China is expanding the reach of its One Belt One Road Initiative to Latin America, where countries with rebounding economies are seeking foreign investment in infrastructure to help increase trade.
Ports, railroads and highways, power and renewables are among the assets drawing increased investment activity from Chinese state-owned enterprises and development banks, taking cues from officials in Beijing to invest in strengthening trade ties with the region.
Trade is driving Chinese interest in Latin American infrastructure, according to FTI Consulting’s lead Latin America political risk analyst Roberto Simon. “The relationship with Latin America has always been based on this huge hunger for commodities,” he explains.
China has indeed been trying to ramp up trade with Latin America. Total trade volume between China and countries in the region rose 18.8 percent last year to $260 billion, according to China’s state-owned Xinhua News agency. In January, Chinese officials invited Latin American nations to join its One Belt One Road initiative.
“China has promised quite a large sum of investment to the Latin American and Caribbean states, not just in terms of direct investment, but also in terms of trade,” adds Nicholas Song, a partner based in Beijing for the law firm Dechert, who represents SOEs in transactions. “SOEs are following that direction.”
As China’s outflowing capital increasingly turns toward Latin America, how governments and other investors work with SOEs will play a large role in deciding which sectors and assets China will target next.
‘Buying for the next hundred’
“Alignment is everything in a partnership. I don’t think SOEs are buying to exit in five-to-seven years. They’re buying for the next hundred” Harrington
SOEs have taken a long-term investment approach in Latin America, enabling them to deploy capital without necessarily expecting an immediate return, according to Terrence Foo, a managing partner who works with Chinese companies at law firm Clifford Chance.
A long-term approach may make SOEs “obvious candidates” to buy assets an investor is looking to exit, Foo says, but it can make it difficult to find partners with similar interests.
For example, Michael Harrington, a Mexico-based partner for emerging markets manager Actis, says the long-term view SOEs have does not align with their buy, build and sell strategy for Latin American power and clean energy assets.
“Alignment is everything in a partnership,” Harrington says. “We will build up a business, get it to a certain scale and exit in five to seven years. I don’t think SOEs are buying to exit in five to seven years. They’re buying for the next hundred.”
Power is one sector in Latin America in which SOEs are becoming increasingly dominant, especially in Brazil.
In 2015, Brazil began auctioning concessions for hydropower plants that were generating losses due to a mismatch in supply and demand, Foo says, SOEs participated in a government auction selling 29 hydropower plants, he explains, and China Three Gorges won the rights to own and operate two plants generating 5GW for $3.66 billion.
Foo, who says he advised on the deal for the China-LAC Cooperation Fund, which participated in the deal, says the acquisition came about due to the change in Brazil’s regulatory structure and China Three Gorges having capital ready to commit.
Another example came in 2016, when State Grid – China’s electricity monopoly and one of the largest utilities in the world – agreed to buy the Brazilian generation business CPFL Energia for $1.8 billion.
Elsewhere in Latin America, China Southern Power Grid International agreed to buy Brookfield Infrastructure Partners’ 27.8 percent stake in Chilean power transmission company Transelec for $1.3 billion, while State Power Investment Corporation has reportedly been in talks to acquire wind and hydro assets from the energy company Latin America Power for up to $400 million.
SOEs seem poised to make port investments part of their infrastructure-for-trade strategy as well. Last September, state-owned China Merchant Port Holdings acquired a 90 percent stake in Brazilian port operator TCP Participacoes for $924 million, part of a nine-port acquisition spree that featured assets in other One Belt One Road markets.
Bottom line first
Developing railroads in Latin America has been mentioned as a key priority for China’s trade investments. It also serves as an important example of how politics can get ahead of business.
“[Venezuela] was a very big wake-up call for the SOEs and China. They learned the hard way that this comes with very, very high political risks” Kratz
Since 2014, Chinese officials have talked up a project that would connect resources and commodities from Brazil with ports on the Pacific Ocean in Peru. The project served to highlight China’s commitment to developing trade in the region. But the project never got under way, and in February it was officially called off because it was never likely to be economically viable.
Agatha Kratz, an advisor at the China-focused research company Rhodium Group, says SOEs invest in two kinds of Latin American infrastructure projects: political projects pushed by government officials and projects with deep commercial interests. She says large-scale projects like the Brazil-Peru railway are sometimes announced after government-to-government meetings to show future co-operation.
“In these cases, SOEs are part of the national team. They’re not always super happy to be part of that team, because sometimes they don’t make as much money or the project is not in their priority markets, but they still do it,” Kratz explains.
Foo, the Clifford Chance lawyer, agreed that early Chinese investments were politically driven, but argues most investments taking place now are about the bottom line first.
This was a lesson learnt after what happened to China’s investment in Venezuela, Kratz said. Starting in 2005, China loaned Venezuela $62.2 billion, according to the Inter-American Dialogue, to invest in and develop the country’s oil reserves. When oil prices plummeted a decade later, Venezuela’s economy plunged, which has led to political turmoil. China has yet to recoup the majority of its investment.
“It was a very big wake-up call for the SOE and China that investing in risky countries can be extremely costly,” Kratz explains. “They learnt the hard way that this comes with very, very high political risks.”
The trade link
For now, many Latin American countries have been open to investments from China’s SOEs, but they are also mindful of allowing too much foreign influence.
“There’s always an issue of how open you are to China in terms of welcoming sources of investment that are pretty promising but, on the other hand, trying not to give in to too much political influence,” Kratz says.
This kind of Chinese scepticism is already leading to protectionist policies in Europe, according to Foo. He cites a proposal put forward to the European Commission to consider how to regulate non-European Union investments coming into the EU. The proposal doesn’t expressly mention China, he says, “but everyone knows these were sparked by concerns about Chinese investments”.