May 2007

MAC Economic Commentary

China as an economic superpower – implications for the Canadian mining industry

By P. Stothart

There is no shortage of printer’s ink being spilled in recent years writing about the emergence of the Chinese economy. This is, without question, one of the top global news stories of the past decade. After 15 years of double-digit annual growth, the size of the Chinese economy has now reached a state where continued double-digit growth has very meaningful implications for many industries and countries. Where 10 per cent growth in 1990 may not have had much impact on a global scale, similar growth in 2007 on a much larger economic base has reverberations throughout the global economy.

The emergence of China as a world economic power, and its continued growth, will have direct implications for the Canadian mining industry in three important areas.

Impact 1 – Driver of world mineral prices

First, China remains the prime driver of world mineral prices. China is building a domestic infrastructure for 1.3 billion people and is concurrently expanding its role as the world’s manufacturing centre for many product areas. The country simply cannot meet its own needs for copper, zinc, nickel, and other core ingredients of a transportation, power, and communications infrastructure.

In response to this growth, China now imports $100 billion worth of base metals annually. It presently buys around 25 per cent of the world’s base metals versus a 5 per cent share in the 1980s. As one specific example, where China accounted for 10 per cent of world zinc consumption in 1996 (one-third of Europe’s share), a decade later it accounted for 28 per cent (versus 25 per cent for Europe). The US and Japanese shares have fallen from 16 to 10 per cent and from 10 to 6 per cent, respectively, during this period.

With the emergence of India in the near future - perhaps on a scale comparable to China - and with a constrained availability of new global reserves, the supply and demand conditions are such that many forecasters feel the world’s mining industry will enjoy an extended commodity price boom. It is worth noting, for example, that while China is now the world’s largest consumer of all major metals, its metal consumption per person is still low in comparison with developed Asian economies.

Drawing on these fundamentals, metal prices have increased very strongly in recent years. During 2005, copper prices grew 50 per cent, gold 20 per cent, silver 31 per cent, and zinc 46 per cent. In 2006, these prices grew by a further 48, 30, 55, and 118 per cent, respectively, while nickel prices increased 142 per cent.

This price growth, in turn, translates into record company profits, large executive compensation packages, and multi-billion dollar mergers and acquisitions. The takeovers of Inco and Falconbridge by CVRD and Xstrata were each driven, in no small part, by views on how best to take advantage of the Chinese reality.

Impact 2 – Canadian trade and investment partner

A secondary impact on the Canadian mining industry relates to the simple fact that Canada and China have an active trade and investment relationship that will likely become more significant in the future.

Most Canadian trade with China is one way - Canada’s trade deficit has risen from $1 billion in 1995 to some $15 billion a decade later. The ports, highways, and railroads of Canada are strained to capacity with containers carrying east-bound Chinese-made electronics, machinery, clothing, and toys. Containers moving in the other direction are often empty or half-filled with resource-related products. Mining products, pulp, other forest products, wheat, fertilizer, and chemical products are noteworthy Canadian exports to China.

The Canadian mining and metals industry exported some $60 billion worth of metals and nonmetals worldwide in 2005, including around $13 billion in iron and steel, $4 billion in each of gold, copper, and nickel, and $2 billion in both uranium and iron ore. The United States is the main destination for Canadian mining products, receiving 70 per cent, although China is an important destination for mineral products such as iron and steel, nickel, copper, potash, and sulphur. Canada supplies an estimated 17 per cent of China’s nickel requirements.

While important, it is nonetheless possible that the trade relationship will become secondary to the investment relationship over the coming years. The Canadian mining industry has historically had a significant global investment reach. As of 2005, Canadian mining companies had $50 billion invested abroad - aimed primarily towards the United States and South America. Investment in China could increase as the country continues to modernize, particularly if downstream investment policies are liberalized.

It is also possible, if not probable, that Chinese investment in Canada’s mining industry will grow over the coming years. China presently holds US$1 trillion in foreign exchange reserves. While investment abroad was discouraged by Chinese authorities until only a few years ago, this is no longer the case - China is investing actively in Africa and is increasingly seeking opportunities in Western countries. A Chinese company has made a modest investment in a Canadian oil sands project and more investment may be on the horizon. Given the prospect of increased investment flows, the governments of Canada and China are presently negotiating a Foreign Investment Protection Agreement.

Impact 3 – Potential source of future disputes

In line with its emerging position as a world economic super-power, it is likely that China will also emerge as a potential source of future global disputes, in areas such as trade, investment, and the environment.

The existence of a $200 billion trade surplus with the United States has already raised concerns in Congress and a dispute over the valuation of China’s currency raises the possibility of US countervailing duties. The US may have limited leverage on these issues, given the influence that China exerts on the value of the US dollar. However, it is worth noting that a first formal panel against China under the World Trade Organization has been struck - by the US, Europe, and Canada - challenging Chinese auto parts tariff policies.

With respect to mining, many economic observers believe China is becoming increasingly protective of its raw material supply. For example, China has a permit system for copper concentrate and an export duty applied on unwrought copper—both of these policies are aimed at protecting critically important raw material supplies for domestic use. The effect is to keep these raw material flows out of the global trading system. A similar effort is being seen in energy. Countries such as Germany and Japan are themselves reliant upon raw material supply to feed large domestic manufacturing needs and are increasingly concerned about this practice. The OECD has recently agreed to study this general issue in greater detail.

Other disputes will likely emerge in other areas, such as the environment and climate change. This theme will be the subject of a future column.

Paul Stothart
Paul Stothart is vice-president, economic affairs, at the Mining Association of Canada. He is responsible for advancing the industry’s interests regarding federal tax, trade, investment, transport and energy issues.

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