International Perspective, by Marshall Auerback
China: Why Revalue when you can go on a Shopping Spree Instead?
June 28, 2005
prudentbear.com
Give the Chinese credit: at least they’re not using their substantial foreign exchange holdings to buy trophy properties in New York or golf courses in California, as the Japanese did during the 1980s. One might query the price they are paying, but at least there is a certain strategic logic for Beijing to acquire assets which will help to secure the country’s future voracious needs for natural resources, particularly energy.
With the opening up of China in the mid-1990s to foreign investors, its abundance of cheap labour, and the authorities' encouragement of Chinese banks to lend more, have allowed the country to build infrastructure and capacity at a rapid pace. Unsurprisingly, China's share of global trade has also grown rapidly. But over the next fifteen years, to improve living standards, the authorities plan to move three hundred million workers from rural areas where they earn just over one dollar a day, into the towns and cities where they could earn four and a half dollars a day. So China is likely to add to its infrastructure at a rapid pace for many decades, both to house the workers, and to build the manufacturing plants for them to work in.
One consequence of the rapid growth to date is that demand for electricity is now outstripping supply. According to the International Energy Agency, China had a deficit in electricity generating capacity of more than 10% at the end of 2003, resulting in periods of blackouts in Beijing. To alleviate the energy bottlenecks the Chinese authorities are
trying to constrain the pace of investment activity with a massive crackdown on lending. In parallel with this, they are beginning to use their substantial foreign exchange reserves toward the purchase of leading natural resource companies.
Which explains the energy buying spree currently being sponsored by the Chinese government. Although China is not the only significant surplus country, it is likely to generate well over a sixth of the overall current account surplus of emerging market economies (including the oil exporters) this year. It also has an extremely strong capital account position, so it is uniquely well-placed to underwrite deals of the sort being contemplated by CNOOC as it seeks to outbid US-based Chevron for Unocal.
True, CNOOC is ostensibly an entity independent from the government, but its attempted takeover of Unocal is largely being funded from government loans, and it is clear that a deal of this magnitude would not be occurring in the absence of approval from Beijing.
A deal is now therefore on the table and in dramatic fashion, China has yet again given indications that its priorities in relation to an anticipated currency revaluation timetable do not coincide with those of Washington. Unocal and China National Offshore Oil Corporation’s advisers have started to gather in the US in order to begin negotiations on the state-owned Chinese company’s landmark $20bn takeover offer for the California-based energy group, and there is nary a thought being given to currency revaluation at this juncture.
Why would there be, when the immediate effect of such a revaluation would be to devalue the very currency in which the transaction is supposed to take place, whilst simultaneously introducing a degree of potential domestic financial instability? The status quo, by contrast, offers the prospect of using those same dollars to gobble up companies which satisfy a bunch of China’s strategic needs. CNOOC is by no means the first deal of this kind, as was noted last year: “Sinopec Corp., the giant Chinese energy company, is eyeing a major investment in Alberta's oil sands,” Canada’s Globe and Mail reported last summer, “as it pushes to secure supplies for its booming home market. That push comes even as the United States increasingly looks to the oil sands as a secure source of supply for its own uses, with terrorism and other geopolitical upheaval threatening conventional oil production overseas.”
Unlike the reception that has greeted CNOOC’s proposed takeover of Unocal, Canadian authorities have welcomed such deals: “I met with them in Beijing [last June],” explains Alberta Premier Ralph Klein, “and true to their word they came over to examine the potential of investing in the tar sands. We encourage their investment...what they're talking about is either joint-venturing with an existing oil sands developer or acquiring a new lease.”
Not for nothing is China’s increasing need for oil reserves wandering to the West. Supplies from the Middle East have become increasingly unreliable. Even in China’s own backyard, America’s increasingly bellicose statements in regard to the Taiwan Straits and ongoing difficulties with Tokyo over the Senkaku Islands suggest trouble ahead.
Similarly, Beijing appears to have been caught in the political fall-out of Yukos, the troubled Russian oil company, which abruptly halted crude oil shipments to Petrochina after its CEO was arrested. All of these factors have forced the Chinese to look elsewhere for supply. Along with CNOOC’s proposed takeover of Unocal, Petrochina has also had discussions with the Canadian Oil Sands Trust to structure a long-term agreement to buy synthetic crude from the joint venture in which the trust is the largest shareholder.
In addition, China's recent deals with both Kazakhstan (pertaining to Caspian energy) and Iran (pertaining to Persian Gulf resources) signify that the purview of the new great game is not limited to one particular region, but in fact has a broader, more integrated, purview increasingly enveloping even Iran. Increasingly, the image of the Islamic Republic of Iran as a sort of frontline state in a post-Cold War global lineup against US hegemony is becoming prevalent among Chinese foreign policy thinkers, especially in light of last year’s signing of a mega-natural gas deal between Beijing and Tehran worth over $100 billion.
One thing is certain: China’s acquisition strategy is an economic counterpoint to America’s increasingly militaristic posture in the Middle and Far East. In both cases, the ultimate aim is to achieve energy security. As present and future superpowers, both Beijing and Washington are reluctant to accept import dependence for so vital a commodity as oil. Both are using their comparative assets: In Washington’s case, this means bullets, in the case of Beijing, dollars.
Beijing is also trying to cut oil use, and has dispatched its oil companies far afield to find and produce new oil. But China's thirst for oil - helping drive the crude price over $60 a barrel - is such that it is now also trying to buy reserves on the stock market, as so many western majors have done in recent years. India shows signs of following the same energy security strategy. The FT’s David Buchan and Carola Hoyos explain the rationale:
“In general, owning foreign oil reserves does not increase energy security. Were CNOOC to win Unocal, it could not insist on shipping Unocal's US oil off to China; US law would prevent this. But there are two other possible ways of enhancing energy security. One is through long-term supply contracts, which existed in the energy-anxious 1970s and before the development of the oil futures markets. OPEC producers now prefer to play the spot market for the highest price. But it is possible to imagine oil importers of the weight of China and India striking deals where smaller oil consumers could not. The second option is to build up an oil stockpile. China is doing this and India is talking about it. But neither belongs to the International Energy Agency, through which the US, Europe and Japan agree not only to hold a certain level of stocks but also to share them in a crisis.”
It is also the case that the CNOOC deal, like last year’s ill-fated attempted takeover by Minmetals of Noranda, is by no means a done deal. People close to Chevron say the company sees no reason to raise its bid, noting that the uncertainties around the timing of any deal with CNOOC, as well as whether it will get through the approval process, favour Chevron. The Chevron acquisition could be completed as early as July or August, while any purchase by CNOOC could take up to a year. Chevron can only benefit by the questions being raised in Congress and elsewhere about whether CNOOC, as a Chinese company, should be given a fair shot at Unocal given that China does not offer a level playing field to US companies and will therefore be reluctant to raise their bid.
On the other hand, as Lee Raymond, ExxonMobil's chief executive, noted last week when asked if Congress should take some sort of action to kill a bid by CNOOC for Unocal: “I think that's a big mistake because the facts are that the US is dependent, and will be for a long, long time, on significant imports of oil. And, to the extent that they preclude the Chinese from buying assets here, it could easily come back and reflect that we couldn't buy assets in a foreign country.” There are clearly a lot of dollars involved here and influential Wall Street firms, such as Goldman Sachs, will almost certainly be pushing on those same Congressmen to enable the deal to go through.
In spite of the political risks in attempting to secure such a politically sensitive asset, and the comparatively high cash price being offered, it may very well be in China’s interests to continue in this strategic direction. From Beijing’s perspective, one of the virtues of the CNOOC deal is that it need not have any immediate damaging effect on the US dollar exchange rate. As long as sellers of commodities and Western based materials firms are willing to accept US dollars in these transactions, the shift in Chinese government portfolio preferences need not collapse the dollar (as a revaluation might very well do), which of course would be detrimental to China's current export led growth path.
As its formidable pace of economic development accelerates, global policy makers are calling on Beijing to play a role commensurate with its increasing international economic status. It appears to be doing precisely that, although perhaps not in a manner sanctioned by Washington. Going on a shopping spree for natural resource based companies with its substantial dollar foreign exchange holdings may be no bad thing for China, although the strategy may well signal further conflict ahead with Washington given that this suggests a future clash of priorities between Washington and Beijing. In that regard, the reaction to the CNOOC attempted takeover is but a small bellwether of what lies ahead. But it probably beats the alternative.
True, the deals may end up costing billions, and there is also the politically sensitive job of allocating a certain proportion of foreign exchange reserves to the goal of recapitalizing China’s state banking system. Throwing bad money after good, one might say, but if any country can afford to waste money it is China, given the fact that the country’s foreign currency reserves are already almost as big as one year’s worth of imports. Although this strategy might not seem sensible for the medium term, measured against the prospect of an imminent currency revaluation, does it not make more sense to China to use this window of opportunity to secure as many strategic natural resource assets as possible? What is the pay-off offered in the event of a revaluation of the currency, which might do nothing more than create further speculative instability? However high the prices paid for some of these assets, as a strategy it certainly appears to make more sense from Beijing’s perspective than, say, spending $800m to buy Pebble Beach or even recycling money back into US treasuries, where the risk of capital loss mounts every day. In that regard, China has absorbed the lessons of previous Asian buying sprees better than most. There may be a political price to pay for learning that lesson rather too well, but the CNOOC deal signals Beijing’s readiness to embrace that risk. The old Chinese curse, “May you live in interesting times”, has become even more relevant today. |
