After the Federal Reserve announced its latest round of so-called “quantitative easing” in mid-September, some analysts noted China was likely to be a major beneficiary, as cheap developed-world capital flows toward investments in growing emerging market nations. Additionally, they observed that perhaps China’s own efforts at monetary stimulus were relatively muted because the Middle Kingdom had been hoping to ride the Fed’s coattails.
But another consequence of the Fed’s everlasting easing is that Chinese policymakers fear it could erode the value of dollar-denominated holdings in the nation’s estimated $3.3 trillion in foreign currency reserves. That’s forcing the sovereign wealth funds (SWF) that invest a portion of these reserves to diversify away from the dollar.
Given Canada’s abundance of natural resources, it makes perfect sense that China would seek investments there as a hedge against the inflationary policies of the developed world’s central banks.
And today comes news that the China Investment Corporation (CIC) is close to purchasing a 12.5 percent stake in timber assets from Brookfield Infrastructure Partners LP (TSX: BIP-U, NYSE: BP). The deal is valued at roughly $100 million and encompasses about 634,000 acres of timberland on Vancouver Island.
The CIC was created in 2007 and now ranks as China’s second-largest SWF and the fifth largest in the world, with $482 billion in assets. According to CIC Chairman Lou Jiwei, the fund has allocated approximately $10 billion toward the purchase of infrastructure assets. That’s a mere 2.1 percent of the fund’s portfolio. And China’s outward stock of foreign direct investment (FDI) in Canadian firms was estimated at just CAD10.9 billion at the end of 2011, which is a scant 1.8 percent of Canada’s CAD607.5 billion of inward stock.
So clearly there’s room for the flow of capital between the two nations to grow. Although China’s investment in Canada is dwarfed by countries such as the US and the UK, its stake has grown substantially over the past eight years, albeit off a very low base of just CAD113 million in 2004. However, China’s level of investment has fallen about 10.7 percent from its high of CAD12.2 billion in 2009, likely as a consequence of the global financial crisis.
But that could soon change dramatically. After all, CIC is not the only Chinese entity hoping to mine Canada for resource plays. For example, China’s state-owned energy firm CNOOC (NYSE: CEO) is seeking to acquire Canadian energy producer Nexen (TSX: NXY, NYSE: NXY) for CAD15.1 billion.
But that deal could be stymied by a rule in the Investment Canada Act that requires such an investment to provide Canada with a sufficient “net benefit.” After all, that same rule recently scuttled the CAD5.2 billion takeover of Canadian natural gas producer Progress Energy Resources Corp (TSX: PRQ, OTC: PRQNF) by Malaysia’s state-owned oil company Petronas.
That’s raised some concern that Canada could be the latest nation to succumb to resource nationalism. On the other hand, Prime Minister Stephen Harper has said it’s a “national priority” to sell more commodities to Asia, while Natural Resources Minister Joe Oliver has noted that it will require significant investment to exploit Canada’s oil and gas resources. The latter comment, in particular, suggests that Canadian policymakers are keen on foreign investment to help spur exploration and production.
But the Organisation for Economic Co-operation and Development (OECD) has described Canada’s regulatory environment as posing among the world’s most restrictive barriers to FDI. And while the Conference Board of Canada has taken the OECD’s assessment and adjusted it for other criteria, which puts Canada in a more favorable light relative to its peers, it too characterized Canada’s approach to FDI inflows as a “confusing mix of protectionism and openness that seem to work at cross purposes.”
Perhaps adding a wrinkle of complexity to the Canadian government’s consideration of the merits of the Nexen deal is the fact that the government signed an investment treaty with China in early September after roughly 18 years of negotiations. The Canada-China Foreign Investment Promotion & Protection Act (FIPA) supposedly won’t impact the Nexen ruling, nor is it expected to lead to a sudden jump in FDI. Although it does provide a framework for dispute resolution, it’s significance is considered largely symbolic, an indication that both countries are encouraging investment in one another.
In the meantime, the government has further extended its review period for the Nexen deal until early December. That could bode well for its ultimate approval, at least according to Morningstar analyst Robert Bellinski. After the Progress acquisition came undone, he estimated the likelihood of approval for the Nexen takeout at just 10 percent. But Bellinski did say that if the review period were to be extended past its original Nov. 9 deadline, then he would consider that an “encouraging sign.”
Should the deal eventually garner approval, that could be a broader signal that Canada will take greater steps toward improving its conflicting approach toward FDI, which means investors in Canadian firms can hope for more takeovers at premiums to fair value.