Chinese Mining Firms in the Year of the Horse: a Trot, 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
Last 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 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 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 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.
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 which was invested by private firms. The figure for private firms likely 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 in their internationalisation efforts. These new players, despite being 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 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 beginning to consider brownfield projects as well. In Africa, for instance, the Fenxi Mining Group’s recent investment in a greenfield coal project in Kenya, Yinfu Gold’s acquisition of a Zambian copper mine and Dingyi GP’s potential investment in Congo’s brownfield potash project 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 demonstrated in China’s ‘Angola Mode,’ which finances infrastructure 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’s development policy and a key target for Chinese investment. 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 SOEs will continue to be driven by political considerations, especially strategic resource acquisition, in addition to profit. Chinese companies are learning from their failures. Many companies 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