SOEs’ Overseas Mining Investment Faces Great Risks

Recently, the dilemma of CITIC Pacific concerning its investment in magnetite in Western Australia has once again come under the spotlight. In March 2012, Chang Zhenming, Chairman of CITIC Pacific, ever indicated that the first production line of the magnetite project in Western Australia would go into operation in August 2012, However, he noted not long ago that the project cannot be commissioned as planned in this August and would be postponed to November 2012. The western Australian project has turned out to be a nightmare for CITIC Pacific and taken away lots of assets of the company. It is reported that, as of the end of June this year, the project has consumed USD 7.8 billion, 86% higher than USD 4.2, which was predicted in 2009. Although Chang said that the expense of the project would not exceed USD 10 billion at large, it is widely estimated that the total capital expenditure of the project will go far beyond USD 10 billion. If it is the case, the project’s expenditure will account approximately half of the total assets of CITIC Pacific!

The magnetite project in Western Australia is a“legacy” left over by the former Management of CITIC Pacific. It is a headache for the current Management including Chang Zhenming,who, in despite of their responsibility, are unwilling to save the situation since they are likely to lose the whole game as a result of even a single mistake. Besides the abovementioned difficulties and problems, CITIC Pacific is confronted with global economic downturn, which is the largest macro risk. It implies that even if CITIC Pacific makes a great investment in the project, it cannot get rid of losses. Since the economic trend is irreversible, if CITIC Pacific continues to make investment in the project, it is very likely to fall into the above trap.

CITIC Pacific is not alone. According to a follow-up study conducted by Anbound research team, most overseas mining investments made by Chinese SOEs face great risks.

In recent years, China’s overseas investment soared and became a driving force in the field of transnational investment. According to Anbound’s data, China’s direct foreign investment has exceeded 100% y-o-y and reached USD 55.9 billion since 2008, and has been remaining high growth since then. According to the data released by the National Bureau of Statistics of China, in 2011, China’s non-financial direct overseas investment reached up to USD 60.1 billion, 19.7 times than that in 2003, with an annual average growth of 46.4%. As of the end of 2011, China’s total non-financial direct overseas investment has reached up to USD 318.9 billion.

In China’s overseas investment, energy and mineral investment led by SOEs take an important position. It is also an important strategic objective of China’s previous “going out” strategy - ensuring energy and resource supplies for the “world factory”. However, since Chinese enterprises are lack of strategic research before“going out”, and lack of risk information tracking in the process of overseas investment,moreover, foreign countries differs greatly with China in terms of market, law, labor policy and environmental protection, etc., Chinese enterprises that are short of foreign investment tal-ents and experience tend to face lots of difficulties.

As of the end of 2010, the number of companies invested by Chinese enterprises in foreign countries has exceeded 15,000, and the total asset of Chinese-funded overseas enterprises has exceeded USD 1,000 billion.

According to statistics of Norton Rose Law Firm, an overseas institution, China’s total foreign mining investment in 2010 accounted for 10.5% of the total mining trade volume of the whole world. Chinese enterprises made 161 mining transactions in total, 69.2% of which were mainly carried out by state-owned enterprises directly under the central government.But 60% of the transactions failed. After extensive researches, Norton Rose believes that, domestic regulation and the trivial system of examination and approval, cultural conflict, deficiency in acquisition and management skills as well as undue policies and blind request for share controlling are main reasons for failure.

Another example of investment failure is the investment of Wuhan Iron & Steel Group(WISCO) in Brazil. In 2010, WISCO announced that it would invest USD 5 billion in construction of a large-scale steel mill in Acu Port, which is expected to complete in 3 years with annual production capacity of 5 million ton. It will become the largest overseas steel mill of China, and is the largest investment of China in Brazil. The steel mill is considered to a model that controls upstream raw material resources through overseas investment. Nevertheless, after 3 years of efforts, it is reported that in this July WISCO decided to give up the project since it went beyond WISCO’s riskbearing capability. In despite of the failed investment, WISCO is luckier than CITIC Pacific, and did not put money in jeopardy.

At present, Chinese enterprises have made great investment in foreign countries. As of the end of 2010, the number of Chinese-funded enterprises in foreign countries has exceeded 15,000 with the total assets of over USD 1,000 billion, of which state-owned enterprises take half of the total overseas investment. As of the end of 2009, overseas asset of state-owned enterprises directly under the central government has exceeded RMB 4,000 billion. However,China’s state-owned enterprises directly under the central government suffer from a surprisingly big loss in the overseas investment. According to incomplete statistics of SASAC, in 2008 alone, the floating loss caused by overseas investment of China’s 68 centrallyadministered SOEs amounted to USD 11.4 billion.

As the global economy gets into a declining cycle, China’s oversea mining investment spearheaded by SOEs faces rising risks in an all-round way. Most SOEs of China made investment when the price of mineral resources was high. Unfortunately, they face the global economic downturn after they invest heavily in the market. It remains unknown that how long the economic recession will last. But it is sure that the economic recession will make the mining investment of Chinese SOEs face long-term risks until the next economic upswing.