China Targets Canada!

International Trade Minister Stockwell Day has returned from a goodwill trade tour of China making all the right gestures and remarks; a commitment to fight protectionism, two new Canadian trade offices to promote our goods and services in China, and kind words for Chinese officials in an effort to improve bilateral relations.  There is even talk of a visit by Prime Minister Harper at a later date, a change of heart from his failure to attend the 2008 Olympics.

Truth is, the Chinese could care less about bilateral Chinese-Canadian trade.  Compared with US and European volumes, Canada’s purchasing of goods destined for the consumer market is of middling importance at best.  What are truly captivating are Canada’s riches in natural resources, which China would like to purchase in increasing quantities and would prefer to be able to control these resource companies outright.

China is the second largest consumer of energy in the world and is dependent on imports for half of its consumption.  It will likely surpass the United States sometime in the next decade.  Chinese companies have gone on a resource-company spending spree over the past five years, flush with cash and seeking strategic acquisitions wherever they can find them.

Consider the following examples of Chinese acquisition efforts:

April 2009: Chinese National Petroleum Corporation (CNPC) seeks to acquire Syrian and Libyan oil assets likely to be sold by Suncor following its takeover by Petro-Canada;

A US$10-billion investment in Brazil that secured 100,000 barrels of oil per day for the next 10 years;i

A US$25-billion deal in Russia that will deliver 300,000 barrels per day for two decades.ii

In March, CNPC also made a takeover bid worth $443 million for Alberta-based Verenex Energy, who controls more promising Libyan oil assets; Libya chose to block the deal in the end;

Total SA of France and Chinese petroleum company Sinopec have joined forces to each hold 50% of Northern Lights, an Alberta oil sands mine expected to cost over $10 billion to develop;

Consolidated Thompson Iron Mines Ltd. Of Montreal has accepted a 19.9% stake from Chinese investor Wuhan Iron and Steel Corporation (WISCO) worth $240 million to help it develop its Bloom Lake iron ore project in Northern Quebec.  Ironically, the co-chairman of Consolidated Thompson is Brian Tobin, formerly known as Captain Canada and defender of nationalist interests.  Apparently when capital is in short supply, nationalism takes a back seat to expediency.  WISCO has committed to take 25% of the mines production once it is available in 2009.

The above examples are a mere snippet of Chinese activity in the Canadian resource sector.  They have been equally active around the world, particularly in the developing world and also in South Africa.  As China is the only major world economy likely to enjoy positive growth in 2009, albeit at a reduced rate estimated at 6%, it will continue to produce the cash necessary to pursue the acquisition strategy as the capital-starved resource industry around the world will welcome the Chinese as willing and sophisticated investors.

Figure 1 from the latest World Bank Report on China clearly illustrates that China’s growth, even during the worst economic crisis since the Great Depression, will not slow its thirst for more natural resources to fuel its expansion.  If China’s international acquisitions continue apace today, imagine how those efforts are likely to accelerate when its GDP growth rate rises once again to 10% or more.  In China’s view, a 6% growth rate is about as much of a recession as it can tolerate.

Hey, what about the Americans?

If these were normal economic times, the Americans would be mounting a massive diplomatic offensive to encourage the Canadians to bring back the Trudeau-era FIRA (Foreign Investment Review Agency) to block these investments based on national security requirements.  The US is too distracted with is banking melt-down and multi-trillion dollar budget deficits to take on the Canadians at this point, Obama simply has too much on his plate.  The Americans are also reluctant to annoy the Chinese who are expected to provide the lion’s share of US deficit financing by continuing to purchase US Treasury bills.  When the Chinese premier makes noises about seeking an alternative world currency to the US Dollar and simultaneously chides the US for its profligate spending, the message to the US is clear; don’t rock our boat, and we won’ pull the plug on your vicious cycle of consumption and debt.

That does not mean that the Americans are not watching developments in the Canadian resource sector with concern and dismay.  It is ironic that US money developed the Canadian oil and gas sector at the beginning, only to see then pushed aside during the Trudeau era with the creation of Petro-Canada and FIRA, resulting in favoritism for Canadian capital.  Now that Canadian resource sector companies have been devalued by the market melt-down and the Canadian dollar is back to 80 cents US, China is stepping in and filling the void that the Americans are unable to enter themselves.  If US resource investors do not re-focus on Canada in short order, they will find that the best opportunities will already be gone.  Canadian capital investment will eventually be revived and there will be fierce competition for compelling investments, which will drive prices up and profits down.

The Canadian reaction: What, me worry?

Up until the recent recession Canada was still a net investor abroad, meaning that Canadian corporations owned and invested more in foreign companies and assets than foreign entities held in Canada.  Public perception was always the opposite; that Canada was easy prey for foreign investors who were going to scoop up our valuable assets on the cheap.

From the 1960’s to the 1990’s, this concern was primarily focused on our manufacturing and technology industries as candidates for vulture-like foreign takeovers.  After all, the Americans had already assured domination of Canada’s petrochemical industry long ago, as this was before Petro-Canada and FIRA.  Mining always had a substantial foreign presence as well, and Canadians were concerned that they were losing control of their innovative manufacturing industries on top of their resource producers, and that there would be little of value left in Canadian hands.

Now that manufacturing is below 25% of Canada’s GDP, the risk of losing manufacturing companies and jobs to foreigners is less important than losing control of our natural resources, which have grown in exporting importance as the world beats a path to our door to purchase what Canada extracts from its lands.  We should be far more concerned about our natural resources because once a mining deposit is sold to a foreign firm it is extremely expensive to find another one just like it.  Indeed, when it comes to conventional oil, many experts believe that all the big fields have been found and that new discoveries cannot hope to replace their depletion, hence the theory that “peak oil” has been achieved.  Alberta’s oil sands take a lot more effort, and therefore money, to refine into useable products and therefore more capital investment is required to bring these fields into production.

But what of iron ore, copper, zinc, gold, silver, potash and the myriad of other resources found in Canada?  Given that financing for new prospection and mine development is scarce in Canada, the government is under pressure from developers not to ratchet up the diatribe against foreign investors, including the cash-rich Chinese.

The Canadian government is unlikely to try to stop Chinese or any other non-Canadian investment in our resource sector as long as there is a lack of home-grown capital ready to replace it.  The recent meeting of the G-20 major world economies placed particular emphasis on avoiding protectionism, be that in trade or investment, and Prime Minster Harper was one of the greatest proponents of avoiding a slide towards the trade wars of the 1930’s.  It would be diplomatic folly to turn around and begin limiting foreign investment in the resource sector at this point, which would result in serious damage to Canada’s international credibility at a time when we are once again seeking to “punch above our weight” on the world stage.

Canada has grown used to being economically integrated with the United States.  In the 21st century, we need to prepare ourselves for inter-dependence with an even larger elephant – China.

i,ii  “China Eyeing Canadian Assets” Duncan Mavin, Financial Post, with files from Carrie Tait, Published: Tuesday, April 07, 2009