stopped the now two separate countries pumping out a sizable supply of oil, while Zambia’s copper mines enjoyed a renaissance as prices soared and mines upped production.

What connects these two stories is of course the “China effect” – the unprecedented demand for the raw materials required by Chinese industry; copper, iron ore, nickel, aluminium, crude oil, coal and timber, not to mention soft commodities such as soy, wheat, beef and corn which help to feed agri-businesses and a growing consumer class. The last thirty years have seen these commodities all winding their way to China in increasing numbers, until such time when China had become the key price setter of many commodity prices, all thanks to its overwhelming market share in these goods.

China’s influence and buying power around commodities is perhaps the most noticeable and debated aspect of its increasing global engagement with the world, with many painting it as neo-colonial in its approach, others lauding its investment in poorer countries as highly beneficial for their economic development.

China’s success has been driven by these factors:

  • Political and economic focus and discipline – the State’s overarching policy of ensuring a steady supply of raw materials, by befriending commodity producers and directing state owned companies to invest in mines to obtain them.
  • Massive financial firepower, China has the world’s biggest currency reserves and a state owned banking system, which together means it has cash to spend. The support of state banks means that projects can be completed with a cost of capital close to zero, making normally uneconomical projects viable.
  • Demand, the requirement for all these inputs is subject to the internal growth of the Chinese economy (which has of course been extremely high), new roads, cities and ports being built, which has meant demand for raw materials go through the roof – leading to huge expansion in their supply, in other words more mines, oil rigs and quarries opening up or expanding.

How Jinchuan Group cracked the South African platinum market

Jinchuan Group a company headquartered in the far north-western Chinese province of Gansu, is the country’s largest producer of red copper and nickel. In 2011 Jinchuan took a 51 percent stake in Wesizwe Group, a South African platinum mining company. What should have been a straight forward deal was nearly destroyed by the intervention of a shadowy US controlled group called Musa Capital. As part owners of Wesizwe Group they tried to embezzle USD 70 million from the company as well as attempting a messy takeover to cover up the loss before Jinchuan Group could complete their deal, in the confusion also finding time to fire the CEO Michael Solomon.

The owners of Musa Capital eventually ended up in court, as well as defrauding their own company they were also accused of swindling a Sowetan tribe that owned RZD 700 million worth of Wesizwe’s shares. Musa Capital had set up a series of companies to aid them in stealing the funds, but their scheme fell apart and Jinchuan eventually took their stake in the company ousting Musa Capital and reinstating the CEO.

Jinchuan Group then enlisted the help of another Chinese organisation, the China Development Fund (CADFund). CADFund was set up by the Chinese Development Bank with USD 1 billion of seed finance to support Chinese projects across the African continent. Although CADFund has been criticised for poor investment decisions by generally pro-Chinese commentators like Deborah Brautigham, this time their equity stake of USD650 million for the Frischgewaagd-Ledig mining project near Sun City was a major fillip for Jinchuan.

The battle for the firm was worthwhile. The deal was brokered by Martyn Davis CEO of Frontier Advisory who described it:

This is a very significant strategic play because it gives China its first direct access to platinum”.

This might not seem like a big deal, until you consider the structure of the world platinum market, where the vast majority of transactions for the precious metal are done on a long term contractual basis, and only 10% or so of the metal is available on the open market. The purchase of Wesizwe gave the Chinese a presence in the market dominated by the South African “big three” Anglo Platinum, Impala Platinum and Lonmin. The Frischgewaagd-Legig project should produce around 415,000 ounces of the rare metal a year, which will double Jinchuan’s current production levels.

Platinum is a totemic metal, think of the order in importance of credit cards or value of records sales. Platinum is highest in the hierarchy above bronze, silver and gold. Valued because of its unreactivity and therefore a vital component in catalytic convertors, laboratory equipment and watch making, South Africa holds 80% of the world’s supply, giving it and the companies that control production a near monopoly.

Chinese “Resource Grabs”

So when commentators talk about Chinese resource “grabs” or control, Jinchuan is a classic case in point, a Chinese company purchasing and financing a mine and then exporting an essential metal for its industrial sector. The fact that platinum is controlled by a few companies and not a freely traded fungible commodity such as crude oil validates the theory that China is trying to “control” commodities. However the contrary argument can also be made, that the Chinese are trying to break the monopoly of control enjoyed by South African companies.

China’s search for energy security is taking it to remote destinations and difficult to extract oil, the easy to reach sources of oil such as the gigantic shallow fields of the Middle East have already been found, tapped and lie under the control of other companies and countries. China has done its best to befriend certain governments, Angola, the two Sudans and Venezuela but it still faces a massive oil import bill and reliance on supply from all corners of the world. Thus any company that can help provide acreage or supply to China can be onto a winner, the likes of CNOOC and Sinopec can pay handsomely for proven sources of crude.

Chinese demand for technology

Those firms which can offer advanced technology in terms of deep sea drilling and refining capability will be extremely attractive to Chinese firms, who are way behind their western counterparts in these fields. For governments and oil firms looking east it is an increasingly sensible strategy, as demand in Europe and the USA stagnates, while demand in China (as well as India) is predicted to continue growing.

For some this may mean a shift in political and military alliances overtime, while the USA has been seen as the regional hegemon in the Middle East for 50 years or so, represented by significant military assets in the Persian Gulf, primarily the US Navy’s 5th Fleet in Bahrain.  Things change, if Washington no longer requires Middle Eastern oil then it may reconsider its long term position in the region, could one day China replace them, it seems unlikely now, but it is not a scenario that should be ruled out.

Another key component of China’s oil imports is its dependence on sea lanes, the routes through the Persian Gulf and Straits of Malacca underline the nations’ growing strategic weakness, despite recent growth China does not have a powerful navy and the US remains dominant in terms of sea power. While many might argue that cyber or proxy warfare will be more crucial in any falling out between the two great powers of East Asia, naval strength remains crucial.

What this is does mean is that China will look to invest in and develop ports (for now just conventional use), so places like Hambantota, in Sri Lanka, close to the shipping lane connecting the Suez Canal and Strait of Malacca has received significant Chinese investment. Other ports and harbours should also look for Chinese input, particularly those on strategically important positions that Beijing view as critical to the flow of imports and exports that power its economy.

Opportunities

As Chinese manufacturing steps up a gear to more advanced production, the materials and minerals they require will change, if you are a supplier or miner, then analysing what is likely to see more demand in the future, will give you an idea of what might be the best sector to invest in.

Security of supply; the Chinese government is mindful of the fact that it must ensure the steady flow of certain items to feed its manufacturing base remains, this creates opportunities for miners, national governments and prospectors to sell mining rights and land to Chinese companies.

Chinese urbanization is set to continue

At some point a Chinese slowdown is likely to manifest itself in lower orders for raw materials at factories and workshops across China, while this may seem like disaster for those involved in the commodity trade, as a glut in copper, iron ore and other natural resources will drive down prices and profit.

But it would be wise to remember that China still has a lot of (relatively high) economic growth in it, although it may move away from the resource intensive production of the past, there is still a great deal of building to be done, just consider that 300 million people in China are likely to urbanize in the next twenty years, that is the equivalent to the entire population of the United States. When taken altogether that is a lot of copper wiring, steel and not to mention cement, stone and all the other materials needed in construction.

All this means that Chinese mining firms will remain in the market for new sites and opportunities to extract minerals and metals across the globe (although growth might not be as spectacular as before), for mining companies this entails sustained demand for mines and for transport firms the means to move them. However others have be alert to shifts in policy and demand. For example China’s decision to impose a coal import duty to protect its own struggling industry could well have a devastating blow to an international industry which has become reliant on Chinese demand.



Categories: China Goes Global, Company Case Studies, Development finance, Geo-Economics

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