Commodities Crash Boosts China's New Silk Road

  • Project costs fall as plan to rebuild trade route takes off
  • Price slump gives China incentive to speed plan's execution

Xi Jinping, China's president.

Photographer: Seong Joon Cho/Bloomberg

While commodities producers grapple with the lowest prices in more than a decade, the slump could prove a blessing for President Xi Jinping’s signature initiative to build an intercontinental web of infrastructure and trade links with China at the center.

The New Silk Road program announced by Xi more than two years ago is finally gathering steam just as the prices of oil, steel, concrete and other building materials sink. That’s making it easier for China to sell its ambitious vision to build roads, railways, pipelines and ports from Xian to Athens, diversifying the country’s trade options and exporting the excess industrial capacity that’s dragging down its own economy.

The so-called Silk Road Economic Belt and 21st-Century Maritime Silk Road -- or "One Belt, One Road," for short -- sits at the center of Xi’s effort to bolster geo-economic clout across more than 70 countries in Asia, Europe and Africa. With many nations along the route dependent on commodities exports, the prices slump could make them more willing to accept Beijing’s investment pitch and a share of its $40 billion Silk Road infrastructure fund.

"It will help to ease cost pressures on OBOR construction projects, potentially boosting their financial viability," said Andrew Wood, the head of Asian country risk at BMI Research in Singapore. The commodities meltdown could make participant countries "even more amenable to the stimulative effects of the large infrastructure projects proffered by China," Wood said.

Iron ore plunged 39 percent last year, hitting $38.30 a dry ton last month, the lowest since at least May 2009 by Metal Bulletin Ltd. Citigroup Inc. said last Thursday that there was a "strong possibility" of the material falling below $30 a metric ton this year amid weak Chinese demand. Crude oil is selling for about $30 a barrel, a price not seen in more than a decade.

Meanwhile, the Silk Road, which until recently appeared to be a nebulous collection of existing projects and civil engineer pipe dreams, is finally taking shape. Xi hosted senior financial officials from 57 countries in Beijing on Saturday to mark the formal launch of the Asian Infrastructure Investment Bank, which he envisions as a big sponsor for OBOR projects. 

On Thursday, construction began on a $5.5 billion high-speed train between the Indonesian cities of Jakarta and Bandung, the official China Daily said. It’s being built by a joint venture between the two countries and financed with a loan from the China Development Bank.

"This year was the year of action for the One Belt, One Road, the year when the concept materialized to action and implementation," Chinese Foreign Minister Wang Yi told a conference in Beijing on Dec. 12. China signed more than 20 country-to-country energy cooperation deals last year to facilitate the plan.

Kazakhstan Deals

The People’s Bank of China announced in April that a dam project in northern Pakistan -- part of a $46 billion economic corridor linking western China to the Arabian Sea -- would be the Silk Road fund’s first recipient, a total investment of $1.65 billion. China also started building a highway between Karachi and Lahore, and took over a 923-hectare (2,281-acre) free-trade zone at the deep-sea port Gwadar.

More nascent projects have helped expand Chinese influence in places such as Southeast Asia and the former Soviet states of Central Asia, where Russia has long been the dominate power.

Kazakh Prime Minister Karim Massimov, who has watched oil’s fall upend budget projections, during a visit to Beijing last month locked in Chinese support for 52 projects worth $24 billion, with at least 10 expected to start next year. At the same time, China’s Shenyang Lianli Copper Co. signed a memorandum of understanding to explore mining resources in Kazakhstan’s Atyrau region.

Reducing Obstacles

Yang Shu, director of Lanzhou University’s Institute of Central Asian Studies, called the commodities slump "a great opportunity for Chinese capital to further penetrate Central Asia, a key link in the Belt," and could help alleviate concerns about becoming too beholden to Beijing. "The oil-price collapse helps reduce obstacles to the initiative," Yang said.

Malaysia, which derives more than one-fifth of government revenue from oil-related sources, is also courting Chinese infrastructure investment. Malaysian Transportation Minister Liow Tiong Lai said at Silk Road forum in Kuala Lumpur last month that connectivity was a key growth driver and that railway cooperation with China was a core focus, according to this official Xinhua News Agency.

The Silk Road has been cast as a solution to several of China’s most vexing challenges, from reducing reliance on oil shipped through Pacific ports to converting economic strength into geopolitical might. The project, outlined in a 9,000-word action plan released in March, would eventually "directly benefit 4.4 billion people, or 63 percent of the global population," Xinhua said.

One more pressing motivation is to "correct internal imbalances" by exporting China’s glut of industrial materials such as steel and cement. That oversupply is fueling deflation at the nation’s factory gates and contributing to the country’s economic slowdown.

With the plan still ramping up, Chinese steelmakers, who produce about half the world’s steel, are already exporting at record levels. Outbound cargoes soared 20 percent to more than 112 million tons last year, an all-time high.

Low commodity prices also make it cheaper for Chinese state-owned companies to acquire energy and material assets along the Silk Road route in exchange for infrastructure, said Hong Hao, chief China strategist at Bocom International Holdings Co. in Hong Kong. "The commodity cycle is still in a secular bear market, and will probably start to consolidate at low levels," Hong said. "As such, these assets can be had at a cheap price."

The commodity slump isn’t a clear positive or negative for the new Silk Road because it reflects weak Chinese demand and a domestic production glut, said Mark Patrick, head of Asia-Pacific country risk for JPMorgan Chase & Co. Still, it provides extra incentive to quicken the plan’s pace.

"It will increase pressure to execute the policy," Patrick said. "And maybe that makes China bolder regionally."

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