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December 03, 2006

Feeding the Chinese Dragon
by Mike Hewitt

For the first four months of 2006, new construction expenditure in China was 40 percent higher year on year, driven by increased infrastructure development for the Beijing Olympics in 2008, Shanghai's World Expo in 2010, and continued high rates of rural to urban migration.

Over the next five years, China will spend more on underground and overland rail networks in the next five years than the rest of the world has spent in the last 20 years! (Credit Suisse, Brave New World II, Nov 2006)

These new railways will include: six railways for passenger transportation, a major one being the rail connecting Beijing to Shanghai; five inter-city railways, including one between Beijing and Tianjin; and the upgrading of five existing railways such as the one between Datong and Qinhuangdao.

There are planned upgrades to twelve seaports, including those in Dalian, Tianjin and Shanghai in order to receive raw materials such as coal, imported oil, gas and iron ore. Port construction along inland rivers and canals is expected to accelerate with continued dredging of the Yangtze, Pearl River and the Beijing-Hangzou Canal.

Ten airports will be expanded upon to accommodate for increased air traffic, including those in Beijing, Shanghai and Guangzhou. Those in Kunming and Hefei will be relocated.

With nearly 100 Chinese cities housing more than one million people and increasing numbers of Chinese moving into urban centres in search of employment, the associated requirements for housing and metro infrastructure projects such as public transit, water and wastewater infrastructure, power transmission, and roads is expected to continue to place pressure on global raw material supplies.

Global Commodities and China

China is the global leader in consumption of aluminium, coal, copper, gold, lead, nickel, tin, and zinc.

Galvanized and stainless steels for Chinese steel and automotive industries are consuming zinc and nickel at such a pace that metal stocks in the London Metal Exchange are falling to multiyear lows.

China was an oil exporter during the 70's and 80's. As recently as 1992, China was self-sufficient in oil. Presently, the world's most-populous country is importing 40 percent of its needs. Oil makes up only 23 per cent of the country's total energy consumption, far less than coal, which accounted for 68 per cent. The U.S. Department of Energy predicts the reliance of China on foreign oil to reach 75 percent by 2025.

China is now the second largest oil consumer behind the United States, having recently surpassed Japan.

China is currently the sixth largest oil producer but recent statistics from BP's Review of World Energy 2005 show reserves will only sustain the country for a further thirteen years if current production levels are maintained.

Growth in Chinese oil consumption has accelerated mainly because of a large-scale transition away from bicycles and mass transit toward private automobiles, made more affordable since China's admission to the World Trade Organization.

The number of privately owned automobiles in China is now 23 million, more than double the figure three years ago. By year 2010, China is expected to have 90 times more cars than in 1990. Some projections predict that China could surpass the total number of cars in the U.S. by 2030.

According to the Organisation Internationale des Constructeurs D'Automobiles (OICA), China was the fourth largest producer of automobiles in 2005. China is expected to easily surpass Germany in 2006.

For the first four months of 2006, China produced 2.6 million motor vehicles, 32 per cent more than in the corresponding period of 2005. Low labour costs and greater access to China's growing market for motor vehicles have encouraged manufacturers such as Ford and General Motors to relocate more production capacity to China.

Over the next five years, China is set to create fourteen new expressways, including one connecting Beijing to Hong Kong and Macao.

Chinese Foreign Investment

As China's demand for raw materials increases, Chinese foreign investment has been skyrocketing. China's foreign investment grew on average 65.6 percent from 2000 to 2005. For 2005, Chinese investment in other countries hit US$12.26 billion and is likely to reach US$60 billion by 2010.

The principal destinations for 2005 were Hong Kong (16.5%), the United States (10.3%) and Russia (5.8%). (United Press)

This money is also used to secure sources of oil and raw material in countries that may be shunned by the United States and/or Europe, such as Sudan, Angola, Zimbabwe, North Korea, Iran, and Cuba.

Chinese companies enjoy several major advantages over Western firms when seeking trade agreements.

1. China has a strict policy of non-interference in other nations' internal affairs allowing Chinese firms to enter countries where international sanctions restrict activities by US or European firms. This has served China well as it secures resources from authoritarian style governments that the west has criticized or sanctioned. At least China isn't hypocritical.
2. Chinese firms have access to financing from state-owned banks, which are more willing to back projects where risk-versus-return tradeoffs would seldom appeal to private investors. China's existing projects in Sudan, as well as the preliminary agreement by Sinopec to develop the Yadavaran oilfield in Iran, illustrate this effect.
3. The Chinese government can make side deals involving foreign aid and arms sales to promote its interest in acquiring raw materials. Sudan is a prime example, as Chinese state-owned arms manufacturers have sold T-59 tanks and Shenyang F-7 combat aircraft in the wake of Chinese development of Sudanese oil resources.
4. Lack of transparency constitutes another competitive advantage. Western firms have reporting requirements that do not apply to Chinese firms and are often under pressure from their home country governments and investors to keep their transactions with foreign governments transparent. For US firms, the Foreign Corrupt Practices Act prohibits some types of side payments that Chinese firms could easily make.

South America and the Panama Canal

Through, Hong Kong billionaire Dr. Li Ka-shing's Panama Ports Company, China controls the ports at either end of the strategic Panama Canal which left US control on Dec 31, 1999.

China is interested in potentially widening the Panama Canal to allow for larger Chinese ships to move goods from the Pacific to the Atlantic. (Washington Times)

Access through the Panama Canal has been beneficial to China's recent strengthening of diplomatic and economic ties with Latin America as it seeks to gain raw materials to support its manufacturing base.

In 2004, Baosteel signed a framework agreement with Arcelor and Companhia do Rio Doce (CVRD) to build an integrated steel plant in Brazil for an expected US$1.5 billion. There are current plans between Sinopec and Brazilian Petrobras to build a 2,000 km natural gas pipeline backed by an US$10 billion energy deal.

China has entered trade and infrastructure agreements with Cuba. In 2005, Sinopec signed a shared-production agreement for prospecting and exploiting crude oil with Cubapetroleo. In 2006, China announced it would invest US$500 million in Cuba's in nickel industry.

Especially important for China is oil-rich Venezuela. As relations between Venezuela and the US have soured, China has been quick to move in. In 2005, China announced it would invest US$400 million in Venezuela's infrastructure, including oil and gas fields as well as railway and refinery infrastructure. In August of 2005, Caracas purchased three military grade radar systems from Beijing.

Jamaica is China's biggest trading partner in the English-speaking Caribbean countries and an important source of bauxite ore for China's aluminium demand.

China and Africa

China's thirst for oil and raw materials has lead to stronger ties between China and numerous African countries. China's overall trade with Africa has risen from $10.6 billion in 2000 to $40 billion in 2005. According to Chinese government the statistics for 2006 will be larger still.

Angola is China's most important partner on the African continent and leading supplier of oil. Angola is currently the second-largest oil producer in Africa and may soon overtake Nigeria as its oil boom continues. When Angola emerged from its 27-year long civil war in 2004, China greatly increased diplomatic relations by granting Angola an immediate US$2 billion credit line to rebuild infrastructure. The international community criticized the action because the loan lacked transparency or accountability.

Since 1997, China has invested billions of dollars in Sudan and is by far the largest investor. In September 2004, the United Nations Security Council passed Resolution 1564, threatening Sudan with oil sanctions unless it curbed its support for janjaweed militia groups that have massacred tens of thousands of people in the Darfur region. To protect its oil interests in Sudan, which supplies seven percent of China's oil imports, Beijing stated very clearly that it would veto any bid to impose such sanctions.

China and Iran

The Iran issue is the most recent source of tension between China and the West. The United States and Europe are pushing the United Nations to impose sanctions because of Tehran's refusal to suspend uranium enrichment programs. China has threatened to veto any such measure as its right being a permanent member of the Security Council. China does support the demand that Iran curtail the program.

Mike Green, an analyst at the Center for Strategic and International Studies has stated that the Iran issue is "...the first test of whether the world can influence China, or China influence the world."

The reason behind China's support for Iran is from a preliminary agreement signed in 2004 to buy a 51 percent stake in Iran's Yadavaran oil field, located in the Western Kurdistan province near the border with Iraq. This deal would also allow China to buy 150,000 barrels of Iranian crude a day and 250 million tons of liquefied natural gas at market rates for 25 years amounting to as much as US$100 billion.

There is growing speculation that China will take over the Japanese contract to develop the south Azadegan oilfield. Japan and Iran signed the US$2 billion contract in 2004, but delays as a result of Iran's nuclear program have resulted in Iran's announcement that Japan will be dropped if it fails to advance the project.

Conclusion

China has had a significant impact on commodity supplies and subsequent price. Some of that demand may be attributed to 'displaced demand' in the sense that a consumer good produced in China consumes the same amount of material as it would if produced in the US. However, the development of an emerging Chinese middle class and a mass migration, perhaps the most significant one in modern history, of millions of Chinese from rural to urban areas of the country will result in a fundamental structural change in the Chinese economy.

On the global stage, China's policy of non-involvement in sovereign nations has enabled its state-owned companies to seek out trading agreements with those countries of the world considered unsavoury to the US and Europe. China's position as a founding member on the UN Security Council and subsequent veto power has been instrumental in China building diplomatic and economic relationship with 'rogue' nations. China can be expected to bear continued pressure from the international community as it seeks to secure raw materials from any source for its fast-growing economy.

Mike Hewitt
DollarDaze.org

Mike Hewitt is the editor of www.DollarDaze.org, a website pertaining to commentary on the instability of the global fiat monetary system and investment strategies on mining companies.

Disclaimer: The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and I encourage you to complete your own due diligence when making an investment decision.

Copyright © 2006-2008 Mike Hewitt

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