Chinese Foreign Investment or Acquisition. May 2016

 

 

China Rising

In 1991 Mt, Pinatubo, Luzon, Philippines erupted with devastating  results, in addition to the appalling loss of life the eruption altered the Pacific balance of power and the course of history. The volcano destroyed two critical  American military bases, the Clark Air Force Base and the Subic Bay Naval Base, both enormous military arsenals.  America withdrew its assets to Alaska and Hawaii and immediately created a military vacuum. Within months of this withdrawal the Chinese Government promulgated a far reaching decree., “The Law on the Territorial Waters and their Contiguous Areas”. From this all else follows.

With the rise of China manifested by the Chinese Dream and the One Belt One Road aspiration contemporaneously with the Australian mining boom, it is interesting to dwell on the concepts of Foreign Investment versus Foreign Acquisition as they apply to Australian assets.

 

One belt one Road
One Belt One Road. Asian Century Overland and Maritime Trade Routes
(www.china.comfocus)

Germaine to this discussion are four factors relevant to Australian and Chinese commercial and strategic imperatives. (Professor Bath, Chinese and International Law, Sydney University)

  • Australia sees itself as a reliable supplier of minerals and agricultural products; China encourages the acquisition of natural resources to service national growth and its millions of citizens.
  • Australian companies invest for a commercial return; Chinese companies, some with links to Government agencies, are required to supply imports necessary for Chinese growth, profit for the overseas entities is less important.
  • Australia’s capitalist ethos requires returns to shareholders; China’s objective is to sustain growth over generations, profit is secondary. Three year political cycles and associated budgetary gymnastics are viewed with contempt.
  • The Australian government maintains a foreign investment oversight via the Foreign Investment Review Board (FIRB) on media, banking, airlines, airports and telecommunications.  In Australia, China is making significant acquisitions in ports, power companies as well as mining and agricultural projects  These are also subject to FIRB scrutiny with value or national security implications. China’s acquisition of Darwin port or south east Australian power companies appear to have other objectives than purely commercial.

Within informed society, Australia’s relationship with China is an important issue. For China, Australia is only a pawn in a grand expansionist strategy. Integral to the Chinese Dream  are the commercial imperatives of the One Belt One Road policy. This policy is to revive trade and commerce along the ancient Silk Road linking China to western Europe augmented by the maritime trading routes that linked East Asia, East Africa, the Arab Middle East and thence to Venice.

This initiative has been dubbed China’s ‘Marshall Plan’ as it will promote trading links with countries along the transport corridors. This initiative will tend to reduce the importance of the North West Passage as Arctic sea ice retreats. In this grand scheme, Australia appears to be relegated to a ‘colonial ‘ source of minerals and agricultural products specifically for Chinese consumption.

 

China Marshall Plan
The Chinese ‘Marshall Plan’. Chinese Trade along the Maritime Route. (www.csa.com)

It has been noted by Professor Hugh White, Strategic Studies Institute, Australian National University, that the acquisition of Darwin Port by the aptly named Landbridge company, with links to the Chinese government, may be a clue to Chinese ambition for Australia. The urban population of Shanghai is around twenty-two million; Australians must come to terms with the fact that, with a population around twenty-four million, a projection of national influence will be difficult.

 

Chinese Iron Ore Acquisition

Superficially, the foreign acquisition of iron ore mines in Western Australia appears to be a complex of large and small producers jostling for sales contracts; the reality is more sinister. The big picture reduces to a Chinese determination to break the monopoly held by Rio Tinto, BHP/Billiton and Vale de Rio Doce in Brazil. In 2013-14 Chinese steel mills imported 850 million tonnes of iron ore. Australian production was around 610 mt.

To force lower prices, Chinese companies acquired mines with only a modest production of five to fifteen million tonnes. These high cost operations tend to run close to break-even or a small loss. Falling iron ore prices thus means lower feedstock prices to the Chinese steel industry. For every $10 drop in iron ore prices the Chinese economy saves $8.5 billion.  The $70/tonne drop in iron ore prices since 2013 has saved the Chinese economy more than $40 billion. (The Conversation, Canberra. May, 2014)

The Chinese government is astute enough to realise that:

  • increasing supply in an inelastic market, mine revenue will fall but buyers will receive more for less money.
  • upstream investment from unprofitable mine production makes economic sense. This is another form of transfer pricing beloved by multi-national foreign investors.
  • new production onto an oversupplied market is warranted under a Chinese procurement policy, but would not be considered rational by investors not involved into a vertically integrated process.

At any time, production from mines can be halted and the plant mothballed or restarted by a Chinese controlled Australian work force. The concern for the Australian Government is the future of infrastructure, population stability and employment continuity if Chinese state funded entities are investing in new production to force down prices rather than develop a  profitable mining venture.

The economic politics of the West Australian iron ore industry, like a good strip tease, has been laid bare. The State Government will extend its Magnetite Financial Assistance Program for another year to two wealthy Chinese companies in an effort to preserve Australian mining jobs. The government will pay a $41 million subsidy to keep the 1000 strong work force  in employment. The Chinese companies, Citic (profit $7.3 billion) and Ansteel operate the Pilbara Sino Ore and Karara magnetite deposits. Gindalbie Metals Ltd is the minority Australian partner. It appears Chinese mineral acquisition policy has engineered the Australian political system to subsidise local mining operations that ensures low operating costs that maximises profits in China by ensuring low cost feed stock for Chinese steel mills. (The Australian, 13 May, 2016)

Despite the reliability of Western Australia iron ore industry, there are warnings on the horizon. The Chinese objective is to diversify away from Australia and to a lesser extent Brazil as pre-eminent suppliers of iron ore, there may be a myopic tendency to regard Western Australia as an unassailable source of iron ore. There are monster deposits awaiting exploitation in sunburnt or freezing country in Guinea, Liberia, Mongolia and Brazil. (Fortune, Connected Logistics, February, 2016)

Concerning Brazil, it is a stirring giant. By 2018, Vale de Rio Doce is slated to exceed the combined production of Rio Tinto and BHP/Billiton in Western Australia. Currently, China is contributing $5 billion to Vale for the construction of five high tonnage iron ore carriers. (Investing News, November 2015; SMH, January 2014)

 

New Iron Ore Carriers
New Iron Ore Carriers for Brazil. (abc.net.au Kathy Diss)

A conclusion that may be drawn from Chinese acquisition in the Australian iron ore industry, is that economic production in Australia is less important than the ability to source low cost feed stock for Chinese steel mills. This import policy will drive prices down.

In the frenetic fish bowl that small Australian mining entrepreneurs inhabit, the public are encouraged to support Initial Public Offerings (IPOs). Subsequent joint ventures with Chinese acquisitors will ultimately drive share prices into the bulldust to ensure low cost mine product. The Pilbara and Hammersley iron ore provinces have competitors overseas.

Chinese Lithium Acquisition

More than one million electric cars were anticipated to be in circulation by the end of 2015 with a planned 500,000 annual production by 2020. Lithium for car batteries are expected to grow by 10% a year. According to the United States Geological Survey (USGS), global reserves of lithium are in very tight supply,. The top four producers are:

TABLE.  Lithium Producers

CountryProduction (tonnes)Reserves & Resources (tonnes)Ore Type
Chile12,0007,500,000Brine
China5,0003,500,000Pegmatite
Australia13,0001,500,000Pegmatite
Argentina2,900850,000Brine

Despite low production costs in Chile and Argentina, China prefers to obtain lithium ore from Australia. Currently, China is the largest lithium consumer- around 50,000 tonnes at a market price of $6,600/t. The price is forecast to rise as demand outstrips supply. (Batteries, Storage and Fuel Cells,.J Hunt, 2015)

In Australia, lithium reserves and resources are mainly confined to Western Australia where they occur in spodumene (lithium aluminium silicate) rich pegmatites. Deposits currently of interest to Chinese industry are (Investing News, July 2015; WestAustralian, September 2015):

  • Greenbushes. Talison Resources and Chengdu Tianqi Group. This is the world’s largest high grade spodumene deposit running 61.5  mt at 2.8% lithium oxide.
  • Mt Marion. Reed Industrial Minerals and Jangxi Garfeng. Deposit 14.8 mt at 1.3% lithium oxide.
  • Mt Cattlin. Galaxy Resources, formerly with Jiensu Lithium Carbonate Plant, now with General Mining, Canada, planning to re-enter the Chinese market. Deposit 9.9 mt at 1.1% lithium oxide.

Very early in Japanese industrial development, the Japanese government decided to preserve its forests and import timber from overseas. With large reserves of lithium, it appears China has adopted the same policy as the Japanese and is seeking off shore deposits. It is significant that the largest hard rock lithium deposit in the world has slipped from Australian to Chinese control.

Foreign investment in the Australian mining industry is necessary., Taxation policy must minimise transfer pricing and market price manipulation.

Chinese Agricultural Production Acquisition

The Chinese imperative for acquisition  of Australian agricultural production is driven by a population estimate of 1.4 billion by 2050 which is coinciding with declining soil fertility and increasingly polluted water supplies. A UN report states that by 2050 food supply must increase by 50% and water supply by 30%. To meet this threat, the Chinese government has decreed that three billion dollars must be expended with celerity on overseas agricultural security, (Yahoo 7, June 2015) Target regions for agricultural acquisition and expansion are Africa, South America and Australia.

 

Farming Agreement
Another Agricultural Acquisition (agriculturalminister.gov.au)

The acquisition process in Australia has taken on a permanent drip feed character to include all sections of the food chain from crops, animal husbandry to processing plants. These products will not be sold on the domestic market but will be exported to China. The Financial Review (September, 2015) ran the comment that, during the previous two months, agricultural acquisitions had been running at $40 million per fortnight. In the past few years examples of some purchases are:

  • Cubbie Station. Shandong Ruyu. Cotton. $232 million.
  • Van Diemen’s Land. Herman Shao/Ming Hu. Dairy. $200 million.
  • Glenrock Station. Dashang Group. Cattle. $45 million.
  • Cattle Station search. Chongquing. Budget $100 million.
  • Cattle Station search. New Hope Group. Budget $500 million.

The above and below are a fraction of purchases across the agricultural industry that include:

  • Fifty dairy farms in Victoria acquired by ?COFCO Group involving 90,000 cows and 500 million litres of milk annually.
  • Sugar and sorghum development in Western Australia by Shanghai Zongfu. $700 million.
  •  There is a growing trend for wealthy Chinese to enter the wine industry- vineyards are being actively purchased. Australians will soon be come aware of new names  in the industry or on the labels, for example, Zhitai Wang, Kuifen Wang, Xin Jin, Yingda Investment Company and Xingfa Ma. The bottom line is -“the Chinese value land and wineries more than the Australians do”. (BBC News, October 2014)

There are two issues that discomfort the Australian people; first the apparent frequency of acquisitions and second, the opaque nature of the arrangements through the use of shelf companies, trust funds and extended settlements. (Daily Telegraph, February 2014) The FIRB is said to examine all foreign investment proposals exceeding $244 million, however, lower value investments do incur scrutiny. The comment ‘selling off the farm’ raises concern but an Australian Bureau of Statistics table (below) shows there is not yet cause for concern.

SectorAgricultural Land %Agricultural business %
Sheep, Cattle, Grain8799
Other Crop9199
Floriculture9597
Dairy Cattle9799
Fruit, Nuts9797
Deer, Other9799
Vegetables9897
Poultry9897
Grapes-96

TABLE  Australian Agricultural Land and Agricultural Business Ownership.

The acquisition of Australian agricultural assets will continue and an increasing number of Australian managers and labour will have to accept instructions from Chinese owners. It was mooted (ABC RN 9 May) that under the Free Trade Agreement with China, Chinese labour might be permitted to work on agricultural projects.

There could be a financial downside to increasing acquisition of agricultural assets by Chinese interests. Currently,  Australia sells 58% of its food production overseas; this represents 70% of the sector’s total value. Food exports for 2013-14 were valued at $40 billion. With increasing Chinese ownership, this export income will reduce and will tend to be exacerbated by transfer pricing and suppression of farm gate values by a technique similar to that employed in the iron ore trade. (Future Directions, September 2014)

At the end of May, the Bank of China with the Australian Chamber of Commerce hosted a conference principally on the dairy products industry. Over 600 Chinese delegates attended who are aware of the purchasing power of the anticipated three billion Middle Class in East Asia by 2030. (The World Today, ABC, 23 May) It would be naive to anticipate Chinese foreign investment, rather it will be foreign acquisition of Australian agricultural assets as already exemplified in Victoria and Tasmania. It makes commercial sense for foreign investors to acquire virtually a 100% equity and to create a vertically integrated export industry.  An extension of the Mercantilist theory!

The Future

Since the Colonial period, Australia has relied heavily on foreign investment and this will continue into the future. What appears to be changing, is the subtle move away from infrastructure investment to natural resource and agricultural product acquisition, which, if carried out to an extreme,will result in the hollowing out of a nation. Foreign investment should ideally include the construction of tollways, railways, ports and mass housing but this appears not to be happening despite the concept of the Public Private Partnership (PPP) being well established. The problem is that the States are short of money and, like the Federal Government, carry unsustainable debt; hence the sale of Darwin port by the Northern Territory government and the sale of power assets in South Australia, Victoria and New South Wales to Chinese interests. The NSW Trans Grid sale of ‘poles and wires’ to China’s State Grid has recently been approved by FIRB, consideration $9 billion. The proceeds will go towards the rebuilding of sports stadiums. Back to the Roman coliseum!! (Daily Telegraph, November 2015)

A trend has been established and, if continued, there, will be significant redistribution of Australian assets. The President of the National Farmers Federation recently pithily remarked  “foreign investors have spotted an opportunity domestic investors have shunned”. Of deeper impact is Australia’s destiny in the Chinese Dream.