Chang Zhenming, chairman of Citic Pacific, is unambiguous about the significance of his company's Sino Iron mine in the desolate, red-soiled Pilbara region of Western Australia. "The whole of China is watching this project," he says.
More to the point, China is watching with some trepidation as his Hong Kong-listed company faces increasing cost overruns and delays. The stakes are high. Mr Chang says Sino Iron is four times bigger than any iron ore project at home.
While outside observers often fear Chinese companies are unstoppable juggernauts in their ravenous pursuit of the world's minerals, much of this perception is inaccurate. China's international resource expansion is not running smoothly.
The world's second-biggest economy had hoped it would more easily control its economic destiny by taking huge mineral stakes, robbing companies such as BHP Billiton, Vale and Rio Tinto of the ability to dictate commodity prices.
But the Sino Iron project, far from being a showcase for China's might, has become instead a cautionary tale of the difficulties Chinese enterprises face as they seek to expand abroad. When it was first conceived in 2006, the total cost was estimated at under $2 billion. By now, it has already cost Citic Pacific $7.1 billion. Analysts at Citigroup calculate the bill could swell to a possible $9.3 billion, while others say they expect the ultimate bill will be closer to $10 billion. The mine is at least two years behind schedule.
"This is no longer about commercial goals," says a senior executive at one leading Asian trading company with extensive sourcing operations in Australia. "It is about Chinese machismo. They have plonked down too much money to pull out now."
In fact, it is about more than machismo. China imports about 60 per cent of its iron ore and the project was a fundamental attempt to break free of foreign suppliers, which Chinese steelmakers accuse of driving prices too high.
"China has always been captive to a few players. Now the country no longer wants just to passively receive the offtake from projects," says James Cameron of HSBC, describing the trend. "They want to develop new sources of raw materials and they want equity in projects."
But the problems at Sino Iron show China is struggling to do this. Its companies are straining to prove they have the knowhow and managerial skills to work in environments very different from their homeland.
Chinese enterprises are often unprepared for the rigours of foreign competition after spending so long operating cosily under government protection at home. Cultural problems over labour laws and the nature of contracts cause particular angst.
Sino Iron is not the only Chinese project in trouble in Western Australia. There are 14 important iron ore projects in the region. Eight of them have Chinese money and bankers say several are plagued by similar delays and cost overruns.
The $2.6bn Karara iron ore joint venture between China's Anshan Iron and Steel and Australia's Gindalbie Metals has been weighed down by infrastructure design changes, rising material and labour costs, and currency movements.
In some cases, there is simply bad luck. But in most, the problems are partly due to overly optimistic estimates of everything from the productivity of local workers to the environmental sensibilities of their host government – all considerations that are not problems at home.
China's difficulties in forecasting realistic costs for foreign projects stretch beyond the mining industry.
China Railway Construction Corp, the Hong Kong-listed unit of a mainland enterprise, said last year it expected to lose about Rmb4bn ($628 million) on the construction of a light railway line between Mecca and other cities in Saudi Arabia, after construction cost overruns.
Embarrassingly, the deal was a high profile one. Both President Hu Jintao and the Saudi king were at the signing ceremony. The project was eventually transferred to its state-owned parent, limiting the listed company's losses and future liabilities. Beijing is now expected to help compensate the company for unexpected project adjustments and changing requirements from the Saudi government.
China certainly has successfully managed some foreign enterprises – such as Volvo cars, acquired by Geely in 2010. Its oil companies are also establishing an international presence in areas as far afield as Africa and Latin America.
But mining projects are a special concern for Beijing's strategy makers and there is a regular set of difficulties that repeatedly undermines its companies abroad in this sector.
Labour at mines causes particularly deep misunderstandings.
China's mining plans call for the use of Chinese labour with its lower cost and higher productivity. But Australian labour laws and visa requirements made that impossible. Instead, projects rely on expensive Australian workers. Even truck drivers can be paid $200,000 each year, receive three-room housing and free home leave every two weeks, which in some cases means flights to Bali. Despite what the Chinese regard as generous pay packages, they still have to contend with labour strife.
More broadly, Chinese companies want to control their own fate in projects, which is why they head abroad in the first place. This is in contrast to the Japanese, who have learnt to opt, at least initially, for minority stakes and rely more on local players. By seeking control, negotiations can become confrontational, especially since the Chinese are generally reluctant to pay high fees for local advisers on the ground.
Moreover, the Chinese have a preference for vague language in contracts, lawyers say. That makes sense in China, where conditions change rapidly and both sides understand that contracts are a starting point for talks rather than rules set in stone.
One of the less well-known drawbacks of Chinese businesses is that they sometimes fight among themselves and are hardly monolithic executors of a central mission statement from Beijing. This is partly because Chinese enterprises are evolving into commercial animals with competing interests. "China and its banks are growing out of the posture of China Inc," says one banker working in project finance at a leading international bank.
More specifically, all the main participants in the Sino Iron saga, Citic Pacific, with 80 per cent of the equity, China Development Bank, its principal lender, and China Metallurgical, the main contractor with the remaining 20 per cent equity in the project, are squabbling. CDB wants to pull out of the project, while Citic Pacific has considered suing China Metallurgical for the delays and budget overruns, according to people familiar with the matter. Recently, the dispute went to the State Council, or cabinet, where Wang Qishan, the vice premier in charge of financial matters, adjudicated, according to a person with direct knowledge of the matter. Citic Pacific declined to comment.
The project is a source of particular frustration for its financiers at CDB, which has lent almost $5 billion. Sino Iron was exactly the sort of undertaking CDB, an unlisted policy bank whose priorities are set by Beijing, was meant to finance. When the project was first envisioned six years ago, China was desperate for iron ore to turn into steel, the innards of everything from cars to capital equipment, from residential towers to railway tracks.
The market has changed, however. Chinese developers are coming to the chilling realisation that they are planning to churn out iron ore at the wrong point of the steel cycle. Over the five years since the project was first conceived, China's steel demand growth has dropped and prices have fallen. In 2010, for the first time in more than a decade, China imported less iron ore than the previous year. In 2011, tight money policies and harsh restrictions on property construction continued to put downward pressure on steel prices.
If this were not enough of a headache, miscalculations over currency have played a role in increasing costs. The Australian dollar appreciated over the life of the project and controversial hedges that Citic bought went wrong, causing a $2 billion loss and the departure of senior executives.
The Mineral Resources Rent Tax that the Australian government plans to introduce on July 1 will further dent the profitability of mining projects, as will a plan to levy fees on carbon emissions.
The troubles at Sino Iron mean Citic Pacific, which officially sits directly under China's State Council, carries a junk rating from Standard & Poor's, despite its august parent, China's Citic Group. Brokerage CLSA says the shares of the conglomerate, which also owns utilities, should trade at a 45 per cent discount to its net asset value because of the mine.
In the past, the Chinese government has not held its enterprises accountable for their failure to deliver. That is changing now both at home and abroad, as losses from projects gone wrong mount up.
Indeed, the State Assets Supervision and Administration Commission recently called on its charges to improve the management of their overseas operations. In an unusually public denunciation, Chinese media quoted the commission berating state companies for frittering away cash.
For example, Sinosteel last June stopped work on another iron ore project, its Australian Weld Range mine, which it had acquired in 2008 for A$1.36 billion. This depended on the Oakajee Port and Rail project to transport the iron ore, but this has also run into difficulty. One of the proposed solutions was that Sinosteel should buy half of the Oakajee project. But Beijing has removed Sinosteel's president, Huang Tianwen, and sources in the industry say it is unlikely that the Chinese government will approve such a deal.
This all gels with signs that China is now reining back its high-spending ambitions. CDB is becoming palpably more cautious. The state-run China Railway Engineering Co has formed a joint venture to build a railway to transport coal in Indonesia. While in the past this would have seemed a very straightforward CDB project, it is now seeking that the sponsors, including foreign partners, guarantee the loan in order to avoid a repeat of the Sino Iron debacle.
One person involved in the deal says: "It is a good project but slow progress means the Koreans may spoil the party."
As the Chinese become more wary about expansion, it will not just be the Koreans who seek to fill the gaps they leave behind.
Additional reporting by Leslie Hook.
Copyright The Financial Times Limited 2012.
China's Australian mining void
The Sino Iron project is a cautionary tale of the difficulties Chinese companies face in attempting to exert control over commodity prices through international expansion. And it's not the only project in trouble in Western Australia.
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