By All Means Necessary (10 page)

Indeed, Western oil companies have long employed (and continue to use) a similar scheme, known as a “cash waterfall, ” in some of their overseas investments. The ultimately ill-fated joint Venezuela-ExxonMobil Cerro Negro oil project is a good example.
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In 1998, the pair financed the project in part through the sale of $600 billion worth of bonds. The strict terms of the bonds required that proceeds from oil sold by the project be deposited into an account at the Bank of New York. Those funds would be used first to pay project costs, then to pay back bondholders, and only after that to pay the project developers, including the Venezuelan national oil company PdVSA—a sequence of payments known as a cash waterfall. The Venezuelan government could still decide to nationalize the project—indeed, it eventually did—but in the interim, investors gained an extra layer of security from the cash waterfall arrangement.

The Chinese loan-for-oil arrangements share important similarities with the cash waterfall approach, but instead of using an American bank, they use a Chinese one. This is hardly a surprising choice for Chinese authorities seeking greater control over their financial dealings with foreign countries. Making it work, though, requires having Chinese companies buy the oil. (Other companies wouldn't necessarily agree to make their payments to a Chinese bank.) Ultimately, then, many requirements for mandatory oil sales to China are likely driven as much by the need to have a consumer willing to make payments to the China Development Bank (and not a Western bank) as by a Chinese desire to “secure” more oil.

Understanding Chinese overseas resource investment also requires grasping the sheer diversity of approaches applied to natural resources. In areas ranging from oil and gas to water and land, China's overseas investment strategy reveals a fractured approach. This approach also shapes the consequences of China's foreign investment on the ground.

Chinese overseas oil production is dominated by three companies (and their subsidiaries): CNPC, China National Offshore Oil Corporation (CNOOC), and Sinopec. Smaller investments have
been led by Sinochem, Zhenhua Oil (a subsidiary of the massive manufacturing, defense, and construction company Norinco), and CITIC Energy, a subsidiary of the financial giant CITIC. These enterprises are supplemented by services companies that do not take equity stakes in overseas fields but often drill projects owned by Chinese and other companies.

CNPC is the most prominent player overseas. In 2011, it reported production of roughly 2 million barrels of oil a day, with more than 800, 000 barrels of that its own equity production from projects overseas in which it had a stake.
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(Global oil production is roughly 85 million barrels a day. “Equity” production refers to the output in which the oil company has an ownership stake, or the functional equivalent, allowing it to share in higher profits when oil prices rise; companies can also be involved in oil production as service providers, in which they charge a fee for their services but don't share in the upside potential or downside risks in the same way owners of the oil do.) Its natural gas output, meanwhile, totaled over 8 billion cubic feet (bcf) a day, out of which 1.2 bcf per day was its own overseas equity output. (World natural gas production is about 350 bcf a day.) This was still a fraction of what ExxonMobil, the largest private oil company, produced that year, when its equity share in its operations yielded 2.3 million barrels a day of oil and 13.2 bcf a day of natural gas.
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CNOOC and Sinopec trailed CNPC in 2011: Sinopec reported 460, 000 daily barrels of overseas equity oil and did not specify any overseas natural gas production.
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CNOOC was third with roughly 85, 000 daily barrels of overseas equity oil and 0.35 bcf of equity natural gas production per day.
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Chinese oil investment is widely distributed around the world. As of 2010, Chinese companies controlled a larger share of Kazakh oil production than they did of any other country; they accounted for 23 percent of Kazakh output.
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(China was involved in various forms in a larger fraction of Iraqi production, but it shares its stakes with others and did not own them, instead providing extraction services to the owners.) Chinese participation exceeded 10 percent in Sudan, Venezuela, and Angola. Total overseas equity production was equivalent to 36 percent of Chinese oil imports that year, though much
of the oil was not shipped back home and instead sold on world markets.

As Chinese companies expand their investments, they have tended to focus on projects with relatively little technical risk, typically buying into well-established resources where successful exploration and production is likely. This is not unusual for oil companies the size of CNOOC, CNPC, and Sinopec; their international peers, such as ExxonMobil and Shell, typically leave high-risk exploration to smaller independent companies and enter when large-scale development is all but assured.

Chinese companies are, however, willing to take large political and security risks, particularly where Western companies will not. Take the case of Sudan: though often assumed in the West to be a new frontier for oil exploration, the real risks in Sudan have long been political, not geological. Sudanese oil was already well understood decades ago as a result of extensive exploration by Western companies, which left because of unstable conditions and human rights abuses that were untenable and a source of fierce international criticism. To be certain, there are exceptions in which Chinese companies drill a handful of wells with highly uncertain prospects. Sinopec's independent exploratory drilling in Gabon, for example, was risky enough that the company stopped in 2008 without any success, while exploration in Kenya was similarly unsuccessful. In both cases, though, observers speculate that the Chinese companies drilled more as a favor to host governments than as a serious attempt to develop oil.
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Chinese companies also pursue international oil projects to acquire technology and managerial skills. They do this both to apply those skills in other international projects and to use them to boost their domestic production. This helps explain, in part, interest in U.S. shale oil and gas developments that have little prospect of generating exports to Chinese markets, even in a future crisis: the Chinese companies involved are interested in learning how to develop similar properties back home. (It also explains why the companies are fine with a minority stake; such stakes need not limit their ability to learn how to develop the resource.) Similar patterns can be seen in Chinese efforts to tap dense oil deposits (in Canada and Venezuela)
and offshore oil deposits (particularly in Africa). Indeed, technology motives can be found in surprising places. One would not think of Angola, for example, as a target for improving oil production technology. But CNPC activities there are pursued largely in partnership with BP, which has provided important opportunities for learning skills involved in producing oil in challenging offshore environments.

China is not as influential a player in natural gas development as one might expect at first blush, particularly given its highly active efforts on oil. This appears to be due in part to technological limits. But it may also reflect weaker dependence on natural gas imports. Chinese companies have taken important roles in natural gas development in neighboring countries from which the gas can be shipped to China by pipeline. But projects further afield need to be integrated with systems for liquefying and transporting the fuel. The natural gas projects that seek to produce LNG are hugely complex and expensive and take many years to develop. They also require sophisticated efforts to market the produced gas (given the absence of a large spot market for LNG that allows buyers and sellers to connect without underlying long-term contracts). Host governments typically focus on bringing in those companies that are most capable of delivering, and Chinese companies aren't seen as being up to the task.

Moreover, in many of the world's cutting-edge natural gas prospects (such as areas off the coast of Australia or East Africa), technical risks either remain or have until recently been high. This environment appears to deter Chinese companies from participation as operators, though that may be changing. The companies can enter as equity participants later in the game; indeed, in some cases, such as in Mozambique, they have. But there are important limits to this. Project developers typically sell ownership stakes to companies that plan to take a share of the produced gas for themselves (those companies do so to hedge against uncertain natural gas prices). Since other countries (particularly South Korea and Japan) are still more prominent than China as LNG importers, they are also more likely to be sold the available equity in LNG export projects. This all may change if China shifts to become a larger LNG importer.

The two biggest Chinese companies involved in overseas mining investment are also the biggest players domestically: Chinalco (by volume) and Minmetals (by number of transactions).
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Yet in contrast with oil and gas, where the biggest companies dominate, neither holds a majority share of the market for overseas projects; according to one Chinese government survey, only 37 percent of companies engaged in overseas mining projects are state-owned, with private companies particularly prominent in regional neighbors.
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The line between public and private, though, is blurry, since private enterprises may enjoy significant backing from the government.
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Furthermore, as in the oil industry, many mining industry leaders are tied to the government or the Party. For example, Guo Guangcheng, chairman of Foshun International, a large private company involved in the mining industry, also has served as a Shanghai delegate to the National People's Congress.
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Australia has been the top destination for Chinese minerals investment in recent years. Investment in deals valued at $100 million or more totaled nearly $30 billion between 2005 and mid-2013.
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Eighty percent of China's direct investment in Australia is concentrated in the mining industry, of which 50 percent is invested in iron ore.
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Chinese minerals investment in South America, totaling nearly $17 billion between 2005 and mid-2013 (excluding small deals), is second only to its investment in Australia.
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As of 2011, China had thirty-four major resource projects on the continent. Total FDI (foreign direct investment) in Latin America, concentrated heavily in mining, jumped sharply over the last decade.
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China's mining activities in Africa have also expanded significantly in the last decade in pursuit of a host of mineral resources, as sub-Saharan Africa became China's second biggest source of minerals after Australia.
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(It remains a less prominent destination for investment.) Chinese officials are pushing for resource companies, both state-owned and private, to invest in African countries.
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China's neighbors to the north and the southeast are important investment destinations as well. Mongolia is playing an ever larger
role in China's mineral investments. In July 2011, Shenhua Energy, China's largest coal producer, made a bid for a 40 percent share of Mongolia's massive Tavan Tolgoi reserve. Although the deal was initially scuttled after protests from Japanese and Korean bidders, it was completed in October 2013 following Mongolian elections in June.
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China is also looking to Vietnam and Indonesia as opportunities for investment in bauxite.
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China is the largest investor in Burma (Myanmar) with $14 billion in direct investment, a significant amount of which is directed toward the mining industry.
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There is no one driver behind Chinese companies' mining investments. Proximity to China is one consideration.
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Australia, Mongolia, and Burma all offer abundant resources and geographic proximity, and large SOEs have pursued massive investments in these countries. In other cases, firms may target countries with which China has a free trade agreement (FTA). In Chile and Peru, for example, China acceded to “lopsided” FTAs in good measure to reduce trade barriers for its extractive industries firms.
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Both countries now have substantial Chinese mineral investments. Smaller Chinese mining companies often seek out “quick profits for minimal investment, ” as in the Democratic Republic of the Congo.
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It is essential, though, to keep Chinese mining investment in perspective. As one industry journal noted in 2012, “Chinese mining investment activity outside China remains mostly marginal. China's scramble for resources in Australia, Africa and elsewhere involves minimal investment values despite rapid growth in recent years.”
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The sheer volume of global mining investment coming from China still pales next to the shares taken by players from the United States, Canada, Australia, and other established sources.

China's agricultural investors are even more fragmented than its minerals producers. They can be divided into three types: major national enterprises associated with the central government, major regional firms supported by the provincial or national authorities, and local and private investors, usually small firms or individuals.
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The size of the enterprise correlates broadly with the distance it goes in securing agricultural resources. The major national companies, most notably the China State Farm Agribusiness Corporation (CSFAC) and the China National Agricultural Development Group Corporation, receive the bulk of the central government's assistance in going out and are involved in Australia, Latin America, Africa, and other distant locations. Moreover, for the larger Chinese ventures (such as those in Brazil and Australia) as much as 90 percent of the capital comes from the state-owned sector.