Oriental Mining Club – Inaugural Dinner



                        October 18th 2009
                         Kerry Centre Hotel, Beijing

                          Keynote Speaker – Clinton Dines

         
Thank you Peter. 

First and foremost I want to thank you for having me and thank you all for coming out tonight in support of the OMC’s first major function ever.

My sincere congratulations on getting the Oriental Mining Club (Dong Fang Kuang Ye Ju Le Bu or Xie Hui or 东方矿业汇？？) going. I do feel greatly honored to be invited as the inaugural speaker for this event……And I wish the OMC every success in the future as a forum for high quality events and for sharing ideas among the mining community. The Melbourne Mining Club has a very long history and great tradition, and it would be wonderful if something similar (but perhaps with some Chinese characteristics?) could gain the momentum to become established in this part of the world. 

And that’s of course what I would like to talk about this evening……this part of the world, specifically China, and discuss a few key themes and make one or two observations about what I’ve seen and experienced in my time here…….and then of course perhaps look into the crystal ball and ruminate a little on the emerging trends and scenarios that I am sure occupy your minds as well as mine. 

I am very fortunate in having arrived in China over 30 years ago and I’ve been privileged in that time to have been able both observe and, in a very small way, participate in the momentous changes that have taken place and which continue to this day, even accelerating perhaps. The impact of China’s “reform & opening” polices has been massive and profound, on the economy, on Chinese society and even, I would argue, on the way politics is now conducted. Much has changed and China recently had much to celebrate at the 60th anniversary of the founding of the PRC. I would suggest that the second 30 years of the PRC, under Deng Xiaoping’s vision, has been the period in which most of China’s real progress towards becoming a fairer and more prosperous society has taken place. Of course, although all of the change in China during the reform period has been domestically‐directed and intended to raise the living standards of the Chinese people, it was inevitable that the rapid re‐emergence of a nation of China’s sheer scale and population would also have some impact on the world. In the first 20 or so years of the reform period the rest of the world, especially the developed world, didn’t pay very much attention to China or to what was happening in China – only strange people like me who were living and working here and those academics or specialists (or China‐watchers in Hong Kong) were really paying attention – and the jury of conventional wisdom on whether China was making progress was undecided or unconvinced and generally quite skeptical about the likelihood of success. China was still effectively a closed country in many respects, not easy to deal with in many ways, and not really critically important in the global economy…….of course, as a nuclear power, China sat on the UN Security Council, but in other respects China was mostly regarded as just another emerging mid‐sized Asian economy with some potential. It was hard to get head office to take China very seriously as a big priority for the future (I know, I tried….) and even when they did things often didn’t go very well—the story of foreign investment in China in the 1980s and 1990s was not a litany of outstanding successes. in the meantime, almost un‐noticed in many ways, China was pressing ahead with the fundamental reforms which would underpin the spectacular acceleration of economic growth and development in this decade, and which really have brought China to the forefront of everyone’s consciousness, especially in this post‐GFC Era. 

China now matters in ways that very few people or corporations or nations have been able to anticipate. From not being a particularly significant feature of the landscape 10 years ago, China is now the pre‐eminent feature of the landscape and is going from strength to strength – this relatively new state of affairs has huge implications for us all and worth some serious thinking…….. 

Of course, one of the sectors most impacted by China has been mining ‐the energy and natural resources sector. This is a sector that should wake up every morning and say “thank you” to China……… 

From the first Oil Shock in 1973, which saw the end of the Post‐WW2 and 60s Resources Boom……and then this was reinforced by the Second Oil Crisis in 1980 and, in the low growth global economic environment that followed, the minerals and energy sector experienced year‐on‐year real price decline for more than 2 decades. It surprises almost everyone to learn that it was only after the steep prices rises of recent years that prices for most mineral commodities recovered to their 1981 levels in real terms. For most of my career at BHP Billiton copper was below $1/lb, thermal coal was often below $30/ton, iron ore was rarely above $20/ton…….and I saw oil go down to $12/barrel. Markets, shareholders, investors, boards and company managements naturally are forced to react to such circumstances. The impact of low growth and real price decline on most industries in the developed world in that Era was clear enough, but the resources sector, being the furthest upstream, quite capital intensive, cyclical in nature, and being highly dependent on demand from the materials‐intensive kind of infrastructure development and manufacturing activity which was declining in the major OECD economies, was hugely affected. Sustained low growth and falling prices in any business ultimately leads to disinvestment and consolidation – and this happened on a massive scale in the resources sector and as a consequence in all of the sectors which serviced and supported the minerals businesses. By the late 1990s, consolidation had seen the big oil companies all dispose of their mining assets (BP, Shell, Exxon, Arco, Occidental, etc.) because of chronically low returns. In the same period, industry consolidation towards economies of scale saw the emergence of large diversified mining groups like Anglo American, Rio Tinto and BHP. there was also a sustained decline in exploration spending and the shutdown of a lot of capacity among supporting industries such as mining engineering groups, truck and equipment producers, industrial tire manufacturers, explosives producers, etc. the key universities in the big resources nations – the US, UK, South Africa, Australia, Canada – were producing fewer and fewer graduates in mining or geology. Infrastructure developments, like railways and ports, were postponed or cancelled. Rates of return were low, there was global surplus capacity in just about every mineral and energy commodity………..everyone wanted to invest in dotcom, not commodities. 

And then along came China….. 

In the late 1990s and early this decade China was doing four things – growing rapidly year-on‐year, growing on a very large scale, experiencing growth more and more driven by market‐based supply/demand factors and experiencing growth characterized by the development of the physical economy (urbanization, housing construction, infrastructure, manufacturing). The compounding growth and manufacturing expansion of the 1990s converged with Zhu Rongji’s Housing Reforms late in the decade at the same time as the true economic geology of China’s minerals endowment made real costs of being obsessed with raw materials and energy self‐sufficiency much more apparent, and burdensome. The result was that China came into the global commodities markets, at first only buying modest quantities but then accelerating over a very short period of a few years to become the first major vortex of new demand growth for raw materials and energy that the world had seen since the Post‐war Reconstruction Boom and Japan’s Industrialization. What had been a structural surplus of commodities was rapidly absorbed and soon became a deficit, a shortage. Prices responded accordingly, but the supply side, suspicious that perhaps China’s growth story might not be sustainable, was slower to react – a new generation of commercial NPV‐driven MBA‐style resource company managements had taken over from the traditional “build it anyway” mining engineers……they and their boards were reluctant to invest in new capacity until they had real conviction that the new demand was going to be ‘sticky’. The uncertainty about data from China and the reflex lack of transparency of the Chinese government and customers made the situation worse. 

Thus, as China’s demand continued to exceed even our most bullish estimates, the shortages got worse and the prices got higher. Chinese buyers and the Chinese government, being quite new to global commodities markets and, like the rest of us, not having anticipated the impact that China’s buying would have on markets, became concerned about rising prices (for the potential impact on inflation) and about the actual physical availability of raw materials essential for national development (in other words, security of supply). The convergence of these factors led to the kind of high‐profile market tensions that manifested in 2004/05 iron ore price negotiations – a 71.5% price increase is going make anyone sit up and take notice!—and the price negotiations, complex and dramatic as they were, and exacerbated by what was and is a very silly and arcane pricing mechanism, became a lightning rod for a lot of the worries that were building up on both sides. China felt like they were losing out in the commodities markets and foreign suppliers began to realize that China’s was not going to be a nice straightforward ‘dig & deliver’ proposition after all. Both sides have since embarked on the process of learning how to adapt to the new situation and to this day are still trudging their way up their respective learning curves, seeking a modus for the new world. Everyone is learning, it’s going to take a while……

Another aspect of the resources game with respect to China, a much quieter and lower profile one, but nonetheless interesting and dynamic, is that of foreign investment in China’s minerals and energy sector. China is a really big piece of dirt – the 3rd largest sovereign area of land in the world – it is well‐mapped, lots of preliminary geology has been done across much of the land area, geochemistry done for nearly all of it, aeromagnetic surveying done over a large proportion, etc. There are and have been geological prospecting teams working throughout the country for decades, including some foreign efforts in the last decade or so. 

So the question arises, why hasn’t China found lots and lots of really good mineral deposits? Is it, as so many of my Chinese friends have said to me, that Australia is incredibly blessed with minerals and Chinese is cursed with resource poverty? Is it that China has been an active mining civilization for over two millennia and all the good stuff has already been dug up? Is it that China’s years of isolation from the world prior to Deng’s Reform and Opening Policy meant that China missed out on advances in geological and geotechnical sciences which could have unlocked more deposits? Or is it that there systemic and policy limitations that are yet to be overcome before China can have a fully functional resources sector? Are there cultural and philosophical barriers which are impeding the scientific development of the mining as an industry in China? 

For the record, I would suggest that all of these elements are contributing factors but there only some of them which are within the control of Chinese policy‐makers – you can’t change your natural endowment, you can’t change your historical legacy ‐but you can change the way you do things in the future. The minerals sector has been one of the sectors which has been late to change during the Reform and Opening Era. Everyone understands this – the resources sector is sensitive in all nations and cultures all around the world and all governments are cautious about reform and change in the sector, and cling to control of their natural resources sectors. All countries have resource nationalism. In terms of a way forward, China would do well to perhaps look more closely at the countries which have well‐developed mining and energy sectors in order to identify the factors which make these regulatory frameworks successful – it is not just a matter of having good resources, you need good policy. 

My own experiences of being an investor in China have been challenging and fascinating and very rewarding, at least on a personal level. Even before I joined BHP I was afforded the opportunity of a close up look at one of the earliest, and easily the largest, foreign mining investment in China – the Pingshuo/An Tai Bao coalmine in Shanxi. The company that I worked for provided logistics and procurement support for the project. Once, in early 1985, I made the mistake of riding one of our trucks all the way from Beijing to the mine in the middle of winter …a trip of 17.5 hours. We had to stop regularly because the diesel fuel at that time was so full of paraffin that the wax would freeze in the tank and fuel lines and also gum up the fuel pump. Our drivers solved this minor problem by the simple expedient of building fire underneath the truck’s fuel tank to melt the wax and make the fuel flow again. They carried a stock of pine kindling firewood for just this purpose. I stood shivering in the sub‐zero temperatures and howling wind, some distance away, until the fuel was liquid again and the drivers were able to drive the truck off the happily‐crackling fire……

That the Pingshuo JV coalmine was perhaps an ill‐conceived and poorly‐executed investment on the part of Mr. Armand Hammer and Occidental is probably now not a question that I need to address (I believe there are case studies on it) but the legacy for China is that there is now a large well‐developed open‐pit coal mining operation and associated infrastructure in central Shanxi which is now well into its second generation of development with an Jia Ling and other step‐out properties in the area – and there is a lesson in that. 

When I joined BHP we were keen to explore in China and I am proud to have been part of the team of people who negotiated and established the first Sino‐foreign exploration joint venture between China and a major western mining house – the Kang Dian JV in Sichuan. Kang Dian took 2 years to negotiate. There were no rules to refer to, we more or less wrote the book on Sino‐foreign exploration investment as we went along. When measured by how well the partnership progressed and how effectively we worked together to undertake the defined exploration, Kang Dian was a very successful venture – pity we didn’t find anything, but that’s bloody geologists for you! i am assured that we had several “technical” successes……. 

China’s foreign investment rules were structured for manufacturing projects not minerals projects (and this is generally still the case) and were certainly not suitable at all for risk exploration projects. One thing that became clear to us as we negotiated in Sichuan was that if we wanted to see the regulatory environment evolve, we were going to have to contribute to the process. And we did….over the next several years, as China was reviewing policy and rewriting the mineral law, BHP did workshop after workshop here in China and in Australia and the US and Canada, with delegation after delegation of Chinese officials, geologists and drafters. Our lawyers and commercial experts spent many a long visit to China explaining the hows and the whys of overseas regulatory principles. We physically shipped the entire minerals statutes of each Australian state and Canadian province and quite few of the us state mining laws to the ministry of geology (as molar was then known), in many very large heavy boxes I recall! These days you can bring them all on a CD Rom or look them up on the internet…… But this was our view of what was necessary, how we could build relationships and how we could make a real contribution to the evolution of China’s minerals investment regime. And the drafters at MOG made good use of these materials in the comprehensive review that resulted in China’s new mining law. We made a lot of good friends through the process, but I don’t think I will surprise anyone here if I comment that I feel that progress has been disappointingly slow and, in my opinion, to the detriment of China’s own ability to supply herself with at some part of her raw materials needs……..that the major mining houses are all now doing very little in terms of investment in exploration in China is a trend that is worthy of note. And, while some xenophobes here might applaud this trend, I would suggest that an open flexible active diverse technically and commercially capable investment environment for minerals exploration and development is usually also a very productive one. 

Everyone understands the sensitivities of resources and everyone understands that it takes time to evolve towards an effective investment regime – but the fact remains that China is a very difficult and expensive place to explore and has become progressively less encouraging of foreign investment in recent years, both by policy and in implementation. During a time of high demand for mineral resources the emphasis needs to be on achieving the most effective outcomes as soon as possible. 

By the way, don’t let what I have just said lead you to think that the resources sector is being specifically targeted. While resources do have their particular sensitivities I am not suggesting that the minerals sector is being treating very differently from other industry sectors in the way that Chinese foreign investment policy is evolving. China’s needs in terms FDI have changed enormously from when these policies were first promulgated – back then, in the 1980s, China needed capital, foreign exchange, technology, exports, etc. this is no longer the case, China’s needs have evolved and so must China’s foreign investment policy – and I think even a quick reading of the MOFCOM foreign investment catalogue over recent years demonstrates this fairly significant shift in emphasis and priorities. 

All told, in my time at BHP and BHP Billiton, we negotiated and operated some 14 exploration JVs and ran several serious pre‐feasibility studies over major potential projects in China. And we visited and reviewed data on hundreds of other ideas and prospects. At one stage we had 5 dedicated exploration offices in China and about 60 FTEs, and occasionally hundreds of part‐time local staff working on different projects. We also had some great trips to parts of China that few foreigners ever see, and we had some real adventures – our specially‐fitted vehicles, with the big long radio antennas (remember mobile phone and CMDA coverage are very recent) would always attract the attention and suspicion of the local police and we were often stopped and sometimes detained for long periods, even overnight at the police station, while our bona fides were confirmed……in one case the police phone were out and they actually had to use our radio to connect with their superiors! On another occasion we had to charter a 757 aircraft from China southwestern airlines to Medivac one of our geologists out of Tibet – because even ISOS were forbidden by the Chinese military to fly their air ambulance in there. Once, high on top of a mountain in the Himalayan foothills in far South‐west Sichuan, after an 8 hour drive up hair‐raising hairpin bends in the very narrow road cut into the side of sheer cliffs, we arrived at a tiny little lead/zinc mine where, in the hospitable manner that one finds all over China, they were so delighted to receive foreigner guests, that they had prepared a massive banquet for us – the local delicacy was tripe (stomach), I think we might have had dishes made from about 10 different kinds of tripe……sheep tripe, duck tripe, cow tripe, pig tripe, deer tripe, goat tripe, etc. I actually found it to be delicious but some of my BHP colleagues who were visiting China for the first were a little surprised……. 

And there were a myriad of other challenges and interesting moments that came to us over the 20 years of active exploration and business development that we worked on in China. We were very patient, diligent and persistent. We did a lot of work, we trained a lot of people, we gained a lot of good experience and we invested a lot of money in China. We made a lot of good friends……

That BHP did not proceed with any mining developments is not at all unusual – BHP Billiton and the other major miners hunt for elephants, what we call tier 1 assets. These are very scarce all over the world, a tier 1 asset is identified roughly every 1000 exploration projects. So not finding one is not all that surprising. And of course, the tier1s that we did see in China were strictly off‐limits to foreign investors. But we did leave behind some nice smaller scale discoveries which were later developed by our partners or others – again, there is a lesson in that. 

A third important aspect of the resources sector with respect to China is of course China’s outbound investment in overseas resources. As I described before, in the first couple of years of this decade Chinese consumers of raw materials and subsequently the Chinese government became more concerned about security of supply. Also, as China emerged from relative isolation to become a more active participant in global commodities markets, they became more aware of the structure of both markets and resource ownership. Generally, they didn’t much like what they saw (that is, the high degree of consolidation that I mentioned earlier) and, being from a centrally‐planned economy background, they were a bit discomfited by the propensity of commodity prices to move around in an apparently uncontrolled fashion. Chinese companies also generally had (and have) a somewhat short-term outlook and a mistrust of contracts, especially long‐term contracts. As China’s demand grew and began to make an impact on supply‐demand balances and consequently on prices, Chinese companies found themselves facing rising prices and having difficulty finding adequate supply. Of course when prices rise there are always people who are willing to come into the market and build new capacity to supply the demand – this is how markets work. so quite a bit of new capacity came into the market quickly earlier this decade…..but much of this capacity was small scale, low grade or difficult to process or a long way away. In other words, it was high cost supply. Why didn’t the established producers quickly expand capacity? There are two main reasons…..firstly, they simply couldn’t respond quickly to the rapid increase in demand. small expansions can be done fairly rapidly but big expansions (expansions which make a real or material difference to the supply‐demand balance of a global commodity) take several years to study, to get to an investment decision and then to build. Secondly, after more than 20 years of regularly being caught out over‐building excess capacity, the big miners were hesitant and wary...…they wondered if this new demand from China was sustainable. Of course, as China’s economic growth and demand for raw materials surged ahead, the shortages of low‐cost materials became worse. And, of course, this made China all the more anxious about inflation and security of supply. Tensions arose between suppliers and buyers, between producers and customers, and between supplying countries and customer countries at a government to government level. The Chinese response to this was consistent with Chinese traditions and management reflexes, and was based on the Chinese perception that the situation was being exploited at China’s expense. China decided to buy resources to secure supply. The so‐called “going out” policy for minerals resources was first announced by NDRC in 2003 and has been further developed and refined over the years since then. Of course the 3 major Chinese oil companies had been ‘going out’ since the mid‐1990s, remember China became a net importer of oil in 1996 – it was only when China found herself experiencing increasing import dependence for minerals such as iron ore and copper in 2002/03 that a “going out” strategy was loosely conceived for these commodities. 

Soon after, there was a series of pivotal precipitating incidents which really focused the Chinese government’s attention on the issue of supply security – the first was Minmetals unsuccessful attempt to acquire Noranda in Canada and the way that various stakeholders reacted to that (my good friend and former colleague Frank Xu was the Minmetals lead on that effort and I daresay is now among the most experienced “going out” executives that China has because of his detailed knowledge of how things work and sometimes don’t work!), the second was the 2004/05 iron ore price negotiations (which resulted in the famous 71.5% price rise, which BHP Billiton said was not enough! I know a little about that one myself!) and the third incident was CNOOC’s failed bid to acquire UNOCAL in mid‐2005. These incidents, occurring as they did in rapid succession, and engendering as they did escalating international tensions and emotions, had the effect of making senior people across the Chinese government sit up and pay attention to China’s resource supply security in a way that they hadn’t before and caused the “going out” policy to be ramped up and given a great deal more official attention, support and backing than had been the case before. As we have all seen China’s investment in resources assets worldwide has surged exponentially in the past few years, notably in Africa where China feels perhaps more welcome and has more natural competitive advantages as a buyer of raw materials and a builder of projects and infrastructure, and also in South America and Australia. At the same, as a result of strong demand from China and unusually strong global demand, we’ve seen commodity prices continue to rise and a good deal of very competitive M&A activity all across the sector. We’ve also seen the emergence of the developed world discussion around sovereign wealth funds and increasing public discussion in many parts of the world with respect to the nature and implications of inward Chinese investment. 

The key issue in my mind has been the fact of China’s apparently very sudden arrival on the scene. China went from being a virtual non‐participant in global M&A a few years ago to suddenly being everywhere wanting to buy everything! now, in my view, it is only natural and reasonable that the 3rd largest (soon to be 2nd largest) economy in the world, also one of the largest trading nations in the world with many of the largest companies in the world and with a prodigious rate of growth, requiring the supply of a lot of materials, products and technology, with the world’s largest savings pool and easily the world’s largest foreign exchange reserves, should also be participating in the M&A markets roughly in proportion to her economic weight……China’s own currency controls and policy attention to domestic investment priorities have restrained participation in global M&A until now. As I mentioned earlier, things have changed since the early days of the reform & opening policies – back then China lacked capital, technology, exports and Forex…….now China has a surplus or a very robust adequacy of many of these things. The situation has changed and the ever‐pragmatic Chinese government has allowed policy to evolve accordingly. one side‐effect of this policy evolution has been the sudden arrival on many nations doorsteps of a lot of enthusiastic Chinese buyers (I was just in Australia for 3 weeks, there are Chinese deals being announced every single day) – generally speaking, most destination countries were not expecting this, and most countries are more accustomed investors from other origins. Chinese investors, and their needs and intentions, are new and unfamiliar, and many Chinese investors have little or no international M&A or operating experience, so they too are on a fairly steep learning curve. It is going to take a little while for everyone to get used to the new paradigm. And because of the sheer volumes of transactions being done very rapidly – with relative inexperience and unfamiliarity on both sides remember – I would predict that there is a high likelihood of some miss‐steps occurring. 

I hasten to note, however, that Chinese investment is generally quite welcome just about everywhere, especially now in a capital‐poor post‐GFC world. and, in my view, as we get through these early years and up our respective learning curves, as everyone gains the confidence of experience and familiarity, a lot of the current concerns that surround Chinese investment will gradually fade away and China as a big participant in global M&A and investment will be seen as a very normal and ordinary matter. 

So please now allow me thank you for your attention to my ramblings here tonight and note that I am something of an optimist with respect to China and the minerals and energy sector as we look forward. I believe that China’s current levels of economic growth will remain quite high for perhaps another 2 decades while the modernization‐industrialization urbanization‐rising affluence story plays itself through. And while headline growth rates are clearly going to decline from the spectacular highs of recent years, China is growing from such a large base now that demand for materials and energy must continue to be very strong, and the simple economics of competitive supply and comparative advantage mean that China will be a big importer and a very valuable trading partner to many countries in this world, not least my own.

I have my doubts that China will become a very easy and open place for foreign mining investment anytime soon – either in terms of policy settings or in terms of on‐the‐ground operating issues. The sensitivities around ownership of resources are very real and are only ever overcome slowly, wherever you are in the world. as China becomes more affluent and more confident about her place in the world, and a little less anxious about security of supply, I would expect to see a gradual relaxation of restrictions around foreign investment in many sectors of the economy, not just mining ‐particularly since such policy relaxation, in a measured and managed fashion, has been shown to be beneficial to a modernizing economy. But I don’t expect this to happen soon…….. 

In terms of China as an investor overseas I think we will see the situation become less uncertain and less emotional over the next few years as destination countries become more familiar with China as a source of capital and as Chinese investors become more sophisticated and experienced as investors and operators. 

I trust that these few thoughts and observations have been of interest to you all ‐and I would be delighted to discuss my thinking on these topics with anyone who is interested to do so……… 

Finally, let me again offer my congratulations to the OMC on getting things kicked off here tonight, my sincere thanks on being afforded the honor of being the inaugural speaker and my very best wishes for the future of the club as it lunges energetically into the future. 


Thank you