How China's Resource Reach Spread Abroad

飞雪寒冰

Wearing a suit without tie, a homebound Xiao Yaqing waits at an elevator door at the offices of China’s largest aluminum concern Chinalco. “Soon I won’t be getting paid (here),” he jokes. “Please still let me in for lunch.”



As the elevator descends, 50-year-old Xiao contemplates his rising career. He’s not really worried about lunch; he’s a national hero for promoting overseas acquisitions, and one of the most closely watched business leaders in China.



Xiao is also getting a new job as a high-ranking government official. February 16 was his last day as Chinalco’s general manager. The following day, he was seated as a vice secretary-general of the State Council, a vice ministerial post.



Under Xiao’s leadership, state-owned Chinalco prospered at home and abroad. The company paid US$ 1 billion in 2008 to the U.S. aluminum giant Alcoa for a stake in Australian mining concern Rio Tinto. He oversaw an additional US$ 14 billion payout for a 12 percent stake in the company last year.



Shortly before Xiao accepted the State Council post, he engineered another coup for Chinalco: A plan to inject an additional US$ 19.5 billion in Rio Tinto -- an unprecedented overseas investment for a Chinese company. The deal is now being reviewed by government regulators in several countries.

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Not all of China’s overseas deal-making in the resource sector has lifted fortunes like Xiao’s. A few years ago, China’s Minmetals tried but failed to buy the Canada’s largest mining company, Noranda Inc. An earlier flop was Chinese oil concern CNOOC’s attempt to buy the America’s Unocal.



Some deals worked, however. China has successfully invested in overseas iron ore ventures through the jointly operated Channar Iron Ore Mine in Australia since the 1980s. Alcoa’s oxidized aluminum projects started attracting Chinese investment in the 1990s. China National Petroleum Group bought Kazakhstan Oil in 2005.



Chinalco’s plan to boost its stake in Rio Tinto is not a sure thing. It’s now clear – and painfully so after the Noranda and Unocal failures – that concerns of target companies and the national interests of their home countries play into these equations as well. Australia’s government could throw a wrench into the Chinalco plan. The Chinese government has a considerable stake as well.



Regardless, overseas resource shopping is receiving an enormous amount of attention. The story is important because of China’s distinction as a huge consumer of minerals, oil and other natural resources.



Based on its current industrialization trajectory, China has no choice but to move upstream in the resource industry. At stake is the long-term sustainability of an economy with an immense appetite for resource inputs.

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Rutted Course



Going abroad has not always been a popular course for Chinese companies tied to the resource sector.



“Do not meddle with overseas projects” was a 1990s warning uttered by Xu Hanjing, a general manager of China Nonferrous Metals Import and Export Corp. (CNMIEC), China’s largest overseas investor. Later the phrase was adopted by his successor, Zhu Guang, now a senior vice president at Minmetals.



Some years ago, when economic reform and opening was just a slogan in China, few realized how important foreign energy and mineral resources would be for the country. Plans for overseas acquisitions were rare and often controversial.



The cautious Xu was among the first business leaders to test the risky waters of overseas investment. Today, at age 55, he’s more reflective about the dreams and realities of the Chinese mining industry. He agreed to an interview with Caijing on a rainy Saturday last August in a Beijing restaurant. His story is woven into the fabric of the modern history of China’s mining industry and its going abroad strategy.



Xu took a position at CNMIEC’s foreign affairs department in 1984, about a year after the company’s founding. He was in charge of translation – a skill he honed at a publishing company that translated the Encyclopedia Britannica after graduating from Chengdu University of Science and Technology with an English degree.



The encyclopedia job was “an eye opener” to the world outside China, Xu said. “Before that, I thought there was only one event in 1921: the establishment of the Communist Party of China,” he recalled. “After a quick look at the encyclopedia, it seemed quite a lot had happened” that year.



Xu worked his way up the ladder and was appointed a CNMIEC representative in Australia in 1989 -- six years after China’s premier and China International Trust and Investment Corp. (CITIC) Assistant General Manager Jing Shuping visited Australia to discuss the country’s western iron ore reserves. Jing had recommended the use of domestic and international resources as well as overseas resource investments to boost China’s economy – an idea backed by the State Council and Australia at a time when the iron ore industry was struggling.

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Even before his arrival, in 1987, the China Metallurgical Import and Export Co. (CMIEC), under the Ministry of Metallurgy and led by the State Council, had set up China’s first investment in overseas assets through a joint mining agreement with Hamersley Iron Ore Co., a subsidiary of Rio Tinto’s precursor CRA, for an iron ore mine called Channar. That same year, CITIC acquired a 10 percent stake in Australia’s Portland Aluminum and later increased that holding to 22.5 percent.



The Channar mine’s investment totaled US$ 200 million -- 60 percent of which was financed by the Australian side and 40 percent by the Chinese side. The Chinese party had promised to sell 10 million metric tons of iron ore. The contract was to end when a 200 million ton extraction limit was reached, or in 2012, whichever came first.



But the Channar project sparked debate in China, recalled Dong Zhixiong, a former China Steel Group vice president who was in charge of the Channar project at CMIEC. Some criticized the agreement as an “unequal treaty” and wondered why, for a project it owns only a 40 percent stake, China should be responsible for all the sales. The dispute was settled when the State Council approved the investment.



The program has become China Steel Group’s main source of profits in recent years, thanks to rising international iron ore prices. But selling several million tons of iron ore was not an easy task during a mining industry downturn in the 1990s.



“There was no trick” to the process, Dong said. “Each year, the Ministry of Metallurgy would meet and exert strong pressure on companies to buy, often on credit. At the end of the year, receiving payments proved difficult.”



Against this backdrop, investment in overseas mineral resources became a sensitive topic. Dong told Caijing that CMIEC once set its sights on an iron ore project in South Africa that offered a yearly supply of 5 million tons. But the Channar deal left a bad taste, and afterward no one dared invest.

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At that time, the Chinese government offered little support to companies interested in acquiring overseas resources, said China Steel Industry Association (CSIA) Secretary General Dan Shanghua. A major reason was that the country’s foreign exchange reserves were insufficient. Before the late 1990s, all overseas acquisitions required special approval. For example, Capital Steel’s 1992 acquisition of Peru’s Marcona Iron Ore needed specific State Council approval.



Moreover, some government voices argued that companies should utilize domestic resources rather than spend money for mines and labor abroad. As a result, acquiring mineral resources abroad was sometimes criticized as “foolish.”



“At that time, there wasn’t enough understanding of mergers and acquisitions,” Dan said. “No consideration was given to changing a national policy to encourage the use of domestic and international resources.”



Few overseas investment projects were made through the 1990s. In addition to Capital Steel’s US$ 120 million purchase of a 98 percent stake in Marcona – a weak investment, as it turned out – the Chinese steel company Angang and Australia’s Terman Co. agreed in 1994 to jointly developed Western Australia’s Giuliaono mine.



Meanwhile, as CNMIEC’s man in Australia, Xu was far away from debates at home over overseas investments. That freed him to pursue resource deals. He started using Chinese teams for resource explorations in Australia. Then, with US$ 30 million from CNMIEC, Xu set up a wholly owned subsidiary Sino Mining International. In a few years, he worked his way up to general manager.



Sino Mining became China’s earliest overseas mining investment platform. Its first major move was the purchase of the oxidized aluminum business of Alcoa Worldwide Alumina and Chemicals (AWAC), a cooperative project of Alcoa and Australia’s WMC. Sino Mining paid US$ 240 million, and Alcoa agreed to provide 400,000 tons of oxidized aluminum at cost annually for 30 years. The contract was worth an estimated US$ 2.1 billion. CNMIEC and its successor, Minmentals, eventually saw a substantial return on the investment.



But the Sino Mining venture failed to meet its potential. The company had an option to increase its investment in three phases over three years. Each phase would have raised the amount of oxidized aluminum by 200,000 tons, for an annual total of 1 million tons. But at the turn of the century, CNMIEC found itself in dire straits, unable to make any extra investment.



Xu’s career slipped as well. Despite his status as a pioneer for overseas investments, he lost his job and his marriage failed.

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Sino Mining’s Legacy

　　

But Xu stayed in the game. Now, he’s the executive director at Sino Gold (ASX: SGX, HKSE: 01862) and in charge of the company’s mainland operations.



Sino Gold is considered China’s only successful foreign-linked gold company. It’s listed on the Australian Stock Exchange and joined the Hong Kong exchange in 2007. It was built on the remnants of Sino Mining, which dissolved in a management buyout after shifting its oxidized aluminum operations to Minmetals in 2000.



When Sino Mining was established, Xu opted for a western mode of operations with three, core executives lured from Australia’s Macquarie Bank. Nick Curtis, formerly responsible for the bank’s bulk commodities, became CEO, while Curtis’ right-hand man Jacob Klein took a post on the executive committee and was promoted in 1999 to vice director of operations. Michael Cosgrove, formerly of the Macquarie’s Corporate Finance Division, took charge of development.



Klein later became the CEO of Sino Gold, while Cosgrove is now CEO of Asian-American Coal Co. Both continue working in China.

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Today, Xu is a controversial figure in China. But he still has a vision of using foreign investment to obtain the natural resources China lacks. Rising about peers in China’s non-ferrous metals industry, his company pioneered the internationalization of the sector. And the cause lived on even after CNMIEC dissolved and Sino Mining’s staff dispersed.



Any large resource acquisitions by Chinese enterprises now and in the near future will be built on a personnel base Xu assembled to promote and execute such deals. These include 42-year-old Wang Wenfu, now president of Chinalco Overseas Holdings Ltd. and a core member of the team that initiated Chinalco’s moves on Rio Tinto. Another is Zhao Zhenggang, who used to work at the overseas branch of CNMIEC’s planning department. He also served as a board secretary at Sino Mining, and today is overseas development director for Chinalco.

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Minmetals Setback



Xu’s vision sharpened considerably in 2004, when Minmetals launched its bid for Noranda. That spring, the Canadian company’s CEO Derek Pannell took a call from Yang Jianzhen from Brookfield Asset Management’s Beijing office. Yang said a Chinese company named Minmetals was hoping to participate in a deal for Noranda.



“Minmetals? Who? Do they have money?” Pannell reportedly asked incredulously. But he couldn’t hang up. He had to listen to Yang because Brookfield owned 42.5 percent of Noranda.

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It became clear that China was no longer shy about overseas acquisitions. Enterprises such as Minmetals as well as the government were, after 20 years of rapid economic growth, ready to step onto the world stage in search of commercial opportunities. The man who pushed for and led the proposed US$ 4 billion acquisition – which would have been China’s largest overseas acquisition -- was Zhu Guang, vice president of non-ferrous metals for Minmetals.



At the time, Toronto-based Noranda was the world’s ninth-largest producer of copper, third-largest producer of lead and third-largest producer of zinc. It also had considerable production capacity for aluminum. And although the company’s mining costs were not the lowest in the world, its high-quality assets were hard to come by.



Minmetals was then China’s largest metals and minerals trading company, with US$ 4 billion in total assets and US$1.2 billion in net assets -- less than half Noranda’s. As a trading company, Minmetals was exposed to significant price volatility. Thus, company President Miao Gengshu was recommending “industrial restructuring” and “resource control.” Acquiring Noranda became a litmus test for Minmetals’ “industrial transformation” which, if successful, was expected to reduce pressure for the company to merge.

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A source told Caijing that Minmetals was also following the directions of the State-owned Assets Supervision and Administration Commission (SASAC), whose Director Li Rong demanded in 2003 that state enterprises become “bigger and stronger.” Li’s goal was industry leadership within three years. That put enormous pressure on state companies.



Minmetals, through an open tender, bought 100 percent in Noranda for US$ 4.2 billion, beating competitors including Brazil’s Vale and South Africa’s Anglo American. But the transaction met resistance in Canada as well as within certain Chinese government departments. Amid the dickering, non-ferrous metals prices skyrocketed, taking Noranda’s share price with them. Soon, the US$ 4.2 billion offer looked pretty small.



A participant in the transaction told Caijing that Minmetals’ biggest obstacle was the National Development and Reform Commission (NDRC), which frowned on Minmetals’ prospects.



“NDRC officials thought the Minmetals platform was too small, that it was just a trading company and did not have managers with experience in mining industry production and operations,” the source said. “So they dragged their feet on the approvals.”



Caijing learned that NDRC insisted Minmetals ally itself with several domestic steel companies if it wanted to complete the acquisition. As the exclusive negotiation period with Noranda was about to expire, NDRC even asked CITIC to step in and take Minmetals’ place in the deal – an idea rejected by the Canadian company. Another analysis, however, said Minmetals failed because it was relying on bank loans to finance the acquisition