The China Analyst - April 2014


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The China Analyst is an in-house publication of The Beijing Axis for executives with a China agenda.

In the April 2014 edition of The China Analyst, we outline the implications of China’s continued quest for natural resources as the country redefines itself once more through the implementation of key economic reforms.

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The China Analyst - April 2014

  1. 1. September 2013 І Features China’s Increased Presence in the DevelopedWorld The Growing Global Influence of Chinese Consumers China’sTransformation: Implications for Global Supply Chains Chinainthe DevelopedWorld Chinainthe DevelopedWorld April 2014 І International Advisory and Procurement Features Feeding a Billion: China’sTransforming Agricultural Sector Chinese Mining Firms in theYear of the Horse: aTrot, a Canter or a Gallop? Chinese Super Majors:Tilting the Global Oil and Gas Playing Field China’s Continued Quest for Natural Resources
  2. 2. Worked with more than 50industry leaders spread across 6continents and in over 10different industries Conducted more than 80projects in the last 5years, of which 30were emerging market growth strategies Conducted more than 30China/Asia strategic engagements in the last 2years Over 50%of engagements are with repeat clients Supported more than 10companies in the last 2years to set up and launch their operations in China Integrates a multiculturalteam Customised and practical strategy and management consulting solutions for companies seeking to optimise international growth and profitability Strategy Formulation Strategy Implementation Research and Analytics Sales Activation STRATEGY AND MANAGEMENT CONSULTING
  3. 3. Source: Various; The Beijing Axis Analysis With slower economic growth of 7.7% in 2013, the story of China’s contribution to global demand for commodities is still far from over. In March 2014, China unveiled its long-awaited plan to have approximately 60% of its more than 1.3 billion people living in urban areas by 2020 in a bid to boost economic growth and efficiency. These new urbanites will demand greater quantities of disposable goods, electronics and white goods to furnish their new dwellings – ushering in a new wave of consumption. China will undeniably experience some growing pains as it begins to rebalance, yet the country will continue to grow – and from a larger base than when GDP was expanding at a double-digit pace. Multinationals who have not yet entered (or succeeded in) the Chinese market should note the scale of the opportunity in the Middle Kingdom and readjust their long-term strategy accordingly. The Middle Kingdom’s Growing Appetite children are born every day in China 54,720 50%oftheworld’spork iseateninChina vehicles registeredby2012 240mn billionaires in2013,comparedto0in2000 122 ofChina’spopulation consumes25% ofgloballuxury goods 2% metrictonsofgold wereimportedin2013, theworld'slargest 1,066 China’s%ofglobalresourceconsumption OilGoldCopperAluminumSteelCoal increaseinurbandwellers 2000,highestglobally 197mn mobilephoneswerein circulationinChinain2013 1.2billion wastheoverallmarket valueofChina'se-commerce marketin2013 $1.6trillion Chinesetraveled abroadin2013 97million GOLD GOLD
  4. 4. At the Highest Level Underscoring China’s commitment to sustained economic reform, Chinese Premier Li Keqiang mentioned the word “reform” a remarkable 77 times in his opening speech at the National People’s Congress, China’s annual rubber stamp legislative assembly held this past March in Beijing. The China Analyst April 2014 Published by The Beijing Axis 3806 Central Plaza 18 Harbour Road Wanchai Hong Kong, PRC Tel: +86 (0)10 6440 2106 Fax: +86 (0)10 6440 2672 Publisher Kobus van der Wath Advisor William Dey-Chao Senior Manager Barbie Co Editor Daniel Galvez Associate Editor Tim Quijano Designer Qing Lei To view the contents of previous editions of The China Analyst, see Previous Editions on page 35. To subscribe free of charge to The China Analyst,pleasevisitwww.thebeijingaxis. com or For advertising opportunities, please contact Barbie Co at barbieco@ DISCLAIMER This document is issued by The Beijing Axis Ltd. While all reasonable care has been taken in preparing this document, no responsibility or liability is accepted for errors or omissions of fact or for any opinions expressed herein. Opinions, projections and estimates are subject to change without notice. This document is for information purposes only, and solely for private circulation. The information presented here has been compiled from sources believed to be reliable. While every effort has been made ensure that the information is correct and that the views are accurate, The Beijing Axis cannot be held responsible for any loss, irrespective of how it may arise. In addition, this document does not constitute any offer, recommendation or solicitation to any person to enter into any transaction or to adopt any investment strategy, nor does it constitute any prediction of likely future movements or events in any form. Some investments discussed here may not be suitable for all investors. Past performance is not necessarily indicative of future performance; the value, price or income from investments may fall as well as rise. The Beijing Axis, and/or a connected company may have a position in any of the investments mentioned in this document. All readers are advised to make their own independent judgement with respect to any matter contained in this document. Copyright notice: Copyright of all materials, text, articles and information contained herein resides in and may only be reproduced with permission of an authorised signatory of The Beijing Axis. Copyright in materials created by third parties and the rights under copyright of such parties is hereby acknowledged. Copyright in all other materials not belonging to third parties and copyright in these materials as a compilation vests in and shall remain copyright of The Beijing Axis and should not be reproduced or used except for business purposes on behalf of The Beijing Axis or save with the express prior written consent of an authorised signatory of The Beijing Axis. All rights reserved. © The Beijing Axis 2014. The delegates of the National People’s Congress revealed a GDP growth target of“around”7.5% for 2014 while prioritising other key socio- economic issues. Over the past year, Beijing has repeatedly pledged to tackle corruption, reduce production from key polluting industries – aluminium, cement, glass and steel – and increase consumer spending levels. The Chinese government also hopes to continue implementing reforms by opening state- dominated industries up to private, and even foreign investment, coerce banks into becoming more market-sensitive and further ease exchange rate controls. Beijing hopes these structural and financial reforms will unlock additional sources of economic growth and improve the efficiency and market-sensitivity of the Chinese economy. In line with China’s increase in consumption, China’s agricultural sector will undergo structural changes starting in 2014. China’s State Council recently announced plans to abandon the country’s 95% grain self-sufficiency policy, which has been in place since the days of Maoism.This is expected to result in rapid growth in the amount of imported foods consumed locally. Moreover, the population’s continued shift toward a more protein-rich diet will further strain global food supply chains. Genetically modified foods, greater mechanisation and market-oriented central policies can lead to greater efficiency in China’s agricultural sector. Increasing consumption at all levels in China will also lead to growth in demand for oil and minerals. Though China has recently become the world’s largest importer of oil, China’s per capita oil consumption lags well behind the levels of the developed world, which demonstrates room for further growth. As China’s consumption of oil has ballooned, China’s state-owned oil and gas enterprises have developed into global players representing key collaboration opportunities for international firms, especially in areas such as tapping unconventional resources. China has also hinted at opening up the Chinese market to more foreign participation. China’s interest in advancing its climb up the global value chain will assure steadily rising demand for mineral products and advanced mining technologies. As the mining industry cools from its 2012 boom, resource nationalism, an increase in price volatility, higher operating costs and declining mineral grades will increase risk and complexity in the global mining sector. As resource constraints continue to arise, Chinese mining firms will continue their trek into deeper mineral deposits domestically and abroad. Trends in China’s finance and banking sectors will be instrumental in demonstrating the direction the Chinese economy will take. The rapid growth of shadow banking, along with its inherent risk, demonstrates the Chinese economy’s need for a more transparent and accountable financial system. It is against this backdrop that China’s policymakers will continue to dictate the pace of change through their policy of coordinated reform, which will continue to initiate remarkable opportunities both in the Chinese market and abroad. In the April 2014 edition of The China Analyst, we outlinetheimplicationsofChina’scontinuedquest for natural resources as the country redefines itself once more through the implementation of key economic reforms. I trust that our readers will enjoy this edition of The China Analyst and, as always, I welcome your feedback. Kobus van der Wath Founder & Group Managing Director The Beijing Axis 4 І The Beijing Axis
  5. 5. REGIONS Regional Focus: CHINA-AFRICA China-Africa trade and investment analysis and a focus on China’s relations with the South African Development Community (SADC) REGIONS Regional Focus: CHINA-AUSTRALIA China-Australia trade and investment analysis and ‘Australia State Watch’on Queensland REGIONS Regional Focus: CHINA-LATIN AMERICA China-Latin American trade and investment analysis and a special focus on China’s relations with Costa Rica The Beijing Axis News The latest news from The Beijing Axis Group FEATURES Feeding a Billion: China’s Transforming Agricultural Sector Opportunities resulting from the shift in China’s agriculture market FEATURES Chinese Mining Firms in the Year of the Horse: a Trot, a Canter or a Gallop? An analysis of how Chinese mining firms will develop during the mining industry’s expected recovery in 2014 FEATURES Chinese Super Majors: Tilting the Global Oil and Gas Playing Field Implications of China’s sustained increase in overseas production of oil and gas MACROECONOMY Macroeconomic Monitor: Balancing Reform with Growth China executes on its plans to reform the world’s second-largest economy PROCUREMENT How to Procure from China #13 In this edition, we focus on the thirteenth stage of the procurement process: Installation and Commissioning INVESTMENT China Capital: Inbound/Outbound FDI & Overseas Resource Investment Analysis of the latest on FDI in China and OFDI by Chinese firms with a focus on overseas resource investment STRATEGY Mapping China in the Global Production and Consumption of Oil and Gas Global patterns in the consumption and production of oil and gas STRATEGY CNOOC: Expansion into Unconventional Expertise A focus on China’s third-largest oil and gas company to demonstrate trends in Chinese overseas investment in this strategic sector Table of Contents April 2014 12 9 6 18 22 19 24 28 26 16 30 32 5 І The Beijing Axis
  6. 6. Feeding a Billion: China’s Transforming Agricultural Sector As China’s agricultural sector struggles to keep up with the country’s growth in demand, many opportunities are arising for companies interested in capitalising on this challenge. China’s struggle to consistently secure adequate food supplies of a sufficient quality has resulted in its agricultural sector beingplacedunderincreasingscrutiny.TheStateCouncil,China’shighestdecision-makingbody,released guidelines in February 2014 that suggest that the country will no longer aim to match demand for grain through domestic production alone, as has been the case since the days of Maoism. These are the first public signs that Beijing is coming to terms with the realities facing China’s agricultural sector. China’s shrinking farming capacity, as well as some of its archaic agricultural policies, will hamper its ability to achieve food security in the long term. China’s ability to meet the agricultural demands of its population will usher in a new era off opportunities for agricultural companies. By Dominique Scott The situation I f China were self-sufficient with regard to agricultural products, it would have to feed 20% of the world’s population with only 10% of the world’s arable land and 6% of global water resources. In the past, this situation was manageable due to the fact that Chinese citizens generally depended on vegetables and grains for energy with only small portions of meat for flavour. Arguably, these dietary preferences arose as a consequence of many not possessing the wealth to buy more expensive food products, as many can today. However, China’s meat and calorie intakes have climbed in conjunction with the country’s GDP. In 1980, for example, China’s average level of protein consumption was a mere 12% of the average of Japan, Malaysia, Australia and New Zealand, a culturally diverse sample. By 2009, China’s protein consumption had risen to 56% of the above sample’s average. China’s large population and the apparent remaining growth in China’s appetite illustrate how much food will be needed to meet future demand. One of Beijing’s responses to China’s lack of food security was to set a 95%‘self-sufficiency’target on key grain products—corn, rice and wheat—to shape the way land and water resources were prioritised and insulate the country from fluctuations in global grain prices. The production of meat is more land and water-intensive than the production of vegetables, fruit and feed. Putting extra pressure on already strained resources was thought to be unwise. A pound of beef requires a staggering 6,810 litres of water, pork 2,180 litres, soybeans 818 litres, potatoes 450 litres, corn 409 litres and apples 70 litres. Additionally, the low quality of China’s natural resources is exacerbating the country’s resource shortage. The Organisation for Economic Cooperation and Development (OECD) estimates that 70% of China’s arable land is low-yielding, and erosion, salinisation and acidification are leading to a further reduction in the quality of China’s soil. Further, these estimates do not take into account the effect of pollution on China’s arable soil. Some analysts say between 8-20% of China’s arable land is contaminated by heavy metals. Interestingly though, this ‘self-sufficiency’ target has been abandoned for a more open policy according to guidelines released by the State Council in February 2014. Analysts have proposed that land and water-intensive products, like beef, offer higher profit margins than vegetables, fruits and grains. Beijing may be attempting to ameliorate China’s high inequality by allowing farmers to choose to farm more profitable produce. However, this policy alone will be insufficient to overhaul China’s agricultural sector. Furthermore, food scandals, whether it’s comical glow-in-the- dark pork chops or melamine-tainted milk, emerge in China with alarming regularity. Unsurprisingly, China’s growing middle class is demanding imported food and beverages so long as there is apprehension regarding the quality of local products. The apprehension around the quality of domestically-produced powdered baby milk, in particular, has had profound effects around the world. Supermarket stores in Hong Kong, Australia, New Zealand and even as far as the UK have implemented policies aimed at rationing baby formula due to a surge in demand from China. Regardless of whether Beijing abandons its‘self-sufficiency’targets, opportunities for investors lie in the Middle Kingdom’s future nutritional needs.The Chinese market’s sustained growth will result in an increase in demand for a wide range of food commodities – foreign intervention and innovation will help meet this demand. China’s Milk Powder Consumption by Type (‘000 tonnes, 2012 vs 2022F) Note: 2012 refers to an average of 2010-2012. Source: OECD-FAO Agricultural Outlook; The Beijing Axis Analysis CAGR5.0% CAGR2.1% 0 500 1,000 1,500 2,000 184 314 Skim milk powder Whole milk powder 1,438 1,908 2012 2022F 6 І The Beijing Axis
  7. 7. The outlook If President Xi Jinping follows through on his commitment to double China’s GDP per capita by 2020, demand for the more expensive categories of food, such as animal protein, will rise the fastest. Most of this increase in demand will be met through an increase in imports due to China’s aforementioned shortage of high quality agricultural inputs. The OECD and Food and Agriculture Organisation (FAO) have estimated that by 2022, China’s consumption of food commodities will increase considerably across all categories, as demonstrated in the chart to the right. Possibly as a result of China’s struggle with tainted milk, the dairy category holds one of the largest gaps between domestic production and consumption. Notably, these projections were made before the State Council announced its abandonment of the 95% grain self-sufficiency guidelines, which will expand farmers’ control over which commodities they grow. Now that these targets will likely be removed, China is projected to experience a rapid expansion in grain imports. The solutions There is little doubt that Beijing faces a challenge in solving the country’s dramatic mismatch between supply and demand of food products. While many propose that it is inconceivable for China to achieve food security due to its scarcity of water and land resources, Beijing can reduce its dependence on imports in the long term through the implementation of strategic policies. Remnants of Maoist collectivism, for example, remain present in China’s rural land policies and reduce motivation to increase agricultural production. Providing farmers the opportunity to own, sell and borrow against land to expand business opportunities and profits may solve some of China’s food woes. Allowing for consolidation could create an environment that makes unprofitable enterprises financially unsustainable and rewards those that are profitable.Theeconomyofscaleachievedthroughtheconsolidation of farms will likely achieve higher production volume at a lower unit cost. Since 1997, an estimated 8.2 million hectares of arable land, roughly the area of Austria, has been lost to property developers catering to a growing urban population. While increasing the size of China’s urban population is an important step towards shifting China to a consumption-driven economy, this process has been administered in a haphazard fashion, which has jeopardised the country’s limited fertile land. A policy that preserves the most fertile land while using infertile land for infrastructure could provide for greater efficiency and productivity in the agricultural sector. China’s urbanisation and property development also presents an opportunity to increase productivity in the agricultural sector. Urbanisation has resulted in roughly 25 million Chinese farmers becoming defacto urban residents every year, which has led to the rapid development of labour-saving machines, such as tractors, produce sorting machines and refrigeration systems, for farms and food processing factories. According to a report by the Ministry of Agriculture, only 33% of China’s corn and 69% of its rice are mechanically harvested every year.The report also stated that China performs 72% of its post-harvest processing tasks, such as sorting and packaging, by hand. The opportunity for the mechanisation of the agricultural sector is evident. Mechanisation may, however, result in unforeseen consequences related to unemployment in China’s labour market, so policymakers and the business community would benefit from a coordinated approach to solving challenges in the agricultural sector. Even if new policies could maximise the amount of arable land, China will continue to suffer from its unproductive use of land.While China’s agricultural total factor productivity, a measure of a country’s long-term technological change, has risen in the reform era, it still lags behind that of developed nations. Advanced agricultural techniques and technologies for fertilisation and irrigation, for example,couldhelpwithincreasingproductivity.Graduallyopening up the agricultural sector to foreign investment, which the central government currently forbids, is a potentially effective strategy to transfer such techniques and technologies. Unfortunately, Beijing may not have the luxury of time if it wants to reduce its reliance on imports. Beijing’s‘Going Out’policy, through which the central government aids firms, private and state-owned, to make acquisitions and investments abroad with the intention of securing physical assets and the associated intellectual property, could complement the reform of the agricultural sector. From 2010 to 2013, Chinese food and beverage companies made over USD 9 billion worth of deals overseas according to the National Australia Bank. Deals such as Shuanghui’s acquisition of Smithfield, the world’s largest pork producer and processor, in May 2013 and COFCO’s March 2014 acquisition of majority stakes in Noble Group’s agribusiness unit and Nidera stand out, but there are countless examples from around the world.With China already having established good relationships in Africa, Australasia and South America, where some of the most fertile farmlands in the world exist, the opportunity for increased OFDI in agriculture is certainly available. Genetically modified (GM) food may provide a partial solution to China’s food supply woes as well. GM crops have the potential to overcome many of the challenges of agriculture in China, such as low-yielding arable land and decreasing soil quality. Furthermore, the benefits of lower costs will also aid in keeping inflation in check. However, GM food is a sensitive topic in China—the public remains cautious as to whether the government has fully addressed the potential risks. Nevertheless, the Ministry of Agriculture has taken the lead in publicly declaring the safety of GM food and is slowly pushing domestic production ahead. According to Han Changfu, the Minister of Agriculture, 17 GM products from five plant species are currently sold on the domestic market: soya beans, corn, oilseed rape, cotton and tomatoes. Currently, the only GM crops approved for domestic commercial production are cotton and papaya. Lastly, firms can mollify China’s food safety fears by exporting from their home country or by producing strategically within China. Tyson Foods, one of the world’s largest processors and marketers of chicken, has shifted from its conventional business model of China’s Consumption of Selected Commodities (mn tonnes, 2012 vs. 2022F) Note: 2012 refers to an average of 2010-2012. Source: OECD-FAO Agricultural Outlook; The Beijing Axis Analysis 17 30 51 66 102 201 8 22 37 61 86 129 270 Beefandveal Poultry Vegetableoil Pork Othermeat Oilseed Grain 0 50 150 100 200 250 300 2012 2022F 7 7 І The Beijing Axis
  8. 8. sourcing from independent chicken farmers and has built its own network of farms in China, providing direct oversight over the production process. In 2010, Tyson did not have any farms in China; today, they have 20, and they plan to own and operate 90 by 2015. The opportunity The problems that lie ahead are not unique to China. Numerous countries face the prospect of having to rely increasingly on importing food to meet domestic demand. What magnifies China’s challenges is the size of its population, which has the potential to create shocks on global markets. If China cannot meet demand with domestic supply, global prices of certain food commodities will undoubtedly rise. Should prices rise too much, affordability will become a crucial issue around the world.While farmers may benefit the most from this situation, worldwide consumers will be on the receiving end. China’s challenge, to a certain extent, will become the world’s challenge. China’s growth in domestic food production in the last thirty years is an astonishing feat, yet the country’s deteriorating quality and dwindling availability of natural resources mean that this growth is still not adequate. Pollution must be minimised. Arable land must not be sacrificed for urban sprawl. Land policies should reward profitable agricultural enterprises. Together, these actions could alleviate pressure on China’s agricultural sector. Companies able to navigate China’s shifting agricultural landscape will be primed to benefit from this key market. China’s agricultural players desire advanced labour-saving technology and will undertake joint ventures to attain it. Agricultural exporters around the global will benefit from increasing levels of demand for agricultural commodities and increasing flows of capital from China.The companies that see the magnitude of China’s agricultural challenges will recognise the opportunities available. Dominique Scott, Consultant
  9. 9. L ast year was particularly challenging for the mining sector by many measures – a falling number of M&As, a record low number of IPOs in both the Toronto and Australian stock exchanges (traditionally the hot-bed of global mining financial activity) and the headwinds experienced by many junior miners.The sector felt both the global economic crunch and China’s economic slowdown. As China transitions from an investment-driven economy to a consumer economy, less fixed-asset investment will result in a reduction in the demand for minerals. China will continue to be a key demand centre, but consumption growth will slow. The development of the central and western regions of China will contribute to commodity demand, but the boom-time levels seen from 2003 to 2008 are unlikely to return. Chinese Mining Firms in theYear of the Horse: aTrot, a Canter or a Gallop? The global mining boom created a sense of euphoria in the sector – mining firms could export what was produced at record profits as the world underwent sustained economic growth. As a result, mining companies de-emphasised cost-control practices because commodity prices were high enough to cover lingering inefficiencies in the sector. In today’s market, mining companies must reduce expenses and explore alternatives to traditional mining processes and equipment as costs increase and mineral grades decline. Further, resource nationalism and regulation have resulted in increasing risk and complexity for mining firms operating internationally. Though the Year of the Horse has brought signs that this year will be easier on Chinese mining firms than in 2013, it is unclear how far the recovery will go and how Chinese mining firms will respond to the changing environment. By Walter Ruigu of the Belinga iron project. In fact, Wang Jiahua, Vice Chair of the China Mining Association (CMA), a juridical association approved by the State Council that acts as a bridge between the mining industry and the government, suggested that up to 80% of China’s overseas mining investments since 2005 have failed. Most firms remain reticent and are seeking ways to curtail the risks of overseas mining investments. Beijing has increased pressure on the industry to reduce the number of risky ventures overseas, which has resulted in increased prudence amongst Chinese firms, particularly SOEs, a trend which is expected to continue. Nevertheless, China still recognises the strategic importance of acquiring overseas mineral assets. For instance, in order to reduce reliance on the ‘Big 3’ iron producers – Vale, Rio Tinto and BHP Billiton – China plans to increase its imports of iron ore from Chinese-owned overseas assets, primarily those operated by SOEs, from 40% in 2015 to 50% in 2020. While the viability of achieving these targets within the stated timeframe is debatable, Beijing’s ambition is clear – despite an unfavourable global investment environment, China will continue to seek overseas iron ore targets for strategic purposes. Similar strategies are in place for other non-ferrous and precious minerals. For example, as China’s central bank seeks to diversify its 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2,000 4,000 6,000 8,000 10,000 12,000 14,000 Beijing abolished quotas on the purchase of foreign exchange for overseas investment SASAC tightens regulations onSOEs overseas investments China’s OFDI in Mining (USD mn, 2004-2013E) Source: MOFCOM; China Mining Association; The Beijing Axis Analysis Chinese firms moving up the learning curve: A trot Chinese companies interested in investing overseas have not been spared from the sector’s unfavourable conditions. Since 2005, when Beijing abolished quotas on the purchase of foreign exchange for overseas investment, Chinese mining firms have been eager to‘go out’to acquire assets needed to fuel the growth of the world’s second-largest economy. Nearly a decade later, much of the optimism has faded. China’s initial overseas mining ventures have been marked by some large-scale setbacks, such as the infamous MCC-CITIC Sino-Iron project, Zijin’s inability to acquire Indophil Resources’copper and gold project and, most recently, CMEC’s loss 42% of Chinese mining deals unsuccessful Chinese mining firms still face challenges overseas 32% of global mining deals unsuccessful 0% Worldwide China 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Success* Rate of Mining Deals (USD bn, 2008-Q2 2013) *Note: Success refers to a completed transaction only. Source: Reuters; Various; The Beijing Axis Analysis 180 45 62 382 Success Failure 9 І The Beijing Axis
  10. 10. 10 І The Beijing Axis currency reserves from US dollars to gold, it has become clear that the country will require a large physical quantity of gold. Rather than directly importing bullion, which would alter the global price of the commodity and result in unfavourable terms for China, the country has sought to slowly acquire gold overseas while boosting domestic production. These acquisitions will range from greenfield projects to operating assets. projects or publicly-listed assets with extensive feasibility studies due to government pressure to avoid risky investments. Mid-sized private firms, which unlike SOEs are not subject to regulations, such as those set by China’s State-owned Assets Supervision and Administration Commission (SASAC), will likely set their sights on non-traditional mining countries in Africa. SASAC’s regulations, in effect, are opening investment opportunities for private firms. Given that these private firms have become key players in Chinese overseas investment deals, this development will be a boon for the region. Chinese firms, traditionally known to favour late-stage projects, are beginningtoconsiderbrownfieldprojectsaswell.InAfrica,forinstance, theFenxiMiningGroup’srecentinvestmentinagreenfieldcoalproject in Kenya, Yinfu Gold’s acquisition of a Zambian copper mine and DingyiGP’spotentialinvestmentinCongo’sbrownfieldpotashproject illustrate the shifting investment patterns of Chinese firms. Mining in Africa is no longer focused on Simandou, Tonkolili or Chambishi and other well-known mega-projects. Mid-sized projects, such as the scaling up of artisanal mines with high returns, are likely to be the targets of Chinese mid-sized and private firms. These‘scaling up’ventures have been seen in an incredible diversity of projects: tantalum projects in Rwanda; gold projects in Ghana, including the controversial projects involving Guangxi miners; iron ore projects in Uganda; copper projects in Congo; and alluvial gold mining in Zimbabwe. Investors in such projects are usually subsidiaries of larger firms or nimble private companies capable of navigating the local environment with the goal of exporting back to China. Interestingly, these investments are not always in the form of equity or debt; they are sometimes in the form of capital equipment imported from China and trainings on how to operate said equipment. For instance, given the low-grade iron ore available in China, Chinese processing technology has advanced to process lower grades, which presents an opportunity for Chinese investors to integrate the export of capital equipment into the growing number of African mining projects with a lower mineral quality. China’s exploration bureaus represent another group of non-traditional players who are expanding their role in Africa’s mining scene. Although they have initially focused on government- backed projects, such as geological surveys, these organisations are broadening their presence. Once these bureaus understand a region, they form partnerships with other mainland firms to develop these opportunities, with the latter investing funds while the bureaus provide their mining expertise. Resources will remain a key part of China’s foreign policy as Private Chinese companies overtaking SOEs in mining OFDI: A canter As SOEs lead the pullback in overseas mining investments, private enterprises have become the main source of Chinese overseas mining investments. According to CMA data, Chinese overseas investment in the mining sector reached USD 5.1 billion in 2013 – USD 2.3 billion of which came from SOEs and USD 2.8 billion of whichwasinvestedbyprivatefirms.Thefigureforprivate firmslikely represents an underestimation because private Chinese companies frequently do not report their investments to the central authorities if the capital originates from Hong Kong or other regions, especially tax-havens, as is common in the industry. Concurrently, non-traditional funding sources, such as private equity firms and firms in the cash-rich real estate sector, are becoming increasingly involved in overseas mining projects. The Yuxiao Group, a real estate firm, and Cathay Fortune, a private equity firm, exemplify this trend. Experienced engineering and project management firms may benefit from collaboration with these firms intheirinternationalisationefforts.Thesenewplayers,despitebeing capital-rich, are at higher risk because they lack industry experience. Taking note, Chinese authorities have consistently warned firms to be aware of the risks of investing in overseas markets. Although these new private actors will likely assume a growing role in the industry, the overseas mining investment learning curve is steep, which means there will likely be more failures as the new firms develop expertise. On the other hand, companies that have already experienced the industry’s challenges will either continue with their global ambitions by engaging in new overseas projects, as MCC has done, or re-evaluate their ‘going-out’ strategy, as many SOEs are currently doing. Chinese firms sustained activity in Africa: A gallop As mining firms continue to dig deeper and assets become increasingly scarce, risk-averse firms may focus investment in Canada and Australia, where there are already over 50 Chinese SOEs in operation. SOEs are likely to focus on government-backed Chinese Overseas Mining Investment Destinations (%, 2013) Source: China Mining Association; The Beijing Axis Analysis Southern Africa Australia 30% 25% Canada 10% North Asia 4%ASEAN 6% Latin America 8% 9% 8% Western Africa Other Source: China Mining Association; The Beijing Axis Analysis Chinese Overseas Mining Investments by Firm Classification (%, 2013) PrivateFirms 60% SOEs 40%
  11. 11. 11 І The Beijing Axis demonstratedinChina’s‘AngolaMode,’whichfinancesinfrastructure construction with natural resource development. This strategy will remain a core method of government-to-government cooperation. It will also ensure that the mining sector remains a central part of China’sdevelopmentpolicyandakeytargetforChineseinvestment. Large public projects will most likely see SOEs take the biggest slice of the cake, but SOEs’participation in new investments, particularly in unfamiliar mining environments, will continue to decrease. Looking ahead in the Year of the Horse With the mining boom long gone, firms around the world have reformulated their strategy as profit margins have decreased. As many junior miners struggle to raise the necessary capital for their projects, they will increasingly rely on debt markets. Given the high-risk and temporary nature of this solution, the financing gap will continue to be a challenge for these firms. Mid-sized Chinese firms will continue to play a key role in project financing, albeit with increasing scrutiny from experienced players. Going forward, private Chinese firms will continue to be key players in the global mining scene, and despite being newcomers, they will likely be quick learners and operate on market principles similar to other global companies. Meanwhile, resource nationalism will continue to constrain Chinese mining firms operating abroad. A focus on corporate social responsibility, community relations and stakeholder engagement will remain the most effective methods for addressing this challenge. Chinese Overseas Mining Investments by Mineral (%, 2013) Source: China Mining Association; The Beijing Axis Analysis Chinese SOEs will continue to be driven by political considerations, especially strategic resource acquisition, in addition to profit. Chinesecompaniesarelearningfromtheirfailures.Manycompanies will continue to be reticent about investment in foreign mining projects. If international companies hope to increase cooperation with China’s key mining players, they will have to come to China and convince cash-rich firms that their projects are profitable and that they have implemented adequate risk-control measures. Walter Ruigu, Consultant Manager: Eastern Africa Desk Copper 32% 20% Gold 10% Steel 7% Aluminium 4% Lithium 18% Other minerals 19% Coal
  12. 12. 12 І The Beijing Axis S tarting from a mere 767 kg per capita in 1990, China’s energy consumption has nearly tripled to 2,029 kg per capita in 2013 withapparentoilconsumptionat10.1millionbarrels/day(b/d). This rate, however, still remains far lower than that of developed countries, such as the US, who consumed 7,069 kg per capita in 2012. This phenomenal increase in demand is fuelled by China’s sustained economic growth, rapid industrialisation and widespread urbanisation. As domestic oilfields age and domestic reserves‐to‐ production ratios remain low, China’s rapid rise in demand for oil has also led the country to increase its reliance on imports. This is underscored by the fact that China surpassed the United States to become the largest oil importer on a monthly basis in September 2013. With a push to secure and diversify China’s energy needs, Chinese national oil companies (NOCs) embarked on an all-out effort to acquire upstream oil and gas (O&G) assets overseas in the early 1990s. Since then, they have invested approximately USD 180 billion to expand their overseas oil equity production from a mere 0.15 million b/d in 2000 to a staggering 1.6 million b/d by the end of 2013. These investments have bolstered China’s importance in Chinese Super Majors:Tilting the Global Oil and Gas Playing Field Buoyed by the country’s sustained economic growth, and its resulting need to secure stable energy supplies, Chinese national oil companies have been expanding their international reach by competing and partnering with foreign counterparts. The Chinese government has set a clear target of achieving China’s overseas oil equity production of 2.8 million barrels/day by 2020, indicating that Chinese national oil companies will continue to structurally shift the overall industry landscape with far reaching implications for global peers, EPCMs and oilfield service providers. By Ankit Khaitan the global O&G industry, making it the world’s second-largest oil consumer, largest oil importer, and fastest-growing overseas O&G investor. This also catapulted the three largest Chinese players: Sinopec, China National Petroleum Corporation (CNPC) and China National Offshore Oil Corporation (CNOOC), to the global stage among the super majors, who today control roughly 27% of global reserves. Chinese NOCs ‘go global’ – emerging dynamics and variability On June 15, 1993, when CNPC acquired a 15% operating interest in China’s first overseas oilfield in Canada’s North Twining project in northern Alberta, critics referred to this acquisition as an audacious manoeuvreandraisedquestionsregardingChineseNOCs’supposed inability to identify quality assets, overcome challenges in pursuing deals independently and the tendency to pay above market values. Today, with more experience in foreign markets and deep pockets, ChineseNOCs have establishedasuccessfultrackrecord inacquiring and managing assets of increasingly high-quality in complex and risky environments such as Angola, Niger and Sudan. Map of Selected Chinese Oil & Gas Investments Overseas by Country and Value (1993-2013) Source: Various; The Beijing Axis Analysis 20,000 10,000 500 100 2,500 Total Value of Deals (USD mn) 12 Australia Syria 1 12 Canada 2 Chad Mongolia 2 UK 3 Argentina 2 Brazil 2 Singapore Azerbaijan 2 Norway 6 Angola 5 US Ecuador 2 Thailand 2 2 Mexico 1 1 Venezuela 4 1 Yemen 1 1Peru UAE 3 Colombia 13 Indonesia 1 Mozambique 1Niger Nigeria 4 Iraq 17 Kazakhstan 5 Numbers mentioned in circles indicate total number of deals 3 InvestmentsinAngola, NigeriaandSudan accountforthemajorityof investmentsinAfrica Sudan
  13. 13. 13 І The Beijing Axis Over the years, Chinese O&G investments have begun to shift from being concentrated in a handful of developing countries – largely Sudan, Venezuela and Kazakhstan – to becoming a global phenomenon (see map on p. 12). Central Asia (Kazakhstan), the Middle East (Iraq and Yemen), Latin America (Argentina and Brazil) and Africa (Angola and Nigeria) continue to remain prominent, but more mature and stable destinations such as the US and Canada have recently started to gain traction as destinations for Chinese NOCs’ O&G investments. In fact, in 2012 alone, North America attracted more than 70% of the total value of deals pursued by Chinese NOCs, the largest share of any region around the globe. The nature of investments in the US and Canada differs from deals in other regions. The US and Canadian markets have seen some of the largestdealsvettedbyChineseNOCs.Ontheotherhand,developing markets across Southeast Asia, Africa and the Commonwealth of Independent States (CIS) have seen the highest participation from Chinese NOCs in terms of number of projects invested. At the same time, rising uncertainty over new oil discoveries, largely in unfamiliar or ultra-deep territory (i.e. hard to extract, expensive, and politically unstable), limited foreign acreage and increasing competition from other emerging NOCs and super majors means that the era of ’easy‘ O&G period has ended. In light of evolving market dynamics, Chinese NOCs are adapting their overseas strategy to overcome these challenges. Firstly, Chinese NOCs have become less risk-averse and more willing to invest in early-stage exploration projects and fields with no proven reserves, albeit with a more prudent approach and certain risk-management practices. Traditional exploration, production and stand-alone investments have become less viable options due to Chinese NOCs’ lack of experience in dealing with complex geological assets, oil fields with complex chemistry and, at times, complexity emerging from energy geopolitics. These restrictions have opened the door for various multi-level cooperation platforms. The recent partnership model pursued by Chinese NOCs involve the forming of joint ventures (JV) with super majors and local NOCs to jointly develop projects and, in some cases, even form Chinese NOC consortiums to avoid head-to-head competition and allow for better competition in the international market. Chinese firms have invested in an estimated 140 O&G projects overseas, over one-third of which took place in the last five years. More than 50% of these projects have been in the form of JVs with oil majors or other NOCs. For example, China’s CNPC and India’s NOC, the Oil and Natural Gas Corporation (ONGC), recently collaborated to develop the Greater Nile Oil project in South Sudan. In another project, CNPC and Sinopec jointly invested USD 2.5 billion to acquire the private Peruvian O&G driller, Petro-Tech Peruana. Secondly, market conditions have encouraged a major adjustment in their approach to ownership of such assets. Chinese NOCs have increasingly sought minority, passive stakes investments in strategic ‘learning’ assets, which contrasts with their historical practice of paying above market prices to own controlling equity stakes in projects to lock-in supply. Lastly, Chinese NOCs have expanded from their traditional focus on upstream assets and begun to develop pipelines and refineries. NOCs now view strategic investments in mid-downstream as a mechanism to unlock access to key upstream resources, particularly in risky and politically unstable countries.This strategy is also driven by China’s need to diversify the supply routes of its petroleum reserves. Chinese NOCs are actively investing in transnational pipelines to diversify supply routes and reduce their dependence on the Strait of Malacca; this will alter the dynamics of regional energy supply patterns and future investments. Fomenting China’s own shale gas revolution Atthesametime,Chinahopestodevelopitsownuntappeddomestic source of energy, i.e. shale gas. According to the International Energy Agency, China holds reserves of at least 26 trillion cubic meters of recoverable shale gas, more than any other country in the world. Beijing has previously announced that it aims to produce 6.5 billion cubic meters (cm) of shale gas annually by 2015 and an ambitious 100 billion cm by 2020. However, China only achieved half of its announced 2010 target of 8 billion cm due to limited exploration success, drilling a fewer than expected number of wells and having a narrow focus on only the most attractive shale gas locations.While progress has been slow thus far, there are signs that a spike in shale gas production is on the horizon. Stage of Investment for Identified Chinese O&G Investments (%, 1993-2013) Source: Various; The Beijing Axis Analysis Value Chain Focus of Chinese O&G Going Overseas (%,1993-2013) Source: Various; The Beijing Axis Analysis 84% 11% 5% Upstream Mid-downstream Integrated Total Number of Projects Analysed: 121 Investmentinmid- downstreamassetshas beenusedprimarilyto unlockaccessto upstreamassetsinrisky countries 9% 19% 23% 49% Early Stage Post-feasibility Exploration Operational Most early-stage investments have been focused on unconventional O&G assets Total Number of Projects Analysed: 121
  14. 14. 14 І The Beijing Axis Chinese NOCs have invested billions of dollars in North America to acquire the hydraulic fracturing technologies that are driving the unconventional revolution. NOCs have established partnerships through JVs and acquisitions to gain access to these technologies. For example, CNPC recently announced a new joint venture with Encana, Canada’s largest producer of natural gas, to develop some of their holdings in Canada’s Montney Shale Formation and Horn River Shale Formation. Leading the pack on the domestic front is Sinopec, which stated in March 2014 that its first commercial shale-gas field, in the Fuling district of Chongqing, will produce around 1.8 billion cm of gas in 2014, 5 billion cm in 2015 and 10 billion cm by 2017 – all ahead of schedule. Overall, far fewer than 100 shale-gas wells have been drilled in China, compared with around 40,000 wells in the US, underscoring the long road ahead before China realises its own shale gas revolution. The development of China’s shale-gas industry has moved forward over the past few years, but far more remains to be done than has been accomplished if the nation’s ambitious production targets are to be met. The country must build-up its still nascent, countrywide feeder lines and pipeline network. Moreover, complex geology, water resource constraints near major shale fields and local exploration and drilling companies’ lack of adequate capabilities remain major hurdles. Whereas the development of PetroChina’s first shale gas exploration project in the Sichuan basin took 11 months, a similar-sized project in North America usually takes only two to three weeks. China’s recent decisions to boost private-sector participation and implement reforms are expected to help the shale-gas industry, although a lot more needs to be done. NOCs will need to open the upstream and downstream to private capital in order to expedite the timeline for shale production. Implications for global peers, EPCMs and oilfield service providers The implications of China’s growing role in the global O&G market are profound. The synergies drawn from complementary needs (i.e. strategic capital, equipment from China and technological skills to venture into new markets and optimise recovery in mature fields back home) has opened up opportunities for further cooperation between international oil companies (IOCs) and Chinese companies to learn from, partner with and complement each other across core competencies. Additionally, China recently opened its domestic resource market to some of the world’s major oil and gas producers. Forexample,RoyalDutchShellformedashalegasJVwithPetroChina to participate in a 15-well drilling program; ConocoPhillips signed a joint study agreement with Sinopec to explore, develop and produce shale gas at the Qijiang block in the Sichuan Basin;Total has firm plans to commence drilling this year for shale gas with Sinopec in Anhui province; and Chevron is exploring shale gas deposits in Qiannan Basin with an unidentified Chinese partner. At the same time, cooperation with Chinese NOCs is spreading across the value chain. For instance, Saudi Arabia’s state-owned Aramco formed a joint venture with PetroChina for the construction of a refinery capable of producing 200,000 b/d in the south-western Chinese province of Yunnan while China’s Sinopec took a 37.5% stake in Saudi Arabia’s USD 10 billion Red Sea Refining Company. Moreover, Chinese NOCs often tend to seek EPCM services from foreign players for their overseas projects. For example, in 2009, WorleyParsons was awarded the conceptual design, initial FEED contract and later integrated project management contract for the Rumaila oil field in Southern Iraq, the world’s second-largest oil field and jointly owned by BP, CNPC and Iraq’s State Owned Marketing Organization (SOMO). However, Chinese investors prefer foreign EPCMs to use cost-effective engineering capabilities available through their high-value engineering (HVE) centres in China/Asia, as well as procurement services out of China, in overseas projects in order to sustain a favourable cost profile. Most foreign EPCMs have only started to develop such capabilities, indicating that only a handful of them are likely to receive contracts from Chinese NOCs for overseas projects. Furthermore, the Chinese market has been historically closed off to western service companies for the most part. Service activity is done primarily by the service entities of Chinese oil companies, but shale and deep-water projects demand the experience of traditional western services companies as many Chinese oilfield service providers lack the necessary capabilities. Foreign oilfield service providers, such as Schlumberger, Halliburton and Baker Hughes, have already announced cooperation plans with their Chinese counterparts, such as Anton, and Honghua. These collaborative efforts will allow Chinese companies to gain access to high-end technology and experience in integrated project management. Looking ahead Today, investments by China’s big three oil majors remain small in comparisontothoseofIOCs.Upstreamendeavours,suchassecuring a diversified energy supply, will remain high on the agenda for these companies in the next decade. CNPC announced that it would seek to derive 40% of its crude oil from overseas by 2015 and 60% by 2020, which represents rapid growth from its current ratio of 28%.To achieve this goal, the firm plans to invest more than USD 60 billion in global oil and gas assets by 2020. At the same time, a number of private oil & gas companies in China have been quietly carrying out overseas asset acquisitions as well. For example, Zhenghe Group, a company based in Shandong province, acquired a Pre-Capsin basin block in Kazakhstan late last year for USD 526 million. China’s funding capacity and consumption appetite paired with IOCs’technical know-how and project management skills, especially for unconventional sources, presents the greatest potential for a valuable complementary relationship. Relationships and collaborations with Chinese NOCs will become even more crucial, complex, challenging and largely unpredictable for IOCs. The determinant then should not be whether or not to embrace shared resource ownership with Chinese NOCs, but how best to pursue an integrated strategy that captures the opportunity of China’s integrated position as a global consumer, importer, source of capital and supplier of equipment. Ankit Khaitan, Manager
  15. 15. Macroeconomic Monitor: Balancing Reform with Growth As forecasters around the world scour China’s latest statistics for clues regarding the direction of China’s economic performance in 2014, China’s policymakers seek to steer the world’s second- largest economy on the road to reform and wean the economy off its decades-long reliance on ofteninefficientstate-driveninvestment.Inasimilarmannerinwhichasuccessfulbusinessregularly tweaks its business plan to stay ahead of the competition, China already has its master plan for change in place and the focus is now on execution. ByDanielGalvez 2014. Industrial production, retail spending and the housing market have all shown signs of weakness in the first quarter of 2014. All this translates into more volatile Chinese demand for a wide range of commodities. Moreover, China’s first corporate bond default in March sent a clear signal that the era of cheap credit is coming to a close. However, ahead of the release of first quarter GDP figures, China’s State Council did unveil a mini-stimulus package including additional spending on railways, housing for low-income households and tax relief for small businesses. Macroeconomy Anticipating a hairpin turn around the corner, President Xi Jinping and company have gently applied the brakes on the infrastructure-building boom to move the economy into a more consumer-oriented growth model. However, to depict just how hard this transition will be for China, capital formation actually accounted for 54% of China’s economic growth in 2013, exceeding consumption’s 50% contribution rate. Net exports detracted 4.4% from overall growth, sustaining a trend which began in 2009. Growth has marched steadily downward over the past two years as Beijing clamped down on a spending boom which has pushed local government debt to now highly-publicised dangerous levels. Investment in fixed assets, which has been losing steam over much of the past year, will continue to decline in line with the government’s 17.5% growth target for Contribution to China’s GDP Growth (%, 2003-2013) Source: China National Bureau of Statistics; The Beijing Axis Analysis 140 120 100 80 60 40 20 0 -20 -40 03 04 05 06 07 08 09 10 11 12 13 Consumption overtakes gross capital formation as largest contributor Effect from stimulus package Net exports become a drag on growth Source: China National Bureau of Statistics; The Beijing Axis Analysis Source: China National Bureau of Statistics; The Beijing Axis Analysis Y-o-Y Growth of China’s Monthly Retail Sales (%, 2011-Feb 2014) 25% 20% 15% 10% 5% YTD Growth of China’s MonthlyFixedAsset Investments (%, 2011-Feb 2014) Fixed asset investment growth target for 2014: 17.5% Retail sales growth target for 2014: 14.5% J-F11 J-F11J-F12 J-F12J-F13 J-F13J-F14 J-F14 30% 25% 20% 15% 10% 5% 0% T oday, the world is focusing on the implications of slower growth in China. Companies around the globe have been sluggish to adjust to China’s decline in economic growth and are scrambling to cope with constant changes in the global economic environment. Over the past decade, China poured money into building new factories, highways and apartment buildings, which propelled double-digit growth at home while giving commodity exporters favourable investment returns. Now the story is changing as China has targeted a modest growth rate of‘around’7.5% for 2014, with many analysts interpreting the word ‘around’ as giving the government leeway if China does not meet its intended target by a few percentage points. Source: China National Bureau of Statistics; The Beijing Axis Analysis China’s Quarterly Y-o-Y GDP Growth Rate (%, 2009-Q1 2014F) 2009 2010 2011 2012 2013 2014 6% 8% 10% 12% 4% 2% 0% Q1 Q1 Q1 Q1 Q1 Q1F 5-year(2009-2013) average:8.7% Q4 2012 rebound 2013 y-o-y GDP: 7.7% 2012 y-o-y GDP: 7.8% 16 І The Beijing Axis
  16. 16. Reform is real and here to stay While three decades of breakneck economic growth has lifted hundreds of millions of Chinese out of poverty, it has Competitive forces take hold China’s total annual trade in 2013 reached over USD 4 trillion for the first time ever, overtaking the US to become the world’s largest trader. While first quarter figures are always difficult to interpret due to distortions caused by China’s weeklong Lunar New Year holiday, the latest economic indicators suggest that China is experiencing growing pains as it weans itself off of investment in order to attain more balanced long-term growth. Tightened pollution regulations have made it harder for steel mills to use China’s low-grade iron ore reserves and for power plants to burn China’s low-quality coal. With the increasing focus on the environment and high costs in some industries, China is importing more of the key commodities they need. also inflicted grave damage on the environment; China is now changing its strategy and aiming towards higher-quality development. Although the rate of economic growth slowed in 2013, business is still booming in China, and the new government is taking various measures to ensure that this continues. Thegovernmentannounceditsblueprintforchange following the Third Plenum in November 2013, which promised sweeping changes to the economy and the nation’s social fabric – leading many to label it as China’s most ambitious reform plan in 30 years. Some of the hardest reforms, however, will require the government to break ranks with some of its traditional political allies, such as large SOEs. Tackling pollution remains high on the agenda for the new administration. In 2013, China’s Ministry of Environmental Protection vetoed as many as 32 projects with a total investment of USD 19.5 billion and is feverishly working to improve its environmental assessment capabilities and strengthen its ability to monitor and punish polluters. Some other important economic issues that will be closely watched in 2014 include: • Banks following through on soldier’s orders to cut off financing to sectors plagued by excess capacity such as steel and cement • Management of shadow banking activities and local government debt levels before they can inflict widespread damage to the economy • Continued rollout of Shanghai Free Trade Zone policies aimed at attracting a new wave of FDI • Enforcement of property sector controls and the management of subsequent fallout if prices do eventually fall from their astronomical levels • Accelerated liberalisation of China’s capital and foreign exchange markets, including the recent widening of the Chinese Yuan’s daily trading band, aimed at turning the Yuan into a major reserve currency • The rise of private and online banking channels aimed at raising the overall competitiveness of China’s financial sector The road ahead While the emerging labour shortage and subsequent increase in wages are cutting into profit margins, investment returns and export competitiveness, it has increased household income. Higher wages improve income distribution as low-income households rely on wages and high-income households rely more on investment returns. Consumption’s share of GDP will rise as household income grows faster than national income. But this is only the beginning. Completion of this transition depends critically on Beijing’s implementation of the reforms announced at the Third Plenum. If only a portion of the proposed Third Plenum measures are implemented, China will be well on its way towards becoming the world’s largest economy and boasting a thriving consumer market. Based on China’s success in navigating its economy through new territory, China’s performance for the whole of 2014 should be a cause for optimism. Daniel Galvez Consultant; Editor: The China Analyst Macroeconomy While seeking to avoid overcapacity, Beijing will continue to encourage investment in innovative industries and infrastructure. Also, private capital is set to play a larger role. In a nod to Beijing’s latest efforts to reform SOEs and encourage a mixed-ownership economy, Sinopec, China’s largest oil-refining company, announced plans in February to open up its domestic marketing and distribution operations to both social and private capital. Source: China National Bureau of Statis- tics; The Beijing Axis Analysis Source: China National Bureau of Statis- tics; The Beijing Axis Analysis China’s Monthly Consumer Price Inflation (%, 2011-Feb 2014) 8% 6% 4% 2% 0% Jan11 Jan12 Jan13 Jan14 China’s Official Purchasing Managers’Index (2011-Mar 2014) 60 55 PMI 50 45 40 Jan11 Jan12 Jan13 Jan14 Room for mild stimulus Inflation target for 2014: 3.5% 18 straight months of expansion Source: China National Bureau of Statistics; The Beijing Axis Analysis China’s Monthly Exports and Imports (USD bn, %, 2011- Feb 2014) Jan11 Jan12 Jan13 Jan14 40% 60% 20% 0% -20% 240 220 200 180 160 140 120 100 80 60 40 20 0 Exports Imports ExportGrowth(rhs) ImportGrowth(rhs) Import growth outpacing export growth 17 І The Beijing Axis
  17. 17. Beijing Axis Procurement Guidelines for Installation and Commissioning In large procurement projects, installation and commissioning is a key process that involves various partners—designers, project managers, consultants, subcontractors, and suppliers—across many countries. Coordination and communication are of vital importance during this phase. In these complex, multinational projects, The Beijing Axis (TBA) provides key project management oversight, which is comprised of the following activities: 1. Technical clarification. Though our team attempts to resolve all technical questions before the contract is signed, questions may still arise. TBA’s team of engineers will assist installation partners in deciphering documents received from the suppliers. We provide an effective communications platform to ensure that all parties are kept abreast of each other’s status. 2. Project planning. Prior to shipping, TBA will assist with project planning communications to ensure a prompt delivery timeline. Though several factors may impact the project’s timeline, TBA will do all within its power to minimise any delay. 3. Logistics. With over ten years of procurement experience in China, TBA staff are familiar with the requirements for handling, shipping and warehousing goods. Further,TBA’s recent partnership with Imperial Logistics expands the efficiency of TBA’s logistical management of goods. 4. Quality control. During the installation process,TBA will manage athird-partysupervisorysuppliertooverseeprogressontheground. Because minor quality concerns may impact the installation and commissioning process,TBA will liaise with the supplier to minimise delays and recoup cost claims. 5.Meetingcoordination.Furthertoitsroleasthekeycommunications interface, TBA will remain actively involved in day-to-day activities to mediate misunderstandings before they arise. 6. Documentation management. TBA can assume a hands-on documentation management approach during the installation and commissioning phase to ensure that all parties are kept up to date. 7. Translation. From written documentation to on-site interpretation, TBA will leverage its engineers and other technical staff to provide understanding on the technical documents of large procurement projects. TBA also accommodates the admin requirements of the installation and commissioning process by ensuring the timely preparation of invitation letters and housing arrangements. Our team also frequently manages an onsite office and arranges on-site accommodations depending on our client’s needs. By The Beijing Axis Procurement HowtoProcurefromChina#13–InstallationandCommissioning The Beijing Axis Procurement Services Flow Chart covers every stage in the procurement process, from the first enquiry to the post-transaction services. In this edition, we focus on the thirteenth stage of the procurement process: Installation and Commissioning. The Beijing Axis Procurement and Service Delivery Flow Chart Strategic Procurement Facilitation Supplier Analysis Understanding product specifications RFQ, RFP and RFT process Contract administration Site visit and supplier audit Commercial and technical evaluation Logistics coordination After sales service support Negotiation Contracting Supplier identification and universe list compilation Quality management (QA/QC) and expediting Installation and commissioning Supplier evaluation and long list RFI, supplier pre-qualification and shortlist Supplier Engagement Supplier Process Management SupplierProcessManagementAnalysis 1 5 6 7 8 9 2 3 4 10 11 12 13 14 18 І The Beijing Axis
  18. 18. Notable Chinese FDI Deals in Q4 2013 – Q1 2014 • In March 2014, SBI Group, a Japanese financial services firm and formerdepartmentofSoftbank,acquiredaShanghai-basedonline education firm,TutorGroup, who is backed by Alibaba Group • In March 2014, Unilever, an Anglo-Dutch consumer goods firm, acquiredacontrollingshareinQinyuan,aChinesewaterpurification company. Without stating the size of the deal, Unilever stated that this is the largest acquisition it has made in recent years • In February 2014, Danone, a French food producer and the world’s largest yoghurt producer, more than doubled its stake in Mengniu, China’s largest dairy producer, from 4% to 9.9% for USD 663 mn. Danone has taken an aggressive approach in China, having acquireda51%stakeinWahaha,China’slargestbeverageproducer in 1996 • In November 2013, German automotive corporation, Daimler AG, acquired a 12% stake in BAIC Motor, one of the top Chinese automotive manufacturers, for approximately USD 84 mn • In September 2013, Indofood, an Indonesian food processor and subsidiary of Hong Kong-based holding company, First Pacific, acquired a 3.9% stake of China Minzhong Food for approximately USD 23 mn Chinese Outbound Foreign Direct Investment Summary of China’s OFDI • In 2013, China’s non-financial OFDI amounted to USD 90 bn, an increase of 17% y-o-y • In 2013,The Beijing Axis tracked 117 overseas investment activities by Chinese companies, including on-going transactions and the conclusion of previously announced deals. Among these ChinaCapital: Inbound/Outbound FDI&Overseas ResourceInvestment In 2013, China’s total FDI amounted to USD 118 bn, and China’s OFDI reached USD 90.2 bn, representing increases of 5.6% and 16.2% year-on-year, respectively. FDI continued to be largely sourced from Asian nations, while China’s OFDI continued to spread across the globe. MOFCOM data indicates that future levels of China’s OFDI are likely to exceed the current level of FDI. By Beijing Axis Capital Foreign Direct Investment into China Summary • In 2013, FDI into China amounted to USD 118 bn, an increase of 5.6% y-o-y. Calculated on a monthly-basis, FDI into China fell sharply in the second half of 2013 but bounced back to 12 bn in December 2013 • According to the Ministry of Commerce (MOFCOM), FDI into the services sector reached USD 61 bn in 2013, representing over half of China’s total FDI for the first time • Though eastern China received the majority of FDI with 78%, central and western China received increasingly shares in 2013 • In 2013, 86% of FDI into China originated from other parts of Asia. Traditionally the hub for investment into China, Hong Kong is still the largest source of capital for China, contributing USD 78 bn or 67% of total inward FDI, while Japan and Singapore were second and third with USD 7 bn (6%) each. The US, the largest non-Asian source of FDI into China, provided USD 3 bn (3%) in 2013 • In 2013, the number of newly-established foreign-invested enterprises reached 22,773 Source: MOFCOM; The Beijing Axis Analysis 140 120 100 80 60 40 20 1 2005 2006 2007 2008 2009 2010 2011 2012 2013 Annual Inbound FDI in China (USD bn, 2005-2013) Source: MOFCOM; The Beijing Axis Analysis FDI in China by Country (%, 2013) Hong Kong 66%Japan 6% Singapore 6% Taiwan 4% Other 7% France 1% UK1% Holland1% Germany2% S.Korea 3% US3% Source: MOFCOM; The Beijing Axis Analysis 0 J A S O N J F M A M J J A S O N DD 14 12 10 8 2 4 6 16 -20% 20% 15% 10% 5% 0% -15% -10% -5% 25% Monthly Inbound FDI in China and y-o-y Growth Rate (USD bn, H2 2012-2013) FDI FDI Growth (rhs) 19 І The Beijing Axis
  19. 19. transactions, 41 were resource-related investments and 76 were non-resource investments • MOFCOM reported rapidly increasing flows of OFDI from China into the US (USD 4.2 bn), Russia (USD 4.1 bn) and Australia (USD 3.9 bn) in 2013 • Private Chinese companies accounted for 37% of the total non-financial OFDI in 2013, while state-owned enterprises accountedfor63%,demonstratingtheprimaryroleofstate-owned enterprises as Chinese overseas investors • An overwhelming 90% of Chinese OFDI falls into the following sectors: business services, mining, wholesale and retail, manufacturing, construction and transportation. Construction and culture, sports and entertainment present the fastest growth in investment, with increases of 129% and 102%, respectively; mining, wholesale and retail trade, manufacturing, and real estate also achieved rapid growth • Looking forward, Chinese OFDI in natural resources, such as agriculture, will continue to increase due to increasing domestic demand Notable Chinese OFDI Deals in Q4 2013 and Q1 2014 • COFCO,China’slargestfoodprocessorandgraintrader,announced ajointventurewithmainlandprivateequityfirm,HopuInvestment Management, in March 2014. The new venture will acquire a 51% ownership of Hong Kong-based agricultural commodities trading operation,NobleGroup.ThisannouncementcamedaysafterCofco announced a USD 250 mn acquisition of a 51% stake in Dutch grain trader, Nidera. These deals exemplify China’s rapid overseas expansion in the agricultural sector • In March 2014, Fosun, one of China’s largest privately-owned conglomerates, invested USD 1.26 bn to develop 3.5 sq. km of Greek coastline, which was previously home to Athen’s Hellenikon airport. This deal marks a“buy low”strategy at a time when many investors are avoiding the unsteady Greek economy • In February 2014, Wanxiang, China’s largest automotive group, acquired American electric automobile manufacturer, Fisker Automotive, for USD 149 mn • In January 2014, Lenovo purchased Motorola Mobility, the cell phone division, from Google for USD 2.9 bn. Google had purchased this division of Motorola in 2011 for USD 12.5 bn but has experienced challenges in making the division profitable • In December 2013, Henan Civil Aviation Development & Investment announced plans to buy a 35% share of Cargolux AirlinesInternationalforUSD231mn.ThisdealwillgiveHenanCivil Aviation Development and Investment veto power on decisions madebytheCargoluxexecutivecommitteeandsupervisoryboard. This deal also established a “dual-hub strategy”comprised of four weekly flights between Zhengzhou and Luxembourg • In December 2013, Belgian KBC Bank agreed to sell its subsidiary, the Antwerp Diamond Bank, to the Chinese Yinren Group for USD 270 mn • InDecember2013,HepalinkPharmaceuticalacquiredtheScientific Protein Laboratories (SPL) for USD 338 mn. SPL is an leading producer and supplier of active pharmaceutical ingredients, with over 40 years’experience in drug marketing in Europe and the US • In November 2013, the Sinopec Group purchased a 33% stake in the American Apache Corporation’s Egyptian oil & gas assets for USD 3.1 bn • In October 2013, Beijing-based Sinoma International Engineering purchased a 59% stake in German mining equipment firm, Hazemag & EPR Gmbh, from the Schmidt Kranz Group for USD 140 mn, which will help Sinoma expand its reach in mining equipment • In September 2013, Zhongjin Lingnan (Hong Kong) Mining China’s number three zinc producer, proposed purchasing the remaining 47% of Australia Perilya, which operates metal mines in Australia and the Dominican Republic Trends in China’s Overseas Resource Investment • During the Third Plenary Session in November 2013, Beijing announcedthatitwillcontinuetoexpandthescaleofChina’sOFDI. Large overseas resource investments will remain concentrated in the oil and gas sector and the mining industry • Reinforcing China’s growing role in Latin America, in November 2013, PetroChina purchased the Peruvian subsidiary of Brazilian PetrobrasforUSD2.6bn.ThePeruviansubsidiarywillhandovertwo oil and gas fields, which currently produce 800,000 metric tonnes of oil equivalent a year, and a 46% stake in recently discovered Lot 57, a gas field. This deal comes a month after CNPC and CNOOC each purchased 10% stakes in Brazil’s largest oilfield, Libra, which is estimated to hold between 8-12 bn barrels of recoverable oil for USD 700 mn • Though growth in China’s investment in the African mining sector hadstalledoverthepasttwoyearsduetodepressedmetalpricesand tight credit, Chinese representatives attending the Mining Indaba conference in Cape Town indicated that they would be seeking to make investments offering financial returns and raw materials. Recent deals, such as China National Nuclear Corporation’s USD 190 mn purchase of a 25% stake of the Australian-owned Langer Heinrich uranium mine in Namibia demonstrate interest. Further, a recent document from China’s National Development and Reform Commission stressed that China needed more imports of iron ore to balance steel prices • In September 2013, China significantly expanded its involvement with Central Asia and Russia by making large investments in securing energyresourcesfromRussiaandKazakhstan.PetroChinaandRussian state-owned oil giant, Gazprom, agreed on the basics for a deal that would send roughly 38 bn cm annually at a price of USD 10-11 at the Chinese border. The deal will require the construction of a pipeline, which is predicted to be finished in 2018, and the gas would benefit Chinesepolicymakersinterestedinreducingemissionsresultingfrom coal combustion. China also signed a USD 5 bn deal with Kazakh state-ownedKazMunaiGasforan8%stakeinitsmassiveKashaganoil projectintheCaspianSea 20 І The Beijing Axis China’s Annual Outbound Non-financial FDI and y-o-y Growth Rate (USD bn, 2005-2013) Source: MOFCOM; The Beijing Axis Analysis 100 80 60 40 20 0 100% 120% 140% 80% 60% 40% 20% 0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 Non-financial OFDI OFDI Growth (rhs) CAGR33%
  20. 20. 21 І The Beijing Axis Source: Various media; Company reports; The Beijing Axis Analysis 2014 Mar Noble Group’s agribusiness China (HK) ChinaOilsandFoodstuffs(COFCO) Agriculture USD 1.5 bn 51% Ongoing 2014 Mar Westside Corp Australia Landbridge Group Gas USD 160 mn 100% Ongoing 2014 Mar New Zealand Beijing Capital Group 800 mn 100% Ongoing 2014 Feb Nidera Netherlands ChinaOilsandFoodstuffs(COFCO) Agriculture USD 250 mn 51% Ongoing 2014 Feb ERG Resources US Goldleaf Jewelry Oil USD 665 mn 95% Ongoing 2014 Feb Anadarko Petroleum China subsidiary US Brightoil Group Oil USD 1.08 bn N/A Ongoing 2014 Jan Mundella Foods Australia Bright Food Food N/A n/a Ongoing 2014 Feb Nesko Metal Turkey Jiangxi Copper Copper USD 65 mn 50% Ongoing 2014 Jan Paladin Energy’s Langer Heinrich operation Namibia ChinaNationalNuclearCorporation Uranium USD 190 mn 25% Ongoing 2013 Dec Carabella Australia China Kingho Group Coal USD 60 mn N/A Ongoing 2013 Dec JV with Energy Corporation of America US China Shenhua Shale gas USD 90 mn N/A Ongoing 2013 Nov ExxonMobil’s West Qurna 1 oilfield Iraq PetroChina Oil N/A 25% Ongoing 2013 Nov Petrobras Energia Peru Peru CNPC Oil USD 2.6 bn 100% Concluded 2013 Oct Rosneft’s Taas Yuriakh unit Russia CNPC Oil N/A 49% Ongoing 2013 Oct ACV Solar Technology’s solar farm Romania Astronergy Clean energy N/A N/A Concluded 2013 Sep Tonkolili iron-ore project Sierra Leone Tewoo Group Iron-ore USD 990 mn 16.5% Concluded 2013 Sep NovusEnergy Canada Yanchang Petroleum Oil CAD 230 mn N/A Concluded 2013 Sep Glencore Xstrata copper project Peru China Minmetals Corporation Copper USD 5 bn N/A Pending 2013 Sep Petróleos de Venezuela Junin 10 Block Venezuela CNPC Oil USD 14 bn N/A Ongoing 2013 Aug Apache Corp Egypt Sinopec Oil & gas USD 3.1 bn  33% Concluded 2013 Aug Petrobras’s Block BC-10 Brazil Sinochem Group Oil USD 1.54 bn 35% Concluded 2013 Aug Inova Resources Australia Copper, gold AUD 160 mn 56% Concluded 2013 Jul Rio Tinto’s Northparkes mine Australia China Molybdenum Gold, copper USD 820 mn 80% Concluded 2013 Jun Novatek’s Yamal LNG project Russia CNPC Gas USD 810 mn 20% Concluded 2013 Jun Marathon’s Angola oilfields Angola Sinopec Oil USD 1.52 bn 10% Concluded 2013 May SPAusNet Australia State Grid Energy USD 810 mn 20% Concluded 2013 May BG Group’s Queensland Curtis LNG ProjectTrain 1 Australia CNOOC Oil & gas USD 1.93 bn 50%/25% Concluded 2013 May Stonewall Resources South Africa Gold USD 140 mn 100% Concluded 2013 May Smithfield Foods Inc. US ShuanghuiInternationalHoldings Food USD 4.72 bn N/A Concluded 2013 May Barra Energia do Brasil Petroleo e Gas Ltda Brazil CNPC Oil & gas USD 2 bn 100% Concluded 2013 Apr Joint PE fund with Russia Direct Investment Fund Russia China Investment Corporation Agriculture USD 100 mn N/A Concluded 2013 Apr Sky Energy Holdings Cambodia Sino Bioenergy Corp Agriculture USD 119 mn 100% Ongoing 2013 Apr Oilhub Korea Yeosu Co. South Korea China National Aviation Fuel Oil USD 130 mn 26% Concluded 2013 Apr Ecuador Copper Mine Ecuador Copper USD 2.04 bn N/A Concluded 2013 Apr Ashburton Project Australia Iron, gold USD 2 mn 65% Concluded 2013 Apr ConocoPhillips Kazakhstan CNPC Oil & gas USD 5.3 bn 8.4% Concluded 2013 Apr Elemental Minerals Limited RepublicofCongo Dingyi GP INV Potash AUD 5 mn 4.8% Concluded 2013 Apr Kalgoorlie Mining Australia Zijin Mining Gold N/A 100% Concluded 2013 Mar Sintez Russia State Grid Energy USD 1.14 bn N/A Concluded 2013 Mar Eni SpA’s offshore natural gas field Mozambique PetroChina Oil & gas USD 4.21 bn 20.0% Concluded 2013 Feb Kuantan Port Consortium Malaysia Port USD 650 mn 40% Concluded 2013 Feb ChesapeakeEnergyCorp.’soilandnaturalgasfield US Sinopec Oil & gas USD 1.02 bn 50% Concluded 2013 Feb ConocoPhillips’ explorationassetsinWesternAustralia Australia PetroChina Oil & gas N/A 20%/29% Concluded 2013 Feb Alumina Ltd. Australia Aluminium USD 468 mn 7.8%/5.2% Concluded 2013 Feb African Resources Zambian subsidiary Zambia Yinfu Gold Corp Gold USD 2 mn 65% Concluded 2013 Jan Alumina and Bauxite refinery project Guinea China Power Investment Aluminium USD 6 bn N/A Concluded 2013 Jan Solar Chile Chile SkySolar Clean energy USD 1.36 bn N/A Concluded 2013 Jan Pioneer Natural Resources US Sinochem Oil USD 1.7 bn 40% Concluded 2013 Jan Refineria del Pacifico Ecuador CNPC Oil & gas USD 1.2 bn 30% Concluded 2013 Jan Kichi-Chaarat Closed joint stock company Kyrgyzstan China CAMC Engineering Gold, copper USD 4.8 mn 16% Concluded 2013 Jan St Barbara Southern Cross operations Australia Hanking Holdings Gold USD 23.58 mn 100% Concluded Shanxi Donghui Coal Coking & Chemicals Group Shandong Qixing Iron Tower Company Limited China Railway Construction and China Nonferrous Shandong Energy and Shandong Lunan Guangxi Beibu Gulf International Port Group CITIC Resources Holdings Ltd. and CITIC Group 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 Selected Chinese Outbound Investment Activities In Natural Resources, January 2013 - March 2014 Transpacific Industries Group’s New Zealand waste management business Waste management Month Announced Target / New Company Acquirer/Investor(EnglishName) Commodities Value Stake StatusTarget country#
  21. 21. NorthAmerica China 18.1% 25.7% 26.8% 27.5% LatinAmerica andCaribbeanProduction, % of world total (2012) Consumption, % of world total (2012) Russia Africa AsiaPacific MiddleEast 32.8% 9.3% 16.3% 12.4% 12.4% 3.5% 17.6% 12.5% 8.5% 7.3% 5.3% 5.0% 11.0% 3.9% 6.4% 3.7% 4.8% 21.8% 11.4% 14.5% EuropeandEurasia 7.6% 17.1% 13.1% 20.1% 4.8% 11.4% 3.2% 4.3% Oil Gas 22 І The Beijing Axis 23 І The Beijing Axis Map Source: BP Statistical Review of World Energy; US Energy Information Administration; The Beijing Axis Analysis MappingChinaintheGlobalProductionandConsumptionofOilandGas The global oil and gas industry has long been closely intertwined with geopolitics. China accounted for one-third of the world’s oil consumption growth in 2013 and is projected to surpass the United States as the largest net oil importer in 2014. Domestic production of oil falls woefully short of consumption across most of Europe, Eurasia and China, resulting in heavy dependence on outside sources of oil. China has extended oil-for-loan deals with Russia and select countries in Africa and Latin America to secure favourable terms in future oil supplies. With declining energy consumption per capita at home, the US is eager to cash in on its shale gas revolution by increasing exports to gas-hungry Europe and Asia. To meet domestic demand for a cleaner burning fuel, China has sought to raise natural gas imports via pipeline and overseas shipment (liquefied natural gas), and is also feverishly working to foment its own shale gas revolution. By Beijing Axis Strategy
  22. 22. CNOOC: Expansion into Unconventional Expertise Background The China National Offshore Oil Corporation (CNOOC) Group is the third-largest Chinese state-owned oil and gas (O&G) enterprise after PetroChina and Sinopec. It mainly focuses on exploration and production (the“upstream”value chain) of oil and gas onshore and offshore resources as opposed to PetroChina and Sinopec, who have a more integrated value chain. CNOOC was the first of China’s three O&G majors to be created by the State Council, China’s main governing body, in 1982. It was granted the exclusive ability to leverage joint ventures with foreign companies to rapidly expand China’s offshore assets in the Bohai Bay, the Yellow Sea and the South China Sea, among other sites. As China’s oil consumption has grown by more than three times in the past two decades, China’s O&G companies have been acquiring overseas assets to provide China with greater energy security. This development has catapulted CNOOC Group, through its main listed subsidiary CNOOC Ltd., into the top twenty global O&G firms in terms of production. China does not only want to purchase O&G assets, it also wants to explore, extract and refine them. However, the majority of reserves being discovered today are composed of unconventional resources, which require advanced technology. Though China’s O&G companies are expanding their expertise and experience in this field, their capabilities remain lower than their international counterparts. Outbound acquisitions are enabling Chinese national oil companies (NOCs) to close that gap while, conversely, offering their partners the opportunity to tap China’s recoverable shale gas reserves, which are estimated to be the world’s largest. CNOOC global deals Since the 1990s, CNOOC has maintained a diversified approach to its overseas acquisitions – gaining majority shareholder status in some projects while serving a more passive, minority role in others. The firm continues to diversify its supply of upstream resources to reduce potential risks and vulnerabilities to its supply chain. In the first half of 2013, it earned roughly 25% of its profits overseas. The Beijing Axis has tracked 23 major overseas investments made by CNOOC in 17 countries over the past 12 years.The deals range in size from a USD 1 million purchase of an Indonesian Widori Oil Field to the USD 15.1 billion purchase of Canadian Nexen Energy, the largest Chinese outbound investment in history. As a Chinese state-owned enterprise (SOE), CNOOC initially faced challenges in the international market. Thus, CNOOC Ltd., the main subsidiary, was listed on the Hong Kong and New York Stock Exchanges in 2001.The newly created firm was required to adhere to theregulationsforpubliccompaniesandanswertoprivateinvestors, providing most foreign investors, regulators and governments an acceptable level of transparency and accountability. Therefore, CNOOC Group has subsequently undertaken the majority of its overseas acquisitions through CNOOC Ltd. As a result of CNOOC’s focus on upstream activities, the company has targeted partnerships through which it can attain exposure to international expertise related to exploring and extracting unconventional and geographically-complex energy sources such as deep-water, oil sands, and shale gas. Though China is not yet a world leader in liquefied natural gas (LNG), CNOOC, having facilitated over 70% of China’s LNG imports in 2012, has led the country’s expanding access to overseas gas extraction and transportation through direct investment and imports. Correspondingly,CNOOC’sengineering,procurementandconstruction (EPC) arm, China Offshore Oil Engineering Co. (COOEC), leads China in the construction of the capital-intensive LNG port facilities. Through the lens of two CNOOC overseas acquisitions, this article examines the trend of Chinese NOCs in their overseas acquisitions. Recent CNOOC deals in Africa and Canada China has fostered strong political relationships with Canada and many nations on the African continent for decades. These ties have facilitated the expansion of Chinese companies into those markets. Both hold important global sources of energy. For example, Canada has the world’s third-largest oil reserves and the world’s seventh- largest recoverable shale gas reserves. Fittingly, China represents 28% (USD ~28 billion) of the foreign investment into Canada’s O&G sector from 2007 to 2013, compared to the US’s 19% (USD ~19 billion). Similar in importance to CNOOC, the African continent was the source of roughly 10% of CNOOC’s O&G production in 2013, with Nigeria, Angola, Uganda, Sudan and South Sudan being production hotspots. CNOOC, however, has felt more resistance to its approaches in other countries, especially the US. CNOOC’s failed attempt to purchase Unocal for USD 18.5 billion in 2005 (compared to Chevron’s later- accepted offer of USD 17.1 billion) is a prime example of the US government blocking Chinese investment due to political considerations. Parallel to China’s growth in oil consumption, CNOOC has risen from a relatively unknown player in the oil and gas industry to one of the largest energy firms in the world. This article focuses on two of CNOOC’s overseas investments that exemplify both China’s attempt to diversify its energy sources and the benefits this development will bring to CNOOC and its international partners. By Tim Quijano 24 І The Beijing Axis
  23. 23. OML 130 China’s first investment in the Nigerian O&G industry took place in 2006 through CNOOC’s acquisition of a 45% equity stake in Oil Mining Licence 130 (OML 130) from South Atlantic Petroleum for USD 2.3 billion. With depths ranging from 1,100 m to 1,800 m, OML 130 spans a 2,590 sq. km plot of the Gulf of Guinea in the Niger River Delta. It is composed of four O&G fields (in order of viability) – Akpo, Egina, Egina South and Preowei – and a range of other exploration prospects. Akpo reached a production plateau of 175,000 b/d and 9 million cm of natural gas per day by early 2011. Egina is expected to come on-stream in 2017. CNOOC’s interest in the oil block is related to two facets of the project. First, OML 130 was CNOOC’s first venture into deepwater drilling, a key focus in China’s overseas investment agenda. Deals like this have allowed CNOOC to acquire key technology to explore and develop O&G deposits in the South China Sea. New technology also meant that COOEC, CNOOC’s EPC subsidiary, learned from and gained exposure to Samsung Heavy Industries, the leading deep- water engineering, procurement and construction (EPC) contractor for the Akpo oil field. Secondly, as CNOOC’s first project in the Niger Delta, a minority stake in OML 130 provided a unique opportunity to diversify the firm’s geographical risk and establish a foothold in Africa that could be leveraged for future projects. CNOOC successfully secured the bidding process for OML 130 partially due to its access to a USD 1.6 billion loan from China Exim Bank to develop Akpo. CNOOC also committed to rehabilitate a local refinery, construct a railway line and build a hydroelectric power station; however, these three projects fell through due to a regime change soon after the deal went through. As seen in the “Angola Model”, Chinese companies frequently contribute to improving the local infrastructure as part of an investment. Additionally, the inexpensive financing CNOOC received for this investment is an example of the unique benefit Chinese SOEs bring in their overseas expansions. Opti Canada Opti Canada, an Alberta-based oil sands developer with a 35% stake in the Long Lake Oil Sands Project in the Athabasca region, was seeking a strategic partner after a series of equipment failures and lower-than-expected production figures. The firm filed for bankruptcy protection in early July 2011 after suffering from a shortage of capital for several quarters. Shortly after their application was submitted, CNOOC Ltd. acquired Opti Canada for USD 2.1 billion. CNOOC was well matched for this project mainly because of its deep pockets and access to the Chinese market. However, from CNOOC’s perspective, this deal was only the stepping stone to its 2013 acquisition of Nexen, who owned the other 65% of the Long Lake Oil Sands Project, and other strategic assets around the globe. CNOOC management leveraged this project to expand its oil sands expertise and gain access to Nexen to inform them on their acquisition intention. Nexen, as of February 2013, became CNOOC’s wholly-owned subsidiary in a deal worth USD 15.1 billion. Increasing CNOOC Ltd.’s total oil reserves by over 12%, the Nexen acquisition dramatically expanded CNOOC’s expertise in deep-water drilling, shale gas, as well as conventional O&G. Furthermore, Nexen held strategic assets in the North Sea, offshoreWest Africa and in the Gulf of Mexico. Nexen, whose management team has remained largely the same following the deal, now manages around USD 8 billion of CNOOC’s assets in Central and North America. This strategy of purchasing a minority stake in a firm before making a majority or whole acquisition is not uncommon. Such strategies do, however, have their risks. So far, the Long Lake Oil Sands Project has only been able to reach half its production goals. Some analysts suggest that CNOOC’s inability to overcome rising costs and technical difficulties, and ramp up the project, has contributed to a decline in CNOOC Ltd.’s share price over the last few years. CNOOC continues to be optimistic and has further injected capital into the project. This year will be critical in determining whether the acquisition of an effectively bankrupt project for access to a larger target was a prudent strategy. Key takeaways CNOOC’s investments in OML 130 and Opti Canada demonstrate common themes followed by Chinese companies and provide insights on how international O&G stakeholders, from suppliers and EPCs to project partners, can benefit from them. Lack of expertise in unconventional energy resources. CNOOC’s expansion into unconventional O&G resources demonstrates the firm’s and China’s forward-looking business and energy security strategy. However, Chinese O&G companies’lack of experience in the necessary technologies has constrained its growth. Expect CNOOC to continue seeking partnerships with firms that have access to advancedtechnologiesthatitcanimplementinChina’sshalegasand deep-water reserves, as well as in markets that will provide CNOOC with a more diversified energy and geographic portfolio. Access to cost-saving measures. Chinese companies, especially those with close ties to government, have the ability to borrow at significantly lower rates than what is otherwise available to their international competitors. Furthermore, Chinese EPCs can also leverage, albeit to a decreasing degree, cost-saving avenues, such as Chinese raw materials and labour, to offer more competitive service and product offerings than international competitors. In this manner, the involvement of CNOOC and other Chinese firms can increase their and their partners’return on investment. Opportunities for international stakeholders. CNOOC seeks advanced international firms’expertise and technology in exploring and extracting unconventional O&G resources. CNOOC can offer its partners access to China’s underdeveloped domestic market that may become the world’s largest. In the same way that Nexen has taken responsibility of managing over several USD billion worth of CNOOC’s Central American assets, many stakeholders hold valuable experience operating in key markets without the same level of scrutiny or political interference faced by Chinese NOCs. Conclusion Chinese companies will continue to acquire overseas O&G assets as the country’s demand for a diversified range of energy resources and technologies continues to increase and domestic expertise remains limited. CNOOC and the other Chinese NOCs represent an evolving opportunity landscape to international O&G stakeholders, from foreign EPCMs, to oil service providers. These case studies present examples of a key Chinese company’s strategies and how international stakeholders could benefit from such a trend. Tim Quijano Associate Editor: The China Analyst 25 І The Beijing Axis
  24. 24. China-Africa Investment Trends • The cumulative stock of Chinese investment in Africa has grown rapidly from less than USD 9.3 bn in 2009 to USD 21.2 bn in 2012. At the same time, the number of Chinese companies investing in Africa exceeds 2,000, mainly targeting the finance, mining and manufacturing industries Regional Focus: CHINA-AFRICA Even with a cooling of the Chinese economy, the total value of China-Africa trade in 2013 reached USD 210.2 bn, an increase of 6.2% y-o-y – demonstrating the expanding relationship between the two regions. In this edition, we report the latest China-Africa trade data, review major China-Africa trade and investment deals and spotlight China’s relationship with the South African Development Community (SADC). China-Africa Briefing • In January 2014, Ethiopian President, MulatuTeshome, stated thatChineseinvestmentistransformingtheAfricancontinent. Analysts suggest that Africa has the opportunity to capture a large proportion of the manufacturing jobs China is expected to outsource as domestic production costs continue to rise • In December 2013, African Development Bank compliance and safety experts developed social and environmental guidelinesforinvestmentprojectswithChinesepolicymakers. Together, these partners proposed developing institutions to facilitate regular meetings and coordinate a reporting platform to demonstrate the value of socially responsible business practices and avoid adverse impacts of economic development • The 2013 Africa-China Commodities,Technology and Services Exposition took place in December in Addis Ababa, Ethiopia. This expo marked the first time a China-Africa trade expo was held in Africa, which demonstrates growing demand for Chinese business in Africa. More than 150 companies from across China participated in the event, including major Chinese firms such as Huawei, Sinosteel Corp and Chery Heavy Industry • At the 2013 African Investment Summit that took place in Hong Kong in November, China Exim Bank committed to investing USD 1 tn over the next 12 years in a series of transnational transportation projects including highways and airports in Angola, Mozambique and other countries on the African continent • In late November 2013, Chinese Vice Premier Liu Yandong led a three-day high-level Chinese delegation to Addis Ababa, Ethiopia, to discuss health, education and technology with the Ethiopian President, Prime Minister and Deputy Prime Minister China-Africa Trade Total Trade • Total value of trade between China and Africa reached USD 210.2 bn in 2013, an increase of 6.2% y-o-y • African exports to China continued to grow faster than imports from China; China’s trade deficit reached USD 24.6 bn in 2013 China Imports from Africa • Imports to China from Africa totaled USD 117.4 bn in 2013, a 3.7% increase y-o-y • Trade data for the first three quarters of 2013 reveals that the five leading African exporters to China were South Africa, Angola, Nigeria, Egypt and Algeria • Leading commodities China imported from Africa in 2013 were oil, platinum, copper and other minerals China Exports to Africa • China’s exports to Africa totaled USD 92.8 bn in 2013, an 8.8% increase y-o-y • Trade data for 2013 reveals that the five leading destinations for China’s exports to Africa were Ethiopia, South Africa, Angola, Nigeria and Tanzania • Leading commodities China exported to Africa in 2014 include clothing, toys, construction equipment and military equipment The China Analyst China-Africa Trade (USD bn, 2002-2013) Source: China Customs; UN Comtrade;The Beijing Axis Analysis Source: China Customs; UN Comtrade; The Beijing Axis Analysis China-Africa Trade, Ten Largest Partners (USD bn, 2012 vs. 2013) 140 120 100 80 60 40 20 0 2002 2003 2004 2005 2006 2007 2008 2009 2011 2012 2013 2010 China’s Imports from Africa China’s Exports to Africa 70 2012 2013 60 50 40 30 20 10 0 Angola LibyaEgypt Nigeria Algeria Ghana Congo DRC Sudan South Africa 26 І The Beijing Axis