According to statistics released by China's Ministry of Commerce, Chinese outbound investment will continue its robust upward trend during the latter half of 2013, with energy and resources-related deals dominating the scene. In 2012, China's outbound direct investment reached a record high of $87.8 billion, making it for the first time one of the top three outward investors during the period. Of that amount, $13.54 billion flowed to the mining industry, and more than $1 billion to the energy and resources-related industries, in particular the production and supply of electricity, steam, gas and water(1).

Before closing what is likely to be yet another record breaking year, this article attempts to summarize some of the latest trends and developments affecting Chinese outbound investment into the energy and resources sector generally from a geographical perspective, as well as the forces shaping such trends, and discuss some of the major challenges and risks facing Chinese investors who are riding or wish to hop on the wave of globalization.

Part I Chinese Outbound Investment Trends in Traditional Energy and Resources Industries

AFRICA/MIDDLE EAST: China has continued to maintain its great interests in Africa, thanks largely to the abundant energy and natural resources untapped in this continent and increasingly, the potentially huge market for competitively-priced Chinese industrial products. Nonetheless, despite the existence of individual opportunities in this part of the world, risky environments, a lack of technology and low per capital income levels make doing business difficult for foreign investors. By way of illustration, Angola, Nigeria and Kenya are ranked in the bottom three, while South Africa ranked 49, of the China Going Global Investment Index(2), which balances opportunities against risks for 67 countries, recently published by Economist Intelligence Unit.

  • According to a white paper on Sino-Africa economic and trade cooperation published by the Information Office of the State Council, Chinese direct investment in Africa increased from $1.44 billion to $2.52 billion, with an annual growth of 20.5% from 2009 to 2012. To enhance the competitiveness of its investment, the Chinese government is providing special loans for small and medium-sized African companies wanting to co-invest with Chinese companies in Africa.
  • Recent blockbuster deals in this region include the acquisitions (i) by China National Petroleum Corporation of a 28.57% stake in Mozambique's Eni East Africa for $4.2 billion; (ii) by China Petrochemical Corporation of a 20% stake in Nigeria's Total Nigeria PLC, an offshore oil project, for $2.5 billion; and (iii) by a consortium (which includes, among others, Chinese investors Hebei Iron and Steel Group, Tewoo Group and Cadfund) of a 74.5% stake in South African copper producer Palabora Mining from mining giants Rio Tinto and Anglo American for $446 million.
  • US-based oil and gas producer Apache Corporation is selling a 33% stake in its Egyptian oil-and-gas business for $3.1 billion to state-owned Chinese oil giant Sinopec Group, to reduce its exposure to the recent political unrest in Egypt. The two have also formed a global strategic partnership to jointly pursue upstream oil and gas projects. The Apache deal is Sinopec's biggest overseas acquisition since it bought a stake in the Brazilian unit of Portuguese oil company Galp Energia SA for $5.19 billion in November of 2012.

NORTH AMERICA: Chinese foreign direct investment into Canada hit an all-time high in 2012, with most of that going to the purchases of natural resource companies and projects. The much-debated $15.1 billion acquisition of Nexen Energy by Chinese state-owned CNOOC accounted for close to 60% of the total investment value that flowed into the region.

The latest sign of continued interest in Canada's oil patch by energy-hungry China can be seen in the acquisition of Novus Energy Inc. (NVS.V), a Canadian junior oil and gas company, by China's Yanchang Petroleum International Ltd. for around CAD232 million ($226 million) in September 2013.

It remains, however, to be seen if Chinese foreign investment into Canada will decline as a result of the current Canadian administration's plan to tighten restrictions on foreign ownership of Canadian resources.

In the United States, Chesapeake Energy Corp. agreed to sell a stake in an oil and natural-gas field straddling the Oklahoma and Kansas border to China's Sinopec for $1 billion this summer, as the American company tries to recover from the global financial crisis with a Chinese cash injection(3).

LATIN AMERICA: China's hunger for energy resources and commodities has also led to a surge in Chinese outbound investment into Latin America. China's list of targets is expanding beyond the more mature markets in Latin America such as Brazil and Chile to other up and coming hotspots such as Peru, Colombia and Ecuador.

Brazilian company Petrobras has recently sold a 35% stake in a Santos Basin oil exploration project to China's Sinochem Group Co., Ltd. for $1.54 billion, all of the shares it owned in a petrochemical company, as well as shares in a Gulf of Mexico bloc and a thermal energy company in Brazil.

In December 2012, Ecuador signed a $2 billion loan agreement with the China Development Bank and simultaneously, state-run company Petroecuador signed an eight-year contract to sell crude oil and fuel oil to Chinese companies. Chinese banks are frequently making these loan agreements with oil companies in Latin America(4).

The same Ecuadorian company holds a 51% stake in a refinery project, in which China National Petroleum Corp, CNPC, are negotiating to acquire a 30% stake. These shares will be acquired from Venezuela's state-run oil firm Petroleos de Venezuela, PdVSA, who holds the remaining 49%.

CENTRAL ASIA: In addition, China has been making close ties with neighboring countries Russia and Kazakhstan. A Russia-China Investment Fund was established to jumpstart the investments in this region, where 70% of the investments will be in Russia and 30% in China(5). The purpose of the fund is to improve infrastructure for transportation of minerals among others.

More recently, Chinese President Xi Jinping's visit to Kazakhstan witnessed the signing of a series of deals worth a total of around $30 billion, including a $5 billion oil and gas deal under which China National Petroleum Corp will acquire a 8.33% stake in Kazakhstan's giant Kashagan offshore oil project(6), further increasing China's influence in post-Soviet Central Asia.

SOUTH EAST ASIA: We also expect Chinese investment in South East Asian countries like Indonesia and Malaysia to grow at an accelerated pace over the next few years due to their abundant natural resources. Mining and energy transactions in this region went up 15.7% from 2011 to 2012. China invested in 76 mining projects in ASEAN countries from January to April of this year and has signed seven mining cooperation agreements valued at about 16.3 billion yuan ($2.59 billion)with ASEAN countries during the China-ASEAN Mining Cooperation Forum and Exhibitionrecently(7).

AUSTRALIA: A noteworthy trend reversal is taking place Down Under. Despite being China's long-time favourite investment destination for resources, Australia has seen Chinese investment slip considerably in 2011 and 2012 in general. Statistics published by the Chinese Mining Industry Association(8) show that, in the first half of 2013, Chinese outbound direct investment in Australia's mining and resources sector totalled a mere AUD48 million, hitting lowest level since 2009. Multiple factors have led to such reversal. First, from a macroeconomic perspective, China's slowing economy and the on-going structural change and economic rebalancing have led to the decline in Chinese demand for commodities. Secondly, from Chinese investors' perspective, hindered by lack of execution capability for complicated cross-border transactions, only a handful of them have globalisation plans. Thirdly, from an Australian investment climate's perspective, the country's confusing and unpredictable foreign investment approval policy (especially policy towards foreign government-owned entities or investments in highly sensitive sectors such as agricultural), as well as the negative economic impact of the controversial carbon tax and mining resources tax on specific mining projects, have greatly deterred Chinese investment, shattering long-held beliefs that Australia is a sovereign-risk-free investment destination. In addition, constrained infrastructure capacity and labour shortage issues have thwarted Chinese mining investors' ambitions to engage in large-scale investment. All these factors, coupled with the considerable losses suffered by them as a consequence of failed mining investments in this continent, have, to a certain extent, caused Chinese investors to lose confidence in Australia. At the same time, Chinese investors have found new supply alternatives for their natural resource demands. Regions like Canada, South Africa, South East Asia, Latin America and Central Asia are undoubtedly turning an increasing number of Chinese energy and resource investors away from Australia.

Part II Chinese Outbound Investment Trends in Clean and Renewable Energy Industries

Powered by policy support from the government, China's cross-border investments in renewable energy have witnessed an unprecedented rate of growth in recent years. Over the past decade, China has made at least 124 investments in solar and wind industries in 33 nations around the world(9), and will continue to lead the world in renewable energy investment.

AUSTRALIA, NORTH AMERICA AND EUROPE: Countries in these regions have a focus on renewable energy for investment. Some of them have implemented policies to attract domestic and foreign investments in this sector. For instance, to ensure its goal of achieving 35% renewable energy by 2035, Germany has implemented support mechanisms such as feed-in tariffs and priority connection to power grids. Other countries, like the United States, have tax credits and loan guarantees to make their markets for sustainable energy more lucrative. Cutting edge technologies and know-how offered by these regions are also an important factor in attracting foreign investment.

  • WIND POWER: China's largest wind turbine manufacturer Titan Wind Energy Co. Ltd. announced in 2012 the acquisition of Vestas' turbine manufacturing plant in Denmark. Titan Wind Energy had for long been Vestas' supplier but because of this transaction, they have now become the owner of Vestas' manufacturing facility in Denmark. To Titan Wind Energy, Europe offers the most promising outlook for offshore wind energy, which is still relatively underdeveloped in China.

Early this year, King & Wood Mallesons advised Guohua Energy Investment Corp, a wholly owned subsidiary of Shenhua Group, on its acquisition of a 75 % stake in Hydro Tasmania's (a company owned by the State of Tasmania) 168-megawatt Musselroe wind farm project. The firm previously advised Guohua on its acquisition of a 75% stake in Hydro Tasmania's Bluff Point 65-megawatt and Studland Bay 75-megawatt wind farms in Woolnorth, Tasmania in early 2012. Upon completion, the total installed wind power capacity of Guohua in Australia will exceed 300-megawatts.

  • SOLAR ENERGY: Another renewable energy magnet for Chinese outbound investments is solar energy. China is one of the world's biggest solar panel manufacturers, four out of the ten biggest global solar panel companies are Chinese.

In a recent bid, Chinese company Trina Solar won the deal of supplying 1.1 million solar panels for a power plant in the desert of Nevada, United States.

As well as exporting to the United States, Chinese investors have also shown a great deal of interest in American solar panel companies. China Solar Power Holdings Ltd. has recently acquired 100 % of the shares of ThinSilicon Inc., and a 51% stake in Terra Solar Global Inc.

European solar energy companies are under the radar of Chinese companies as well. Chinese solar polysilicon and wafer manufacturer LDK Solar acquired a 38% stake in Germany's Sunways AG in 2012, adding to the 33% stake it purchased earlier in the year and providing China's second-largest solar-polysilicon maker access to new technology and a distribution network in the world's biggest photovoltaics market.

AFRICA: A recent trend worth mentioning is that Chinese investments in renewable energy in Africa are blooming. This appears to be largely due to the African governments' efforts to open up their economies for private investments and the possibility of feed-in tariffs. Chinese companies Yingli Solar and Suntech Power have invested in solar plants, whereas Goldwind and Guodian Longyuan have invested in wind farm projects in South Africa, for that reason(10). Moreover, Dongfang Electric, one of China's largest manufacturers of power generators, is poised to build a 120-megawatt wind power facility at Aysha, in western Ethiopia, with financial support from the China Exim Bank(11). Separately, just last month, Nigeria signed a $1.3 billion deal with two Chinese state companies, China National Electrical Equipment Corporation and Sinohydro Consortium, to build the Zungeru power plant in Niger state, also with financial backing from China Exim Bank. The hydroelectric plant is expected to add 700 megawatts electricity to Nigeria's current 4600 megawatts(12).

Part III Challenges Faced by Chinese Investors

Despite a slew of preferential incentives offered by the Chinese government, covering areas such as financing and equipment export, Chinese investors still face various challenges when investing abroad.

The foreign investment approval regime of a target country is commonly considered to be one of the major obstacles facing China's overseas mining and resources investment projects. In one recent example, Chinese-owned Ralls Corporation in the US was denied access to buy a wind farm located near a navy area in Oregon, USA. National safety was cited as the reason for rejection. Another example is the Australian finance minister's rejection of China Minmetals's proposed acquisition of the assets of the Australian company OZ Minerals. Again, national security reasons were cited because part of the target assets is near a navy area. Consequently, but unsurprisingly, the foreign investment approval regime of a country has increasingly become one of the key factors to consider for Chinese investors when they invest overseas.

High taxes and labor issues can be a major stumbling block as well. As discussed earlier, Australia is one of the countries seeing a decrease in Chinese investments. When asked why, the Chinese Mining Association quoted high carbon tax as the main reason(13). Because of high taxes, Australia is not able to compete with other mining markets like Africa, Norway, Kazakhstan or Russia. The new coalition government, which came into power in September 2013, has vowed to scrap the carbon tax and mining resource rent tax(14). But the timetable for implementation and replacement policy have yet to be announced, not to mention that the new coalition government is facing its sternest test since election victory as the tensions between its conservative and liberal wings are beginning to surface. It remains to be seen how this leadership tussle would impact the government's policy-making process.

Another general concern when entering a foreign market is the lack of knowledge of local laws and cultural differences. According to the analysis of an industrial insider, when investing abroad, Chinese companies tend to only focus on what they are going to invest and fail to consider every aspect of the investment as a whole.(15)For example, CITIC Pacific was hit with a multi-fold budget blowout on its 2 billion ton magnetite iron ore project in Western Australia and is at the risk of being unable to recover the costs after the commencement of production. The underlying reason for this is its lack of knowledge of the migration policies and environment protection laws, as well as the characters of the magnetite in Western Australia. This is often compounded by Chinese investors' lack of capability to efficiently restructure acquired assets and to execute complex cross-jurisdictional transactions.

Nonetheless, it needs to be pointed out that despite the above setbacks, we have seen positive signs of steady improvement. For example, more and more Chinese investors have taken the initiative to seek and rely on professional advice from financial, legal, technical and PR experts before embarking on their outbound investment journey. Also, Chinese companies are increasingly using consortiums as a form of acquisition vehicle, allowing industrial investors, EPC contractors and financial investors to combine their strengths and jointly execute an acquisition or investment. In addition, the participation of professional investors such as sovereign wealth funds and private funds has enabled Chinese outbound investments to be made in a more professional way.

According to a survey undertaken by PwC, during 1986 to 2006, as much as 67% of China's outbound investments ended in failure. However, according to one news report, the official statistics published by the Ministry of Commerce at the end of 2012 showed that only a small fraction of China's outbound investments ended in failure. In particular, of all the more than 2700 overseas companies owned by the central government, 80% broke even or made a profit, with only 20% reported losses. Despite this, Ministry of Commerce officials did admit in the same news report that Chinese outbound investments were exposed to high risks and there were quite a number of failed cases.(16)