Sunday, March 17, 2013

Michael Komesaroff on Chinese Investments in Afghanistan and the Changing Face of Global Mining

Michael Komesaroff, principal of Urandaline Investments, a consultancy specializing in China’s capital intensive industries, and a former executive in residence at the School of International Affairs, Pennsylvania State University, has produced an excellent analysis Chinese strategies for investment in mining: Afghan Adventure, China Economic Quarterly 7-9 (Dec. 2012).  

(Jonathan S. Landay, China Hungry for Afghan Copper, Seattle Times,  March 10, 2009, "Chinese working on the Aynak copper-mine project in the Logar province of Afghanistan stay in this gated community built for them. They are trying to gain access to the 240 million tons of copper ore though surface mining. ")

Mes Aynak in Afghanistan is one of the world’s largest undeveloped copper projects. Meaning little copper well, the Aynak deposit is located 35 km southeast of Kabul. In 2007, the government in Kabul handed the right to mine Aynak to Metallurgical Corporation of China (MCC). The story of Aynak and MCC illustrates how China’s state-backed natural resource companies are reshaping global mining.

Komesaroff starts with his thesis:  "In Afghanistan—and around the world—China’s state-backed resource companies are reshaping global mining." (Komesaroff, supra, 7). For that purpose Komesaroff looks at the example of Chinese investment in Afghanistan and specifically in its copper resources.  He suggests that the ability of China to combine state and private market power is dramatically reshaping the competitive environment, especially in parts of the world in weak governance zones, like Afghanistan, in which weak governance is reputedly augmented by  kleptocratic elements. 
The object of this study is the award by the Afghan government of the development rights to Aynak's copper deposits in 2007 to a Chinese company, .Metallurgical Corporation of China
In theory, MCC should have had plenty of competition to secure the rights to this world-scale deposit. Yet many multinational miners, which must answer to shareholders in multiple countries, were put off by fragile security and widespread corruption. They also lacked a home government willing to work on their behalf. A handful of mining companies did apply for the international tender, but soon discovered that MCC had an asset with which they could not compete: the full diplomatic and financial support of Beijing. In the race to acquire natural resources in tricky parts of the world, China’s business model—providing sovereign backing to profit-driven yet state-owned national champions—is successfully squeezing out the competition.  (Komesaroff, supra, 7).
But there is great irony here.  As the U.S. continues ot persist in its costly role as a state actor in alliance with its partners in Afghanistan, it¡s resources are being used to protect the investments of Chinese private enterprises that are, in turn, intimately connected to Chinese state policy.  In effect, and in this environment, Chinese state interests, expressed through private market activities, are subsidized and protected collaterally by the United States, whose interests expressed solely through inter-governmental activity. "The U.S. deployment wasn't intended to protect the Chinese investment — the largest in Afghanistan's history — but to strangle Taliban infiltration into the capital of Kabul. But if the mission provides the security a project to revive Afghanistan's economy needs, the synergy will be welcome."  (Jonathan S. Landay, China Hungry for Afghan Copper, Seattle Times, March 10, 2009).
Komesaroff starts by considering  Metallurgical Corporation of China. "Dual listed in Hong Kong and Shanghai, MCC’s major shareholders are China Metallurgical Group Corporation, a large engineering conglomerate specializing in natural resources, and Bao Group Corporation (Baosteel), one of China’s largest steel producers. Both are centrally owned SOEs with excellent access to government and state financing." (Komesaroff, supra, 7). Komesaroff suggests how that connectio9n permitted a blending of private and sovereign investing to procure the rights to natural resource extraction from the host sovereign. 
MCC agreed to a number of pricey conditions. In addition to a sign-on bonus of US$808m, it will pay the Afghan government a royalty of 19.5%. At current copper prices, this will add more than US$115m to Kabul’s coffers every year. Beijing also agreed to build a 400 MW power station with integrated coal mine, plus a US$4 bn railway linking the mine through Kabul to neighboring Uzbekistan and Pakistan. Finally, MCC said it would consider building a downstream copper refinery and smelter. None of these expensive facilities are essen- tial for the mine’s operation, but they were offered by MCC and Beijing in order to win the deal. In total, Aynak will require Chinese corporate and sovereign investment exceeding US$10 bn.(Ibid).
The transaction was of interest to global financial entities, principally the World Bank, which provided the Afghans with experts to help negotiate the deal with MCC. For all that assistance, and despite competition from extractive companies from the United States, Canada, the U.K. and Russia,  the process was contested by the losing entities.  The criticism focused on the usual difficulties in weak governance states--corruption and cronyism.   
The World Bank and its consultants reported nothing irregular in the tender process, but other participants and experts claim the process was rigged. Most of the criticism revolved around Mohammad Ibrahim Adel, the Soviet-educated Minister of Mines, who is accused of shutting foreign advisors and government officials out of the tender process to ensure that the contract went to MCC. US officials told the Washington Post that Adel received a US$30m bribe to favor the Chinese bid. The integrity of the process was further impugned by Hunter Dickinson’s claim that aspects of its confidential offer were passed to rival bidders. While these allegations are plausible, none of them have been substantiated. (Ibid., 8).
But more interesting was the way in which the Chinese state and private enterprise combined their efforts to ensure a successful bid.

MCC offered a higher sign-on bonus and royalty than other bidders—yet it was also aided greatly by Beijing, which used its diplomatic and regulatory clout to help it across the finish line. Chinese diplomats in Kabul provided MCC with valuable commercial intelligence and briefings on the nuances of government policy. Beijing also eased MCC’s path by instructing Zijin Group, another state-owned enterprise with strong credentials in the copper industry, to withdraw from the process. In return, Beijing required MCC to form a joint venture with Jiangxi Copper Ltd (JCL), a dual Hong Kong- and Shanghai-listed company controlled by Jiangxi Copper Corporation, a provincially owned SOE. JCL, which holds a 25% stake in the Aynak venture, is experienced in operating copper mines and marketing copper concentrate. Its skills complement those of MCC, which specializes in engineering, design and construction. (Ibid., 8)
 The object, of course, was to enhance the Chinese position in away that harmonized both the political objectives of Chinese investment policy and the private profit motives of MCC. For anyone who has been following Chinese policy development over the last decade, none of this can come as a surprise.  The Chinese have made no secret of the foundations of public and private economic policy on notions of harmonious society notions and on the unity of the objectives of government, economic forces and society. Dismissed as propaganda by many "China watchers", these ideals have been incorporated into the foundations of Chinese administrative policy, and incorporated into the operating postures of private enterprises.  For enterprises that are also state owned, the dual connection--profit making and coherence with state policy--becomes critical.  And in the later cases, the state will play a positive, not merely a passive role in attaining pubvlic and private ends. (Backer, Larry Catá, Sovereign Investing in Times of Crisis: Global Regulation of Sovereign Wealth Funds, State Owned Enterprises and the Chinese Experience. Transnational Law & Contemporary Problems, Vol. 19, No. 1, 2009).

Thus, as Komesaroff makes quite clear, the issue of economic viability of a specific investment, the calculus that would guide private enterprises detached from the public policy objectives of their home state governments, becomes irrelevant in the Chinese case.  The Chinese measure the value of the enterprise by a calculus based on the blended maximization of public and private objectives.
The Aynak tender demonstrates the competitive advantage Chinese SOEs derive from their cozy relationship with Beijing. The extent of this sup- port does, however, raise the question of whether the Aynak mine is justified on a commercial basis. Using a conservative US$3,200 per ton price for copper, MCC estimates that the construction of the mine, associated copper concentrate facility and directly related local infrastructure will generate a more than acceptable 11% return. While national interest is an important element in China’s overseas investment decisions, SOE managers are also rewarded for their financial performance—so they are hardly likely to propose loss-making investments.

Yet China’s support for MCC also serves the national interest in a number of ways. First, it addresses China’s need to diversify, expand and secure its supply of copper. This has a commercial as well as a strategic purpose, as developing new sources of copper supply will benefit all Chinese consumers by dampening prices. Second, encouraging national champions to acquire assets abroad is an important step in creating globally competitive companies. Making a success of foreign acquisitions is vital if China is to nurture multinationals with the same global clout as BHP Billiton or Rio Tinto.
In addition, investing in Afghanistan serves broader, geopolitical concerns. China fears that any instability in Afghanistan could spill over the border into Xinjiang Uighur Autonomous Region, where many native Muslims resent Chinese control. With independence fighters already running insurgent operations from neighboring Pakistan, an unstable Afghanistan would risk compounding ethnic tension and creating a new sanctuary for Muslim rebels. Stability is also essential for MCC to ensure a healthy return on its massive investment. Aynak represents an obvious and lucrative target for rebels who might want to deprive Kabul of critical royalty revenues. To shore up security both at the mine and along China’s vulnerable western border, Beijing is working closely with the Afghan government to help train and equip local police. Ensuring a stable and friendly political environment is in everyone’s interests. (Komesaroff, supra, 8-9).
Komesaroff suggests that the development of this distinctively Chinese approach to investment, especially in the extractives field, may be destabilizing traditional patterns of economic relations within the parameters of economic globalization. But the model also suggests risks.  
In other parts of the world, Chinese enterprises are frequently criticized for employing mainly Chinese workers and riding roughshod over local interests. Chinese investors are chided both for damaging the local environment and for offering bribes and secret commissions to local elites, much to the fury of ordinary people. Protests directed at Chinese investors have turned violent in several countries, and greater sensitivity is needed in Afghanistan to prevent similar disturbances. There are already signs of problems in Aynak, where local residents attacked MCC employees after they were forcibly removed from their land by Afghan officials fulfilling the requirements of MCC’s land lease. Locals are also frustrated by what they perceive as MCC’s failure to deliver on their promises to create jobs and build schools and mosques. (Komesaroff, supra, 9).
But the real question may be whether the success of the Chinese model will force Western enterprises to adapt their practices to the Chinese standard rather than to pressure the Chinese to modify their largely successful approach. "China’s business model is increasingly effective at beating out competition for access to rich, foreign mineral deposits—but tweaks are needed to ensure that its overseas investments are successful. It is standard for Western mining firms to engage with all stakeholders, to implement environmentally sustainable operating practices, and to be transparent in
their financial dealings. The challenge for Chinese companies is to emulate these practices in a way that does not destroy the leverage provided by their distinctive investment model." (Ibid). The answer, of course, will ultimately depend on the long term welfare maximization of either mode.  The likely outcome will likely push Western enterprises to more closely imitate the Chinese model--expect Western governments to more aggressively underwrite and manage the economic activities of large and tactically important enterprises. But also expect Chinese enterprises to more aggressively embrace Western standards of enterprise activities, especially with respect to activities outside of China. 

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