Africa has presented an untapped paradise of natural resources for Chinese investors who were unconstrained by the human rights protocols and shareholder value constraints of western counterparts. China has invested billions, yet it is feeling the backlash from host governments taking a stand against the concentration of economic influence in the hands of one foreign power and local populations whose expectations of economic growth have not been met. Elizabeth Stephens from JLT reports.

From oil contracts in Sudan, to stakes in South African banks and arms sales to Ethiopia, China is reshaping the investment and risk landscape of the African continent. Trade between China and Africa exceeded £34bn in 2007, a six-fold increase since 2000. The historical major players in Africa – the US, Europe and Japan – have a new competitor in the race to secure long-term access to vital natural resources.

China’s voracious demand for aluminium, copper, nickel, iron ore and oil, has compelled the government to establish mining interests in 13 African countries with prospects in four more territories – Namibia, Ghana, Congo and Mali. At the forefront of the resources drive is the quest for oil. China overtook Japan as the world’s second largest oil consuming nation in 2005 and by 2045 is projected to depend on imported oil for 45% of its energy needs.

With the Middle East beset by instability, China has turned to Africa, to lock in its ‘low-cost’ resource supplies. It is seeking oil supplies from Chad, Angola, Algeria, Gabon and Equatorial Guinea, although its most notable presence is in Sudan where it takes 64% of the country’s oil exports and Nigeria, where state-owned energy company Chinese National Offshore Oil Corporation (CNOOC) has bought a 45% stake in an offshore oilfield for US$2.27bn.

Market flood
Yet the story is not about commodities alone – it is about the domination of an emerging consumer goods market of over 800mn people and infrastructure projects to sustain them. China is flooding the African consumer goods markets with low-cost textiles and electronics, squeezing western companies out through price if not through quality.

Since 1995, China has taken around a US$6bn stake in Africa’s telecommunications sector through Zhongxing Communications and employs more than 1,100 people across the continent. Beijing has invested in prestige projects such as railroads in Angola and Nigeria, sports stadiums in Mali and the Central African Republic and Africa’s largest dam in Ethiopia.

In the textiles sector, some Chinese manufacturers are allegedly investing in African factories both for local commerce and to circumvent US and European quotas on the import of Chinese textiles.

China is also gaining influence among the continent’s more affluent citizens through strategic acquisitions in the retail banking sector. In October 2007, the Industrial and Commercial Bank of China (ICBC) bought a 20% interest in Standard Bank, the largest bank in Africa by assets. Standard is widely considered to be the most blue chip and stable financial group on the continent and the US$5.5bn investment gives ICBC a stake in a continent-wide banking network with over 200 branches in 18 countries. This is a clear sign of a maturing of China’s presence in Africa and its ability to compete with the west in all sectors of investment.

Selling its appeal
China has worked hard to present itself as an alternative to the often perceived presumption of the western model, which has increasingly linked investment with ‘good governance’ and ‘human rights’. It is therefore seen as presenting an element of neo-colonialism in instructing African countries how to operate.

The Chinese come to Africa as equals, with no colonial hangover and no complex relationship of resentment. China wants to buy; Africa has something to sell. There is a tendency for African countries to look to China and see success: according to the World Bank, the Chinese have lifted 400mn of their own people out of poverty in the past two decades and through this process no one forced the Chinese government to change their political system or submit to the scrutiny of a free press.

Many African governments have responded enthusiastically, in some instances reneging on commitments to western companies and passing their interests to Chinese entities. As a consequence, western investors may now find their assets at a higher risk of contract renegotiation or expropriation, than in the past, when they were the only source of foreign investment and the relative ease for African countries of doing business with their Chinese counterparts was not a factor. For example, in mid-2006 the Kenyan government removed oil exploration concessions from two European companies and passed the contracts to the CNOOC.

“The trading of infrastructure projects for raw materials contracts is one strategy China has used to establish itself on the continent,” says Peter Merton, deputy underwriter, marine and specialist risks division, at Lloyd’s broker Kiln. Beijing offered the Angolan government a US$2bn aid package as part of an oil concession agreement, which created business opportunities and market share for Chinese companies to build railways, roads, hospitals and schools.

In September 2007, China signed a deal to loan the Democratic Republic of Congo (DRC) US$5bn to develop infrastructure and mining. In exchange, China will get rights to DRC’s extensive natural resources, including timber, cobalt and copper.

The Chinese companies operating in Africa are usually state-owned enterprises (SOEs) whose operations are viewed in Beijing as a component of the national interest and are inextricably interlinked with foreign policy. As a consequence, Chinese businesses can rely on the wholehearted support of their government when investing in Africa, which is demonstrated by Beijing’s aggressive courting of the leaders of resource rich countries.

China’s president, prime minister and foreign minister all visited the continent in 2007, offering aid packages, debt forgiveness and diplomatic support. China has cancelled the debts of 33 poor African countries as a gesture of goodwill and in July 2006 import tariffs were cut on 454 items from 32 ‘least-developed countries’.

“The lack of financial constraints enables China to provide a source of finance with which the west finds it difficult to compete,” explains Jean Talbot, deputy head of energy and commodity structured debt for Africa and the Middle East at BNP Paribas. SOEs benefit from a greater degree of commercial freedom than their western counterparts and are more likely to be judged on success in securing supplies of raw materials than on the price they get.

Different rules
In contrast, the shareholder value focus of privately-owned western companies fundamentally alters the risk appetite and risk management of a project. This enables Chinese companies to offer the lowest costs when bidding for contracts and the highest price for resources. As a consequence, in major oil producing countries the conditions for bank financing of projects have changed.

Previously pre-export finance transactions were well structured but the inflow of Chinese funds “softened conditions tremendously until 2007 when the credit crisis stopped the trend and in some instances reversed it,” says Talbot.

More significantly, Chinese companies are still effectively immune to the reputational risk that beset western companies investing in some African markets. The best example of how these factors manifest is seen in China’s oil-based links with Sudan, which have drawn bitter criticism from sectors of the international community. China has appeared to use its membership of the United Nations Security Council to shield the Sudanese regime against international pressure over starvation and mass killings in the province of Darfur and in the process secured the majority of current oil production and future exploration rights. This investment ‘strategy’ is closed to western companies.

The reputational risks inherent for a western company investing in the Chinese business model was highlighted by Berkshire Hathaway’s sale of its stake in Petro China, a CNOOC subsidiary traded in New York. While Warren Buffett, who controlled the investment vehicle, maintained that he had sold the stock after realising full return on his investment, the sale came amidst protests from Hollywood stars over China’s response to the situation in Darfur.

The pursuit of disinterested commercial gain is not new. Strategic interest often takes precedence in foreign and economic policy decision-making. The US, for example, is highly selective about who it is moral about. It enjoys strong relations with Saudi Arabia, Egypt and Pakistan, despite their reputations for poor human rights. Ironically, China is making a virtue out of its refusal to link trade and investment while the western emphasis on human rights and democracy “while morally correct, created the space for China to get involved,” says Adrian Lewers, head of political risks and contingency group at Beazley.

“Whilst some African leaders may regard China as easy money, I don’t expect China to prove to be a particularly comfortable bedfellow in the long run,” says Lewers.

Contracts cancelled
On big construction projects, wherever possible, the Chinese insist on importing their own workforce – sometimes even conscript labour. These workers live in sprawling camps, eat food imported from China and make little or no effort to integrate into the African way of life.

A staggering 750,000 Chinese have settled in Africa over the past decade and even unskilled labour is provided by the Chinese. Their unwillingness to employ indigenous workers, thereby distributing wealth throughout society, is creating discontent and in this way “African expectations in working with the Chinese have not been met,” says Talbot.

“There is no reason why the Chinese will not experience the same issues relating to contract enforcement as western investors,” says Lewers. “African governments are aware that investment is available from a range of sources and they aren’t committed to just one.”

This has proved to be the case in Angola where in June last year the government cancelled a deal with Sinopec to build an oil refinery in Lobito, a US$3bn project, in protest against China’s tendency to import labour rather than use locals.

In those countries where locals are employed, labour-employee relations are strained. China reopened some copper mines in Zambia but the relationship soured as miners grew resentful over what they said were harsher and less safe working conditions for lower pay than in the many other foreign-owned mines.

An industrial accident at the Chinese-owned Chambishi mine claimed 46 lives in 2005 and was blamed on lax safety. The following year the police shot five miners at Chambishi in a riot over working conditions. The government temporarily closed another mine after men were forced to work underground without safety gear and boots.

Tensions are so high that during the 2006 presidential election, the leading opposition candidate, Michael Sata, campaigned on an explicitly anti-Chinese ticket. While Sata lost the election overall, he won huge majorities in all the areas of Zambia affected by Chinese investment. His defeat prompted a day of anti-Chinese riots in the capital, Lusaka. Every Chinese-owned shop in the city was barricaded to avoid being looted.

The fear of Chinese ‘colonialism’ is also being used by Congo rebel commander General Laurent Nkunda to justify his campaign against the government. Nkunda has claimed that if the government signs further contracts with China the country will “be under Chinese economic colonialism for 60 years”.

Chinese workers are also falling victim to the activities of terrorist organisations. Kidnappers killed five Chinese oil workers in Sudan in October, while nine Chinese workers were killed in an attack by armed men on an oilfield in eastern Ethiopia in April 2007.

Like all predominantly western investors before them, China’s economic domain in Africa is stirring deep resentment. The surprise is that it has happened so quickly. It is unclear how far the backlash will carry or where the balance of power will lay in a period of falling commodity prices and illiquid markets.