The use of Sovereign Wealth for Strategic National Interests
Sovereign Wealth Funds in China’s Quest for Energy
Hugo Hemmen - 10678115
MSc Thesis Political Science – International Relations Research Project:
The Political Economy of Trade and Investment: The Global Politics of Corporate Sectors Supervisor: Professor Jeffrey Harrod
Second Reader: Professor Daniel Mügge
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CONTENTS
List of Abbreviations ... 4
List of Figures and Tables... 7
1. Introduction ... 8
1.1 Relevance and Current State of Affairs ... 8
1.2 Case Study ... 10
1.3 Research Question ... 12
1.4 Structure of Thesis ... 13
2. Sovereign Wealth Funds ... 13
2.1 The ins and outs of Sovereign Wealth Funds ... 14
2.2 Sovereign Wealth Funds as Strategic Investors ... 20
2.3 Sovereign Wealth Funds and State Capitalism... 23
2.3 Responding to Sovereign Wealth Funds ... 25
3. Chinese Energy Market: The Motives for China’s Energy Investments ... 28
3.1 PEST Analysis ... 28
3.1.1 Introduction ... 28
3.1.2 Political Factors: State Control ... 29
3.1.3 Economic Factors: Oil & Gas Supply ... 33
3.1.4 Social Factors: Economic Growth a Must... 36
3.1.5 Technological Factors: In Search of New Technologies ... 37
3.2 China’s Energy Security Policy ... 38
4.China OFDI, SWFs and Energy ... 41
4.1 China’s OFDI ... 41
4.2 China’s Sovereign Wealth Funds ... 44
4.2.1 Introduction ... 44
4.2.2 China Investment Corporation (CIC) ... 46
4.2.3 SAFE Investment Company (SIC) ... 50
4.2.4 China’s National Social Security Fund (NSSF) ... 52
4.2.5 China-Africa Development Fund (CAD Fund) ... 52
4.3 Other Major Players: The China Development Bank ... 53
5. Applied Methods ... 56
6. Analysis 1. Ownership & Control ... 57
7. Analysis 2. Investment Analysis ... 61
7.1 Analysis: Strategic Investments ... 62
7.2 Analysis: Direct Investments ... 65
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7.4 Analysis: Additional Indicators ... 68
8. Research Findings ... 69
Conclusion ... 70
Bibliography ... 73
Primary Resources... 73
Secondary Resources ... 80
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LIST OF ABBREVIATIONS
ADB Asian Development Bank
ADIA Abu Dhabi Investment Authority
AUM Assets Under Management
BP British Petroleum
CAD Fund China-Africa Development Fund CCG Center for China and Globalization
CCP Chinese Communist Party
CEC Commission of European Communities
CEO Chief Executive Officer
CCTV China Central Television
CDB China Development Bank
CFIUS Committee on Foreign Investment in the United States
CIC China Investment Corporation
CIFOR Center for International Forestry Research CNOOC China National Offshore Oil Corporation CNPC China National Petroleum Corporation
COCOM Coordinating Committee for Multilateral Export Controls CSRC China Securities Regulation Commission
DP World Dubai Ports World
EC European Commission
EBL Energy-Backed Loan
EIA U.S. Energy Information Administration
EU European Union
FER Foreign Exchange Reserve
FINSA Foreign Investment and National Security Act
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GPF-G Norway Government Pension Fund - Global ICBC Industrial Commercial Bank of China
IMAA Institute for Merger, Acquisitions and Alliances
IMF International Monetary Fund
IWG International Working Group
LNG Liquefied Natural Gas
MOFCOM Ministry of Commerce
MOF Ministry of Finance
NCSSF National Council for Social Security Fund NDRC National Development and Reform Commission NEA National Energy Administration
NEC National Energy Commission
NSSF National Social Security Fund
NOC National Oil Companies
OECD Organization for Economic Cooperation and Development OFDI Outward Foreign Direct Investment
OIR Oil Import Risk
PBC People’s Bank of China
PEST Political, Economic, Social, Technological
PESTEL Political, Economic, Social, Technological, Environmental, Legal P&O Peninsular & Oriental Steam Navigation Company
RBL Resource backed loan
RDIF Russian Direct Investment Fund
RMB Ren Min Bi
SAFE State Administration of Foreign Exchange
SCE State-Controlled Entity
SIC SAFE Investment Company
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SOB State-Owned Banks
SOE State-Owned Enterprise
SSA US Social Security Administration SWFI Sovereign Wealth Fund Initiative
SWF Sovereign Wealth Fund
UAE United Arab Emirates
UNCTAD United Nations Conference on Trade and Development
US United States
USCC US-China Economic and Security Review Commission
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LIST OF FIGURES AND TABLES
Figure 2.1 SWFs by year of establishment and by source of funding Figure 2.2 SWFs by assets under management (AUM)
Figure 2.3 SWFs by region
Figure 3.1 Total energy consumption in China by type in 2011
Figure 3.2 China’s domestic oil production and net imports forecast, 2008-2030 Figure 3.3 China’s crude oil imports by source in 2013
Figure 4.1 China’s OFDI decision making structure Figure 4.2 CIC’s assets under management, 2008-2012 Figure 4.3 Major portfolio holdings Central Huijin in 2013 Figure 4.4 Structure of an energy-backed loan
Figure 6.1 CIC ownership structure
Figure 6.2 Overview connections of the CIC with other government bodies, 2008-2013 Figure 6.3 CIC and State Council control of China’s banking sector
Figure 6.4 SIC ownership structure
Table 2.1 Global fund management industry size and growth, 2003-2013 ($ trillion) Table 2.2 The most important SWFs in the world
Table 3.1 China’s NOC’s in numbers (domestic and international activities) Table 3.2 Chinese natural gas data, 2011-2015
Table 4.1 Chinese SWFs
Table 4.2 China Development Bank: Assets & FER loans
Table 7.1 Overview selected direct investments CIC, 2009-2012 Table 7.2 Overview selected direct investments SIC, 2009-2012
Table 7.3 Energy-backed loans by the China Development Bank, 2008-2013 Table 7.4 Transparency of China’s SWFs (LMTI System)
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1. INTRODUCTION
1.1 RELEVANCE AND CURRENT STATE OF AFFAIRS
In late 2005, a $18.5 billion bid by a Chinese energy company (CNOOC) to acquire the American gas and oil firm Unocal sparked a strong reaction by US policy makers because China National Offshore Oil Corporation (CNOOC) was owned by the Chinese government. US policy makers were particularly concerned about the effect of the merger for US energy security and eventually the Chinese backed away under heavy pressure from the US government. The retreat of the Chinese cleared the way for a takeover of Unocal by the American oil company Chevron for $900 million less than the Chinese bid. (New York Times, 2005).
The CNOOC bid sparked a debate among US policymakers about foreign sovereign investments in sensitive industries such as energy and defense. Especially sovereign wealth funds (SWFs) became a focus of concern because of their impressive size. While SWFs controlled only $500 billion in 1990, they had increased their assets to $4.0 trillion in 2007 and were projected to become even larger in the near future. By 2015, their total valuation could range in size from $9 trillion to $16 trillion—or close to 4 percent of global asset markets (Drezner, 2008). The explosive growth of SWFs and their increasing assertiveness in international investments raised regulatory and geopolitical concerns. Robert Kimmitt, deputy secretary of the US Treasury at the time, wrote in January 2008 that "SWFs are already large enough to be systematically significant...[and] they are likely to grow larger over time, in both absolute and relative terms..." (Kimmitt, 2008: 121). At the same time market analysts and regulators were concerned about the transparency of these funds and politicians in the advanced industrialized states fret that SWFs could possess bargaining leverage over their economic and political future (Truman, 2008). Soon it became clear that concerns were persistent, and
spreading. In February 2008, the European Commission (EC) issued a formal statement calling for new scrutiny of SWF operations and government officials’ rhetoric against sovereign wealth funds
sharpened. John McConnell, then director of US national intelligence, declared: “Concerns about the financial capabilities of Russia, China, and OPEC countries and the potential use of their market access to exert financial leverage to achieve political ends represents a major national security issue” (US-Senate, 2008a). That same year it became clear SWFs were there to stay and would play an increasingly significant role in global finance. As the financial crisis of 2008 enfolded, some SWFs invested heavily in the world largest banks to save them from bankruptcy as they were the only investors willing and capable of taking this burden. According to McKinsey (2008), SWFs invested $59 billion into Western financial institutions in 2007 and 2008 including US flagship banks such as Morgan Stanley, Merrill Lynch and Citi Group. These highly visible transactions represented the first time that
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there were large capital flows from the East to the West, contrary to historical trends. As a result, anxiety about the possibility of political objectives underlying SWFs’ investments and the loss of control by Western government over their industrial sectors became widespread (US-Senate, 2008b). In 2008, French President Nicolas Sarkozy was quoted calling non-OECD SWFs a threat to Western companies: “I will not be the French president who wakes up in 6 months’ time to see that French industrial groups have passed into other hands” (Momani & Legrenzi, 2011). Noteworthy is that these national concerns were rejected by Mr. Jiabao, former premier of China. Mr. Jiabao said that SWFs were being misunderstood and described it as “the taller the tree, the stronger the wind it catches.” He stated the activities of China’s main SWF, the China Investment Corporation (CIC), are completely of a business nature without government intervention. Its foreign-related activities and overseas operations are not linked to politics. Mr. Jiabao made these statements while in the UK and Gordon Brown, former UK prime minister, eagerly repeated his statements and proposed London as a place of choice for CICs overseas office (Xinhua News Agency, 2008). This situation beautifully highlighted the different perceptions of SWFs and moreover the trade-offs SWFs provide. As many Western
governments and capital markets are low on liquidity, there are many incentives to not be too critical about sovereign wealth funds.
The emergence of SWFSs has often been placed in the broader context of a shift in wealth from the West to the East. Some commentators have warned against a re-emergence of ‘state capitalism’ which would reverse the privatizations that industrialized economies have been undertaking over the past decades (Beck & Fidora, 2009). Concerns about the ownership of large enterprises are not new and have been tied to nationalist concerns over state power since the industrial revolution in Europe. Contemporary SWFs raise many of the old questions about the relationship between the ownership of large enterprise and state power (Lavelle, 2008). Due to the recent economic and financial crisis, states have re-emerged as important arbiters of the prospects and direction of capitalist economies. Governments from both developed and developing economies have reasserted their positions as insurers of last resort in order to stabilize their economies and save their big banks. Ian Bremmer (2010) was the first one to connect the reaffirmation of the state’s role in smoothing the economic prospects of the nation-state with the rise of ‘state capitalism.’ State capitalism preferred by some non-OECD countries is in direct contrast to ‘market capitalism.’ State capitalism, in which state-ownership prevails in most sectors, is a concern because governments behave differently from private investors. In a state-capitalist system “the country is the unit whose value is to be maximized, with a corresponding increase in the role of the national government as a direct participant in and coordinator of the effort” (Gilson and Milhaupt, 2008: 1346).
For many years the global political economy seemed set on a trajectory of increasingly
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importance of emerging market countries, and their governments, in the functioning of the global economy further support this apparent shift. In particular, China has inspired concern because of its economic potential in combination with a lack of clear boundaries between China’s state apparatus and the market (Jacques, 2009). One major factor to consider in state capitalism is the significant shift from private-owned to public-owned capital in the last decade through SWFs. According to Bremmer (2010), SWFs merely present one facet of a world economy rapidly shifting away from markets towards state control.
The debate about SWFs among policymakers has been perceived as a choice between ‘free markets’ that allow inbound SWF investment or the installment of protectionist measures which could have negative externalities. The purpose of this thesis is to find if concerns about the intentions and objectives of SWFs can be justified. This can feed into the debate about the pros and cons of inbound investment by policymakers. Currently, the world’s largest holder of sovereign wealth is China and its SWFs have been heavily involved in overseas investments in various strategic sectors in recent years. Furthermore, China claims its SWF to be independent from politics and completely commercially driven. At the same time, China does have a visible strategic agenda with regards to its economic growth. China’s SWFs therefore seem to provide an interesting opportunity to find if concerns about SWF being used by nations as a tool of state diplomacy can be justified. The next three sections will justify the choice for China as a case, provide the research question and outline the structure of the paper.
1.2 CASE STUDY
From the outset, China SWFs have been eager to invest overseas in strategic sectors such as banking, agriculture and infrastructure. After the height of the financial crisis, Chinese sovereign investors started investing heavily in overseas energy assets, particularly oil and gas. (Sun et al, 2014a). Did these investments simply reflect a new strategy to increase profit or were they part of a broader strategic agenda of the Chinese government? This section aims to explain why the energy investments by Chinese SWFs provide a valuable case to find if SWFs are used as a strategic state diplomacy tool.
As the world economy is growing and many emerging economies are rapidly developing their industrial and transport sectors, the world remains in desperate need for energy. In the International Energy Outlook 2013, the US Energy Information Administration (EIA) projects that world energy consumption will grow by 56 percent between 2010 and 2040, from 524 quadrillion British thermal units (Btu) to 820 quadrillion Btu. Even though renewable energy and nuclear power are the world's fastest-growing energy sources, fossil fuels continue to supply nearly 80 percent of world energy use
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through 2040. Fossil fuel reserves are non-renewable and will eventually run out. Many governments and companies are becoming increasingly active in the global energy market to secure their supply of fossil fuels. As the largest energy consumer and importer China is particularly active in this regard. China has already topped the US as the world’s largest energy consumer accounting for 20 percent of global energy demand and is now expected to double US energy demand by 2040 (EIA, 2013a). As China does not have the domestic reserves to satisfy its growing energy demand its government is eagerly looking for ways to secure foreign supply of fossil fuels. For example, China imports 55 percent of its oil, of which nearly half comes from countries in the Persian Gulf. At this point, China has
reached the equivalent of the peak of U.S. import dependence and is not showing signs of slowing down (Konan & Zhang, 2008). Establishing a secure supply of energy resources is regarded as essential for the survival of the Chinese economy. Beijing's access to foreign energy resources is necessary both for continued economic growth and, because growth is the cornerstone of China's social stability and thereby essential for the survival of the Chinese Communist Party (CCP) (Zweig & Jianhai, 2005).
The Chinese government has implemented many policies to control its impressive energy demand. It has employed vast programs to increase energy efficiency, develop renewable energy and upgrade its infrastructure. Most importantly, its national oil companies (NOC) and SWFs have acquired overseas energy assets, including US and EU companies, in an impressively rapid pace. Since the CNOOC-bid these investments have gained increased attention from Western policymakers as China is not alone in its quest for the secure supply of energy. The consequences of this Chinese buying spree are poorly understood. Some regard China’s energy investments as controversial, while others state that they do not pose a threat to national security.
The relationship between the China’s oil and gas sector and the overseas oil and gas
investments made by China’s sovereign wealth funds is being researched in this thesis to find if SWFs indeed actively pursue political objectives as a part of state diplomacy. The author choose to research the relation between SWF investments and the energy sector for the following reasons. 1) China has become the world’s largest energy consumer in a relatively short period of time and it is expected that China’s energy demand is to continue to grow significantly; 2) China is struggling to move away from its dependency on its (abundant) domestic coal reserves and wants to diversify its supply of energy with foreign resources (EIA, 2014); 3) It has the world’s largest foreign exchange reserves (FERs) available to invest abroad and has only recently implemented outward direct investment (OFDI) policies; 4) China is home to four of the world’s largest SWFs, of which the largest, the China
Investment Corporation was launched only recently in 2007 (SWFI, 2014); 5) China is one of the most outspoken countries to state that their SWFs are not being used for policy goals. And most importantly 6) Beijing access to foreign energy resources is regarded as essential for the survival of China’s ruling party, the CCP.
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1.3 RESEARCH QUESTION
This thesis is designed to find how the investment decisions by Chinese SWFs are shaped by its domestic political environment. The purpose of this set-up is to provide an illustration of how SWF can be used in state diplomacy as noted in section 1.1 and 1.2. In order to provide such as answer the author choose to conduct a case study of the role of SWFs in the Chinese energy sector. Through combining the position of the Chinese government concerning energy security, the ownership and control structure of SWFs and the strategic SWF activities in the energy market, the writer hopes to provide an insight in the question whether SWFs are part of a strategic political agenda in Beijing.
From a preliminary perspective the Chinese quest for foreign energy resources to secure its energy supply seems to be one of its most important objectives. In order to confirm this, chapter 3 aims to provide the reader with useful insights in the Chinese energy market, particularly fossil fuels. The goal is here to establish a clear image of the current and future situation of Chinese need for foreign energy resources and what factors play a key role. The second element for inquiry is the connection between SWFs and the Chinese government. Questions that have to be answered are: why are SWFs established? Who is controlling their assets? How are they making their investment
decisions? What is their role within the framework of outward investment? Which other actors have a role in China’s outward investments? Next, this thesis aims to find how SWFs are related to the Chinese energy market. In order to find this relation there should be a review of strategic activities and investments concerning SWFs with regards to the energy market. This analysis will focus mainly on the connection between SWFs, its subsidiaries and Chinese national oil companies (NOC), as well as direct overseas investments by SWFs. . This thesis will uses a critical qualitative methodology in order to find a significant relationship between China’s energy security and SWF investments. The concrete research question answered through the case study will be:
What functions do Chinese SWFs have in establishing Chinese energy security?
The methodology of this thesis is based on a case study with a triangulation approach. Triangulation is often used to indicate that two (or more) methods are used in a study in order to check the results. The concept of triangulation is that one can be more confident with a result if different methods lead to the same result and it’s a method-appropriate strategy of founding the credibility of qualitative analyses in social sciences. Triangulation can give a more detailed and balanced picture of the situation and can also capture a more complete, holistic, and contextual portrayal of the unit(s) under study (Jick, 1979). By combining statements and data of multiple sources and actors, this research aims to overcome the weaknesses and biases in contemporary literature about sovereign wealth funds.
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To establish the contents of this paper, websites, documents, reports and data from CIC, CDB, BP, CIEP, EIA, IEA, IMF, OECD, US, EU, SWFI, the Chinese government, and different newspapers from the West, as well as from China will be used. Besides that, secondary literature will be used for analysis. Section 1.4 will go into more depth about the structure of the paper.
1.4 STRUCTURE OF THESIS
In order to get a better understanding of the discussions surrounding large sovereign investors such as sovereign wealth funds, chapter 2 will provide the reader with the context in which sovereign wealth funds are often regarded. The chapter will provide a general introduction about the
characteristics of sovereign wealth funds. Furthermore, chapter 2 will discuss how state capitalism, free market advocacy and protectionism are intertwined in the discussion about the pros and cons of sovereign wealth funds. It will also identify the relevance of this thesis with regards to the existing literature. Chapter 3 will give an overview of the Chinese energy market and will outline the most important concerns and policies of the Chinese government regarding its energy security. The most important finding in this chapter is that the Chinese government has several motives to make overseas energy investments. Chapter 4 will take a closer look at Chinese outward foreign direct investments (OFDI). As China has only been an active player in OFDI since the year 2000, many policies are rather new or still being implemented. This chapter will provide the reader with a framework of how Chinese OFDI is being controlled by the government and what role the different SWFs and other major actors have within this framework. Chapter 5 will describe the method used in chapter 6 and 7. These two chapters can be considered the core of this research and will provide the reader with an analysis of foreign activities and investments of SWFs and related state-owned entities in the energy sector. Chapter 8 will summarize the most important findings and their implications.
2. SOVEREIGN WEALTH FUNDS
This chapter is divided in four sections. The first section consists of a general introduction to the phenomenon of sovereign wealth funds. Section 2.2 goes into the discussion among scholars on the question of sovereign wealth funds are strategic investors or not. Section 2.3 aims to place sovereign wealth funds in a broader perspective and will discuss how state capitalism, free market advocacy and protectionism are an important part in the discussion. The last section is about the response of different stakeholders towards the concerns about sovereign wealth funds.
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2.1 THE INS AND OUTS OF SOVEREIGN WEALTH FUNDS
Sovereign wealth funds (SWFs) are large pools of government-owned or -controlled funds that are invested in whole or in part outside their home countries. SWFs are not a recent invention as Kuwait created the first SWF in 1953. After the first oil crisis in the 1970s,major oil-exporting countries set up their own SWFs because of concerns on depletion of oil resources. In the 1990s,emerging Asian nations quickly followed with their economic development, mainly on the back of exports and
accumulated abundant surplus of foreign exchange reserves(FERs). SWFs are not alien to the advanced industrialized states. Norway's central bank controls the largest SWF in existence. Several other economies within the Organization for Economic Co-operation and Development (OECD)— including Australia, New Zealand and the United States, house sovereign wealth funds as well. The SWFs of Norway, Russia, Saudi Arabia, Kuwait, Abu Dhabi, Qatar, Alaska and elsewhere derive their investment capital mainly from oil revenues. Other countries, such as China and Singapore, have amassed substantial foreign currency reserves by running persistent current account trade surpluses that are unrelated to oil exports (Truman, 2011).
In order to understand the role of SWFs in their countries of origin and their place in the global economy it is important to have a clear definition of SWFs. Due to the diversity of sources, objectives and management structure of the SWFs, there is no widely accepted definition of SWFs to date (Rozanov, 2005; IMF, 2008). After the term ‘Sovereign Wealth Fund’ was first coined by Rozanov (2005), the US Department of the Treasury (2008) defined SWFs as “government investment vehicles funded by foreign exchange assets, which manage those assets separately from official reserves.” The common understanding is that SWFs are government-owned investment funds which are generally funded surplus from other commercial activities of the government, translating either into foreign exchange assets or fiscal surpluses, e.g. from the export of natural resources (IMF, 2008). SWFs undertake long-term investments in search of commercial returns but they are not operating state owned companies. Every SWF is unique and the difference lies in its capital size, complexity, risk preferences, as well as transparency in management and operations. Also the state system of the home country and national interests play a key role in the characteristics of the SWF. Nevertheless, SWFs share at least three elements in common: 1) SWFs are state-owned; 2 ) they have no significant liabilities and; 3) they are managed separately from the rest of the central bank's reserves (Beck & Fidora, 2008). Generally speaking, SWFs, in nature, are government-owned or controlled funds operated as the government's investment tools, in order to achieve a series of economic and political objectives.
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Governments have different kind of investment vehicles at their disposals. Central banks have foreign exchange reserves to manage and many countries have large public pension funds to invest and manage. In addition, many governments operate holding corporations and state-owned
companies that also perform investment activities. However, not every any state institution with large financial holdings can be qualified as an SWF. If this would be the case than the world’s largest SWF would not be the Norway Government Pension Fund (GPF-G) and the Abu Dhabi Investment Authority (ADIA), both funded by oil exports and worth $893 billion and $773 billion, respectively (table 2.2) . Instead the two largest SWF would be the US mortgage giant Fannie Mae with $3.2 trillion in assets and the People’s Bank of China (PBC), with over $3 trillion in assets (Schwartz, 2012). What sets the giants apart from sovereign wealth funds is the fact that they do not have large net holdings. They have large liabilities offsetting their assets. Fannie Mae borrows in capital markets to fund their mortgage holdings and the PBC accumulated its foreign reserves by issuing renminbi (RMB) bonds into its domestic market. Furthermore, large pension such as the US Social Security Administration (SSA), with $2.6 trillion in assets, is obligated to fund pension payments 75 years forwards. GPF-G and ADIA, in contrast do not have offsetting liabilities and the absence of these liabilities gives them a different kind of power in the economy compared to central banks, pension funds and housing banks. Section 2.2 will explain how this power is perceived by policymakers.
The rapid growth of SWFs and the size they have attained suggest that they are becoming an increasingly important class of investors. As mentioned in the introduction, global assets under the control of SWFs increased from $500 billion in 1990 to about $4.0 trillion in 2008. And despite the global financial crisis, assets held by SWFs increased to a staggering $6.6 trillion in 2013 (SWFI, 2014), and by 2015, their total valuation could range in size from $9 trillion to $16 trillion—or close to 4 percent of global asset markets (Drezner, 2008).
As shown in table 2.1, SWF have grown rapidly with a compounded annual growth rate of 16 percent. Currently, SWFs’ assets ($6.6 trillion) are already larger than other non-conventional funds such as hedge funds ($2.2 trillion) and private equity funds ($3.5 trillion) combined. Their seize remains however limited compared to conventional institutional investors; pension funds, mutual funds and insurance funds had combined assets of more than $85 trillion in 2013.
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Table 2.1: Global fund management industry size and growth period 2003-2013 ($ trillion)
Type Assets Type Funds 2003 2005 2007 2009 2011 2013 CAGR*
Conventional Pension Funds; Mutual
Funds; Insurance Funds
46.9 58.9 76.4 71.3 79.8 85.2 6%
Non-Conventional
Sovereign Wealth Funds 1.5 2.3 3.7 3.8 4.8 6.6 16% Private Equity Funds 1.0 1.2 2.2 2.5 2.2 3.5 13%
Hedge Funds 0.9 1.4 2.2 1.7 1.9 2.2 9%
Exchange Traded Funds 0.2 0.4 0.7 1.0 1.4 2.2 27%
TOTAL 50.3 64.1 85.1 80.3 90.1 99.7 7%
*CAGR = Compound Annual Growth Rate
Sources: Compiled by author from: SWFI, 2014; Preqin, 2014a; Barclay Hedge, 2014; The City UK, 2013, Deutsche Bank, 2014; USCC, 2013
Besides their increase in assets, the number of SWFs has also rapidly increased since 2000. Of the 73 SWFs currently recognized as such by the Sovereign Wealth Fund Initiative (SWFI) (2014), 53 percent was launched between 2000 and 2009. This is substantially higher proportion than in all previous decades, and there have already been a larger number of new sovereign wealth fund since 2010. For sovereign wealth fund launches since 2010. For example in 2012, Russia launched its ‘Russia Direct Investment Fund’ and in 2012, Angola launched its ‘Fundo Soberano de Angola.’ Other
countries that are expect to launch sovereign wealth funds in the next few years are Bolivia, India and Panama amongst others (Preqin, 2014b).
Figure 2.1: SWFs by year of establishment and by source of funding
Source: Preqin, 2014b, USCC, 2014
Traditionally, SWF were largely funded by the export of commodities such as oil and gas, however this seems to be changing. While in 2001, 72 percent SWF assets was derived from
commodities, in 2012, this number has decreased to 57 percent (figure 2.1). The size of SWFs varies 7% 8% 10% 10% 53% 12% Pre-1970 1970-79 1980-89 1990-99 2000-09 2011-13 57% 43% Commodities Non-commodities
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widely along the spectrum as shown in figure 2.2. Their size ranges from less than $1 billion in assets under management (AUM) (12 percent) to over $250 billion AUM (10 percent).
Figure 2.2: SWFs by assets under management (AUM)
Source: Preqin, 2014
Figure 2.3 shows how SWFs are scattered around the world and which regions have the wealthiest SWFs. Interestingly, Africa (excluding the Middle East) owns 10 percent of the world’s SWFs, but only 0.2 percent of total SWF AUM, while Asia only own 22 percent of the world’s SWFs, it owns 47 percent of total SWF AUM.
Figure 2.3: SWFs by region Source: Preqin, 2014b 12% 31% 25% 15% 7% 10% 0% 5% 10% 15% 20% 25% 30% 35%
Less than $1 bn $1-9 bn $10-49 bn $50-99 bn $100-249 bn $250 bn or more
10% 22% 6% 11% 11% 26% 14% 0,20% 47% 2% 20% 1% 28% 3% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%
Africa Asia Australia Europe Latin America Middle East North America
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There are several factors that explain the growth of assets held by SWFs. Sovereign wealth has traditionally been used to stabilize revenues from the sale of commodities, such as oil and gas, and to transfer commodity-based wealth to future generations. Over the past decade, commodity exporters have benefitted from an exponential rise in commodity prices, due in no small measure to China’s booming demand. At the same time, SWFs have grown in countries that do not export many commodities such as Singapore and most importantly, China. The rationale for SWFs in these countries is less obvious, since the economy is not as susceptible to market volatility and does not depend on a finite resource. One of the main reasons for this surge in SWFs was the Asian Financial Crisis in 1997-98. After being devastated by capital flight during this crisis many Asian governments have used their trade surpluses to build up much larger dollar reserves in order to avoid future problems (Rodrik, 2006). Table 2.2 provides an overview of the most important and largest SWFs in the world.
Table 2.2: The most important SWFs in the world
Rank Name SWF Country Assets $billion Origin capital Year of start 1 Government Pension Fund – Global Norway $893 Oil 1990 2 Abu Dhabi Investment Authority UAE – Abu Dhabi $773 Oil 1976 3 SAMA Foreign Holdings
Saudi Arabia $738 Oil n/a
4 China Investment Corporation China $653 Non-commodity 2007 5 SAFE Investment Company China $568 Non-commodity 1997 6 Kuwait Investment Authority Kuwait $410 Oil 1953 7 Hong Kong Monetary Authority Investment Portfolio China – Hong Kong $327 Non-commodity 1993 8 Government of Singapore Investment Corporation Singapore $320 Non-commodity 1981 9 National Social Security Fund China $202 Non-commodity 2000
10 Temasek Holdings Singapore $177
Non-commodity
1974 11 Qatar Investment
Authority
19 … 43 China-Africa Development Fund China $5 Non-commodity 2007
Source: SWFI, Fund rankings, 2014
Common goals for the set-up of SWFs are 1) compelling portfolio diversification; 2) raising production efficiency as a future driver of growth; 3) reducing dependence on finite resources through effective deployment of capital in domestic and global economic opportunities; and 4) smoothening of returns and consumption levels. Every SWF is unique and has its own specific structure and objectives. Currently, the operations of SWFs are highly concentrated in and are dominated by three types of countries. 1) Arab oil-producing countries or so-called petrodollar investors (Abu Dhabi, Algeria, Dubai, Kuwait, Libya, Qatar and Saudi Arabia); 2) Non-Arab oil-producing countries (Norway and Russia); 3) Emerging East Asian economies (China, Hong Kong and Singapore). Interestingly, the ten largest SWFs manage around 85 percent of combined assets, indicating that the real financial power that comes with the SWFs resides in a very limited number of states. Within these states China has the biggest SWFs and its operations attract special attention from host countries due to financial and political considerations (Cohen, 2009).As can be found in table 2.2, China has four SWFs and is home to the world’s 4th and 5th largest SWFs; the Chinese Investment Corporation (CIC) and the State
Administration of Foreign Exchange (SAFE). Combined these two SWFs hold an estimated $1.1 trillion or around 18 percent of global SWF assets. What is also interesting about China, is that it is unlike most other countries that have large SWFs, it is a large industrialized country without abundant commodities. This makes China a unique player in the field of SWFs, because it does not need its SWF for stabilizing purposes (Truman, 2011).
SWFs invest in a variety of assets in order to achieve their goals. Most of it in finance, energy, construction and real estate. Compared to the size of their size of $6.6 trillion, the level of FDI by SWFs is still small and limited to a few major SWFs. In 2013, SWF FDI flows were worth only $6.7 billion with cumulative stock reaching $130 billion (UNCTAD, 2014). This is very limited compared to state-owned enterprises (SOEs). According to UNCTAD’s (2014) estimates, there are at least 550 SOEs, from both developed and developing countries, with more than 15,000 foreign affiliates and estimated foreign assets of over $2 trillion. FDI by state-owned SOEs is estimated to have reached more than $160 billion in 2013, accounting for over 11 per cent of global FDI flows.
Because the majority of SWFs lack transparency and do not reveal their investment strategies to the large public, their investment behavior is suspect to speculation and research. A study covering 30.000 SWF investments between 1997 and 2007 by the IMF reported that “SWFs invest in countries that share similar cultural traits,” and “display significant industry biases.” Interestingly, many SWFs
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hold a disproportionately large fraction of their stocks in oil companies, which suggest that they target the energy industry. They also found that SWFs “allocate investments differently from
non-government owned funds” and suggest that SWF could give their non-government influence over global markets (IMF, 2009: 5). The next section will go deeper into this topic.
2.2 SOVEREIGN WEALTH FUNDS AS STRATEGIC INVESTORS
As touched upon in the introduction, the potential implications of SWFs in global financial markets are numerous and so are the concerns that have been raised. Many economic observers have pointed to the implications for the structure of the financial market and the potentially adverse effects on global financial stability as SWFs embody a shift away from traditional foreign exchange reserves to other state-owned investments. SWFs could for example hypothetically contribute to a disorderly unwinding of global imbalances if they would collectively and aggressively pursue more return-oriented investment strategies (Beck & Fidora, 2009).
Most importantly, within the context of this thesis are the national concerns about the increased assertiveness in the international investment and the global merger and acquisition market by SWFs. Here the nature of intent also obviously matters. SWFs mainly trouble those concerned about maintaining US global economic power and Western hegemony, because they reflect a reverse in the neoliberal policy advice of the Washington Consensus (section 2.3). Potentially, SWFs could be used by states to exercise control in global and local markets (IMF, 2009; Truman, 2008). The ends to which control is directed obviously matter also. Western policy makers have become particularly concerned that SWFs would be used by their states as tools to allocate vast financial resources to advance political rather than economic ends. The principle motive to maximize financial profits from investments, which characterizes most private investors, may be displaced by political motives. This way, SWFs can be used in a political capacity either to benefit the investing country (outside of financial gains on investments) or to influence or harm the recipient country or another country, essentially undermining the usual operations of financial markets (Green & Forry, 2010). Theoretically this situation could lead to numerous occasions where national interests would be impaired: "it is one thing...for British Petroleum to purchase Amoco Oil-Company and promptly shut down its operations in the United States; it is quite another if the Venezuelan State acquired enough shares in British Petroleum to induce it to make the same decision" (Green & Forry, 2010: 971). Alongside, the concern exists that SWFs investing freely in financial markets may have particular informational advantages, because the sovereign owner may well obtain information pursuing other sovereign functions but might use that information to manipulate its SWF's investments. Former SEC Chairman Christopher
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Cox has warned of the possibility of: "a world in which governments use 'the vast amounts of covert information collection that are available through their national intelligence services' in trading and other market activities, to the disadvantage of private investors." (Cox, 2007).
An element that has further fueled the anxiety about SWFs is their bad track record with regards to transparency. Many SWFs do not comply with international standards (Santiago Principles). A set of guidelines initiated by the IMF in order to improve the transparency records of SWFs (section 2.4). The difference between the transparency of SWFs is very large. No one complains about
Norway’s GPF-G, the largest SWF in the world, because it publishes detailed quarterly reports and abstains from accumulating holdings of more than 5 percent in any company it invests is. The same accounts for Singapore’s Temasek Holdings, an SWF with $177 billion in assets that unlike GPF-G does create majority owned subsidiaries through its overseas investment arm, but at the same time has one of the highest scores on SWF transparency (SWFI, 2014). On the other side are the highly secretive Persian Gulf state SWFs and some Asian SWFs. They publish no accounts or any form of an annual reports, provide inconsistent aggregate asset figures to the media, and say nothing about their investment strategies (Schwartz, 2012).
In order to avoid concerns about their respective SWF investments, most governments state that the main purpose of their SWF is to serve as a reserve investment corporation with pure and long-term commercial interests, investing in domestic assets and funds , as well as overseas. However as SWFs are funded directly with government funds, they will logically act in accordance to the
interests of their stakeholders to a certain degree. SWFs seem to fulfil various objectives nearly similar to other state-operated entities, such as central banks, development banks and pension funds, as well as to other state-owned assets, like state-owned enterprises and other public entities. The line of separation of powers between the government, SWFs and other stakeholders is very thin and varies from country to country. It is therefore difficult to imagine that all SWFs can operate under ‘arm length’ principles of separation (Shunmugam, 2012).
Originally SWFs were mostly held by oil producing countries with limited geopolitical objectives and fairly good relations with the EU and the US such as Norway, Kuwait, Qatar, the UAE and Saudi Arabia. A turning point was reached, however, when China and Russia joined the game. China and Russia are often regarded as the biggest challengers to Western hegemony and both countries have clear geopolitical ambitions (Cohen, 2009). In 2007, China established the China Investment Corporation (CIC) with an initial capital $200 billion. Only a few months later Russia
announced that its Stabilization Fund, first created in 2004, was to be split into two separate entities, a Reserve Fund and a National Welfare Fund, starting with total resources of $150 billion. Both funds were expected to make considerable overseas investments. The aforementioned concerns about
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SWFs became ever more realistic as two major powers with pockets deep enough to make a real impact entered the stage (Cohen, 2009).
In a response to the increased anxiety, national committees, international governing bodies and academics were eager to address national concerns about SWFs investment. The main question that had to be answered: Should anyone care about ownership by government-controlled entities? If investments by SWFs would indeed be politically motivated, policy makers in recipient countries would arguably have reason to care. Such politically motivated investments would imply risks for national security, to the extent that autarky-related, systemically important, or otherwise sensitive industries could be affected. Interestingly, the contemporary literature about the political motivation behind SWFs investments fails to provide a clear answer.
The literature has, in general, studied four aspects with regard to SWFs: 1) to assess the presence of any divergence between the stated objectives of SWFs and their actual activities; 2) to discover any impact of SWF investment in the recipient economy; 3) to find the extent to which the motives, action and impact of SWFs differ from those of other (private) funds; 4) the response by recipient governments and international organizations towards SWF investment. Many studies found evidence that SWFs acted largely commercially in their activities and investments with a focus on profitmaking, just like other private funds (Shunmugam, 2012). Kern (2008) and Balding (2008) found that SWFs mainly have long-term savings and stabilization investments as the primary objective of their overseas investments. Kirschner (2009: 306) downplayed the concerns about SWFs and
concludes that “SWFs are not now, nor are they likely to become, consequential in and of themselves for questions of national security.” Helleiner (2009: 301) supports Kirschner and confirms that “the challenges posed by SWFs to the existing geopolitical order are often overstated.” An inquiry by the OECD (2008a: 7) also concludes that “SWF investment decisions do not differ greatly from those of other wealth managers” and stresses that fears of SWFs being used for political purposes by acquiring large stakes in Western companies are unfounded.
On the other hand, Cohen (2009) stressed that SWF investments might be deployed
strategically for the pursuit of geopolitical objectives. While Knill et al (2012) even found evidence that bilateral political relations are influenced by SWF investment and confirm that policymakers are right to have concerns regarding a funds’ motives. These contrasting views could be an indication that the literature regarding SWFs is still fairly immature and incomplete. Furthermore, all authors agree that the possibility of political objectives of SWFs cannot be ruled out and that as they grow larger, their geopolitical influence could become significant (Cohen, 2009; Knill et al; 2012; Backer, 2009; Nilsen, 2010). As SWFs are growing every day, the question about their objectives remains relevant.
This thesis tries to provide the discussion with a new insight. Most aforementioned studies on SWFs have one thing in common and that is that they research SWFs in a narrow perspective. They
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take samples of a number of SWFs from different countries and analyze them in a fairly isolated and generalized manner. This thesis tries to place the SWFs of one country (China) in the broader framework of China’s political environment, outward investment activities and strategic objectives regarding the supply of energy. Kirschner (2009), one of the sceptics regarding SWFs geopolitical objectives, does point out that some case studies highlight the importance of seeing SWFs as political actors. According to Kirschner the political logic that drives their behavior is much more often
domestically than internationally focused. This thesis agrees with this statement, but rejects the notion by Kirschner that domestic political logic, such as a Chinese energy security strategy, does not have a significant impact in the international context.
Truman (2011) stated that SWFs are so diverse in their origins, objectives, size, structures, and many other dimensions and that for this reason, one can only make broad generalizations or research individual cases. SWFs also differ significantly in their level of sophistication and appetite for risk, as well as in their style of governance and overall transparency of operation. Some are committed to full disclosure regarding both investment strategies and the size and composition of their portfolios. Others are highly secretive, revealing little (Roy, 2007). The dangers of overgeneralization about SWFs are obvious. In the words of economist Paola Subacchi (2008: 150): “To bundle all of them together risks incompleteness and an over-simplified analysis.” Other authors agree with this notion the by Subacchi and claim that the broader framework of operation and national purposes of SWFs should be researched. Lavelle, (2008) suggest theorists need to analyze the political activity intrinsic to large firms in the states where the SWFs are located. Former, aggregate analyses, which consider the investment activities of SWFs when they list, distribute and buy securities in transnational markets, miss this dimension (O’Neill et al, 2008; Kikuchi & Nagayoshi, 2008). Leong (2012) writes that SWF are unique in its own way and that its investment policies are shaped by its own policy objectives, which arise out of the idiosyncratic political and economic demands of home state. Accordingly, SWFs exist in their own domestic regulatory environments advance the investment objectives of home
governments. This thesis aims to provides evidence to underwrite these claims. The next section will outline the broader context of the research conducted in this research.
2.3 SOVEREIGN WEALTH FUNDS AND STATE CAPITALISM
As mentioned in the introduction, the emergence of SWFs an important class of investors in the international arena is often regarded in the light of a broad transition in wealth from the West to the East, in which state-owned entities are becoming increasingly important. Section 2.2 mentions that SWFs can be regarded as rejection of the liberal policy advice of the Washington Consensus. John
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Williamson (1990) coined this term for the first time in 1990. Since then many scholars have applied the term to broadly describe the global shift towards free market policies and privatization lead by policymakers in Washington. While some argued that this consensus already ended after the year 2000, more commonly commentators have suggested that the global financial crisis was the real end of the Washington Consensus (Skidelsky, 2009). Because of the financial crisis, states have re-emerged as essential actors in the course of capitalist economies. Therefore experts such as Nobel prize winner Paul Krugman and former UK prime minister Gordon Brown declared the end of the Washington Consensus (The Guardian, 2008; New York Times, 2008). As mentioned in the introduction, commentators have warned against the re-emergence of ‘state capitalism’ in the absence of the Washington Consensus (Beck & Fidora, 2009; Bremmer, 2010; Rickard, 2011). State capitalism can be described as a system in which “the state functions as the leading economic actor and uses markets primarily for political gain” (Aligica & Tarko, 2012: 359). Rickards (2011: 149) even goes further to describe the upcoming state capitalism as “a new version of seventeenth-century mercantilism in which corporations are extensions of state power.”
SWFs are seen by some as a way for states to increase their economic influence (Bremmer, 2010; Rickards, 2011). Traditionally, central banks would manage countries’ reserves in a highly conservative manner, which offered liquidity, however not much income. Therefore, SWFs began to emerge to better manage these investments, which might prove to be a very significant change because it can provides governments with alternative income that are independent of taxation, monetary expansion and borrowing. Rickards (2011: 8) goes even further with the notion that SWFs “could be used to exercise malign influence over target companies in order to steal technology, sabotage new projects, stifle competition, engage in bid rigging, recruit agents or manipulate markets.”
Another account of the rise of SWFS is presented by Schwartz (2012). He does not support the claim that state-capitalism is re-emerging. Instead he argues that the liberal global order is an
ideological fiction that did not hold in the first place. He mentions that giant US
government-sponsored enterprises such as Fannie Mae and Freddie Mac were already deeply entangled in global capital market well before SWFs really took off. The same accounts for giant public pension plans (Helleiner & Lundblad, 2008).According to Schwartz the core issue is where political power lies instead of a contest of ideas about how ‘free’ markets are. However, there seems to be a fundamental
difference between the principles of free-market and the current steps towards state capitalism. State capitalists see markets primarily as a tool that serves national interests, or at least those of ruling elites, rather than as an engine of opportunity for the individual. State capitalists use markets to extend their own political and economic leverage- both within society and on the international stage (Bremmer, 2010). Bremmer therefore argues free-market states need to counter this challenge by
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implementing smart regulation while practicing the tenets of free trade and open markets that they preach. This thesis will make some remarks regarding this line of thinking in the discussions of the findings and the conclusion.
Since SWFs are at the intersection of high finance and high politics, they signal a different kind of reassertion of state authority in the markets. SWFs have been identified as the most important new ‘powerbrokers' in the world (Roy, 2007; Drezner, 2008; McKinsey, 2008). International financial governance is experiencing the ‘great trade-off’ between sustaining the openness of capital markets and the national security concerns of individual host countries (Cohen, 2009). Capital markets need to be transparent and open in order to secure global flows of international investments for economic growth. However as the long-term geopolitical implications of the shift of capital from West to East are unknown, policymakers should consider defense measures of their national economies. It seems global capital governance has become a game between state interests, private corporations and geopolitical power. The public and private sectors need to collaborate for the benefit of each nation and others around the world (Clark and Li, 2010). The next section will summarize the different responses by Western countries and international organizations towards SWF investment.
2.3 RESPONDING TO SOVEREIGN WEALTH FUNDS
Policymakers face two polar positions on investments by SWFs. The first position argues that SWF investment should be considered as a matter of national security because SWF supposedly cause important dangers for Western countries. The second position urges SWF investment is merely an issue of economic governance, in which SWF investment can be beneficial to Western countries and that the problems are greatly exaggerated. According to this position, defensive measures against SWF can be a dangerous precedent of a cycle of increased protectionism. When SWFs and SOEs enter certain strategic areas in other countries, such as energy or defense, they usually encounter host governments that are also active in the specific sector and to some degree protective because these kind of areas impact all their citizens (Clark & Li, 2010). What makes the discussion more complex is the fact that several SWFs have features in common with other state-owned and private investment funds, such as pension funds, which have long been accepted as part of the financial system.
The West has responded in varies ways. Both the EU and UK have treated SWF equity investment as a matter of free trade and movement of capital, and imposed few specific restrictions. Many countries have often accepted and welcomed SWF equity investment. Even though the Commission of European Communities (CEC) in February 2008 urged a common European approach to SWFs that should strike the right balance between addressing concerns about SWFs and
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have all adopted their own strategies towards SWF investment. The UK for example has not taken a critical stance towards SWF investment at all. UK policy makers have generally pursued a policy of accepting and indeed welcoming SWF equity investment. They have not intervened in a series of high-profile equity investments by SWFs of which there have been many. For example, when the Abu Dhabi Investment Authority (ADIA) and China Investment Corporation (CIC) took a significant stake in one of Britain’s largest water suppliers, Thames Water, in 2011 and 2012, respectively (Thatcher, 2013). These investments might have been expected to result in serious debates about whether protectionist policies and instruments were needed. As UK policy makers have defined SWF investment as
economic governance issue, with the policy choice as being between ‘free trade’ or ‘protectionism’. The UK government favored the former, arguing that it is in the national interest to attract SWF inward investment because it aids British firms and production and it thereby rejected new legal controls based on overseas state ownership (Thatcher, 2013).
The US and Germany on the other hand have seen strongest debates about whether SWF investment is a free trade or a national security issue, and have both imposed much stronger legislative monitoring and restrictions. In the US the ‘Foreign Investment and National Security Act’ (FINSA) became effective in the end of 2007. This act was mostly stimulated by public concerns about the planned acquisition of US ports by a company from the United Arab Emirates. The company ‘Dubai Ports World’ (DP World), would own the ports because of its acquisition of the British ‘Peninsular & Oriental Steam Navigation Company’ (P&O). The case is so controversial because the US Committee on Foreign Investments (CFIUS) already approved the transaction before it became known to the public. The outcome was that DP World had to sell its US assets to American International Group (AIG) under heavy pressure from the government (Wall Street Journal, 2006). Under the FINSA, the CFIUS must consider several additional factors in conducting reviews and investigations. The CFIUS also received explicit instructions to consider whether a transaction controlled by a foreign government would result in control of critical infrastructure in the US (GAO, 2008). Even though the FINSA enjoys wide support in the US, the new rules can also be criticized as they discriminate between private and public investments and cause investor uncertainty. The effect has been significant as the number of CFIUS reviews conducted increased sharply in 2006 and 2007 (113 and 147 cases respectively compared to an annual average of 51 cases in the period from 2001 to 2005). There were also more second-stage investigations in 2006-2007 than in the previous 15 years combined (Jost, 2009).
After much debate in Germany, in 2009, an amendment was passed to the Foreign Investment Act, the ‘Dreizehntes Gesetz zur Änderung des Außenwirtschaftsgesetzes und der
Außenwirtschaftsverordnung’ (Theiselmann, 2009). The amendment gave powers to the Federal Economics Ministry to verify whether an investment 25 percent or more in a German company by a non-EU investor posed a potential threat to national security. If the investment is perceived as a threat
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the Ministry has the powers to prohibit it. Critics of the new amendment argue that the scope for controlling SWF investment is in fact rather limited. First of all, SWFs are often don’t take 25 percent stakes: almost all have been lower. Second, the Ministry is not obliged to undertake an investigation and an investigation can therefore rather easily be avoided. Third, firms can apply for a ‘certificate of non-harm’ which protects them against any action under the law. Fourth, if the Ministry wants to act and prohibit an investment it must first seek the consent of other ministries to act. In addition, there are the Ministry is limited in its ability to investigate because of strict time limits. the Ministry must start its investigation within three months of the share purchase and then complete it within a further two months. If the ministry failed to do so, then the SWF investment is deemed accepted by default (Thatcher, 2013).
All recipient countries have stressed that SWFs should base their investment decisions strictly on economic objectives, and should compete on fair terms with private-sector investors. To this end, recipient countries have called for greater transparency on the part of SWFs. Many SWFs lack a reasonable degree of transparency and accountability. The rise of SWFs has therefore provoked policy reactions of recipient countries despite efforts of international organizations to prevent new
protectionist measures on international capital markets. Therefore, a group of countries, collectively owning 26 SWFs, recognized an urgent need to demonstrate and communicate more clearly their constructive role in the world economy. Together with the IMF, the International Work Group (IWG) was created. The participating SWFs represented about $2.5 billion in financial assets in 2010, or about half of total SWF assets. The main objective of the IWG was to develop an international
framework of principles that would enhance an open and nondiscriminatory cross border investment regime (Carnegie Endowment, 2010). In 2008 the IWG agreed on Generally Accepted Principles and Practices (GAPP) – the so-called Santiago Principles. The GAPP seek to ensure that SWFs bring economic and financial benefits to home countries, recipient countries and the financial system. The 24 principles are covering: 1) the legal framework, objectives and coordination with macroeconomic policies; 2) the institutional and governance structure and; 3) the investment and risk management framework of SWFs (IWG, 2008). However what the Santiago Principles lack is enforceability. Consequently, guidelines and policies are only as good as the commitment of the signatories. In the absence of private shareholders, the main incentive for SWFs to abide by rules and norms is to improve perceptions in recipient countries. But this incentive may diminish as SWFs become more influential. Another concerns is the fact that the Santiago Principles have not expanded beyond their founding fathers, except for the CIC. Many SWFs today do not adhere to them in any way (Carnegie Endownment, 2010).
What becomes clear in this section is that policymakers have indeed acted to some degree to be able to protect economies from unwanted incoming foreign investment. This indicates that some
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states are already seeing SWFs as instruments of state policy. The results of the case study provided in this thesis will therefore further support the actions taken by these states in defense of foreign
investment because of national security concerns and cast doubt over the decisions of governments to not think twice about incoming SWF investments, such as the UK. Because the case study is focused on China, its results especially support the idea that Chinese SWFs are indeed an instrument of state diplomacy and should be treated as such by Western policymakers.
The following chapter is the first part of the case study and will provide an overview of the Chinese energy market in order to find the strategic needs and objectives of the Chinese government. This chapter will be the basis for the further claims made in this thesis that investments by China’s SWFs are indeed based on political motives.
3. CHINESE ENERGY MARKET: THE MOTIVES FOR CHINA’S ENERGY INVESTMENTS
The purpose of this chapter is to find the motives for the Chinese government to secure energy resources abroad. Section 3.1 will provide a PEST-analysis of the Chinese energy situation. Section 3.2 will go deeper into the topic of China’s ‘energy security.’ The PEST-analysis, is a short version of the PESTEL-analysis. Both concepts are often used as a tool by companies to track an environment. PEST-analysis stands for political, economic, social and technological factors. The PESTEL version adds environmental and legal factors to the equation. This thesis is limited to the
PEST-analysis. Important questions to ask in this chapter are: what is the political situation of the country and how can it affect the energy industry? What are the prevalent economic factors? How much importance do social actors have in the market and what are its determinants? What technological innovations are having an effect on the market structure? By answering these questions this thesis tries to establish the domestic motives that are behind China’s overseas investments.
3.1 PEST ANALYSIS
3.1.1 INTRODUCTION
China is the world's most populous country with a fast-growing economy that has led it to be the world’s second largest economy in 2010, only falling behind the US (Barboza, 2010). China is expected to overtake the US as the world's largest economy by 2016, according to the Organization for Economic Cooperation and Development (OECD) (Davies, 2013). China is home to over 1.3 billion inhabitants and saw its annual real gross domestic product (GDP) grow with 7.7 percent in 2012 and
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2013, after registering an average growth rate of more than 10 percent per year between 2000 and 2011 (IMF, 2014). To fuel its economic growth China has become the largest energy consumer and producer in the world. The Energy Information Administration (EIA) projects that China will surpass the United States as the largest net oil importer in 2014, in part due to China's rising oil consumption (EIA, 2013a). China's oil consumption growth accounted for one-third of the world's oil consumption growth in 2013, and EIA projects the same share in 2014 (EIA, 2013a).
The rapid acceleration of energy demand in China is due to a number of factors. First, China’s economic growth has been concentrated in export-oriented manufacturing activities, which are generally energy intensive. Second, China is developing a more prosperous middle class, and they are gaining increasing access to automobiles and electricity. Consumer driven demand for energy
comprises an ever-expanding share of total energy use in China. Finally, China is investing significantly in energy infrastructure and this greatly expands the capacity to deliver power to clients (Konan & Zhang, 2008).
Oil and natural gas use in China has also increased rapidly in recent years, and China has sought to raise natural gas imports via pipeline and liquefied natural gas (LNG). In addition, China is the world's top coal producer, consumer, and importer and accounted for about half of global coal consumption, an important factor in world energy-related carbon dioxide emissions. China's rising coal production is the key driver behind the country becoming the world's largest energy producer in 2007. In line with its sizeable industrialization and swiftly modernizing economy, China also became the world's largest power generator in 2011 (EIA, 2013a).
3.1.2 POLITICAL FACTORS: STATE CONTROL
China’s top leadership determines the general framework of the country’s energy policy, according to its overall macroeconomic goals. The National Development and Reform Commission(NDRC), China’s central planning agency and a department of the State Council, is the primary policymaking, planning, and regulatory authority of the energy sector. In 2008, the
government launched the National Energy Administration (NEA) to act as the key energy regulator. The NEA is a department of the NDRC charged with approving new energy projects in China, setting domestic wholesale energy prices, and implementing the central government's energy policies (NDRC, 2014).
In 2010, the government formed a National Energy Commission (NEC) with the purpose of consolidating energy policies among the various agencies under the State Council (People's Daily, 2010). Reportedly the NEC was established by senior government officials because they faced difficulties in getting intra-agency cooperation on various initiatives, including reduction of carbon
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emissions and raising energy efficiency to help combat global warming. Also the high-level commission reflects Chinese leaders' concern over growing reliance on imported energy as a potential strategic weakness. The emergence of the NEC is a result of the incapability of the NEA in coordinating China’s energy policy, as this involves a large number of powerful ministries such as the Ministry of Foreign Affairs, the Ministry of Commerce and major national oil companies (NOCs) such as China National Petroleum Corporation (CNPC) and China National Offshore Oil Corporation (CNOOC), as well as the military (for energy security) (Zhiyue, 2010).
A large share of the power seems to be with these NOCs . More often than not, NOCs initiate major energy projects and policies, such as new pipeline projects and the acquisition of foreign energy assets, that are later embraced by the government. These companies are so powerful that they sometimes advance corporate interests at the expense of national ones. For example, oil and power generating companies have periodically reduced their output to pressure the government to raise state-set prices of refined products and electricity, which have not kept pace with market prices of crude oil and coal. Similarly, NOCs have ignored guidance from the central government about where they should invest overseas. CNPC acquired more assets in Sudan even after NDRC in 2007 excluded Sudan from a list of countries in which Chinese oil companies were encouraged to invest. (Downs, 2008).
The goals of China’s energy policy are broadly similar to those of most other countries. The core of its policy is to ensure a secure supply of energy for its economic development at reasonable prices. Simultaneously its policy aims to protect the environment in order to support the objective of sustainable development. The main pillars of China’s energy policy have been in place for several decades, having first emerged during the 6th Five Year Plan (1981–1985)1 (Chow, 1984). They
encompass: 1) structural and industrial adjustment; 2) energy development; and 3) energy
conservation, with energy conservation referring to reducing energy consumption through using less of an energy service. These pillars broadly continue to guide the country’s policy, and are expected to do so in the foreseeable future (Chow, 2011).
Energy is an important physical base of economic development, social progress and the construction of modern civilization. In addition it is regarded as strategic material and major element of a country’s security, which links national and foreign security policies. Energy is becoming more and more important along with competition of world energy market and rising concerns about energy
1 The Five-Year Plans of China are a series of social and economic development initiatives that establish the foundations and principles, map strategies for economic development, set growth targets and launch reforms. The latest of this series is the Twelfth Five-Year Plan (2011-2015).
