Two CEOs I know--one at an oil company, the other at a gold miner--recently had strange encounters with Chinese counterparts. A Chinese oil company and its apparent partner, Standard Bank of South Africa, offered to buy a lot of oil for five years. It would be a direct sale--no middlemen, brokers or spot market involved. "They didn't care about the price," the oil executive says. "All they cared about was locking up the supply."
The gold company had a similar experience. The price offered was extraordinarily high, but the Canadian CEO didn't bite. He wondered what the Chinese knew about long-term demand that he didn't. Maybe in five or 10 years, the price won't look as high as it does today.
Welcome to the world of direct-sale commodity deals, better known as "off-take" deals and sometimes bilateral deals. In such arrangements, the commodity--oil, natural gas, base minerals, precious metals, iron--doesn't go to the London Metal Exchange (LME) or other public energy markets. There are no intermediaries. The commodity is, in effect, locked up and taken off the global market. These kinds of deals are suddenly everywhere, to the point that some energy and mining bosses think that the whole concept of open and transparent global commodity markets, where the highest bids get the shipments, is coming to an end.
Off-take deals are nothing new. The Japanese have been crafting them for years, buying up minority stakes in Australian coal mines in exchange for off-take supply contracts. Until recently, however, they were predominantly the preserve of junior companies looking to secure financing.
The scenario would play out something like this: Chuck's Copper Inc. has known reserves, but banks won't go near it--the company is unproven and the ore body is in a violent country. To reduce its risk profile, Chuck's negotiates an off-take contract in which, say, 75% of the production goes to a single buyer for 10 years at prevailing spot or LME prices. Or perhaps the contract is immune to market conditions (depending on how des- perate the buyer is for the supply). The bank, knowing Chuck's has a secure client at a secure price, is happy to extend the financing. Chuck's mine gets built. Repeat process with second mine.
The off-take game is now getting bigger and more sophisticated as commodity prices soar and something akin to panic sets in among the Chinese as supplies become scarce. Take oil. China ceased being oil self-sufficient 15 years ago, and saw its consumption double between 1996 and 2006. It's set to double again by 2010, the year the country will become the biggest energy consumer, according to the International Energy Agency. In their hunt for oil, the Chinese have picked the path of least resistance and targeted Africa, where the exploration and development game is rich and wild and not utterly dominated by American and European interests. Two years ago, Angola replaced Saudi Arabia as China's single biggest source of imported oil.
The oil CEO I know runs one of the London market's biggest independent producers. China's approach with Standard Bank at its side was no coincidence. The Industrial and Commercial Bank of China last year bought 20% of Standard, Africa's biggest bank. This allows the Chinese to offer oil purchase and financing contracts in one neat package. Direct equity stakes in producing wells often accompany the off-take deals, as do commitments to invest fortunes in local infrastructure, from roads to hospitals. In Nigeria, a $2-billion (U.S.) infrastructure and energy deal gave the Chinese a 45% stake in the offshore Akpo field. This means the Chinese are entitled to 45% of the production. Deals of the same size or bigger have been negotiated in Sudan and Angola, with lesser deals in Algeria, Libya, Congo and Zimbabwe.
In Africa, at least, the Chinese are winning the off-take game because they're willing to pay for it. "China's goal is to get direct control of the barrels," the oil CEO says.
The off-take sweepstakes may just be getting started. Other commodities, including liquefied natural gas, rice, wheat, fertilizer and water, may be the next lock-up targets. Sovereign wealth funds from China and the Arab world may wade into the game. Inevitably, more and more commodities will be taken off the global markets. At some point, the Americans and the Europeans will realize that paying market prices alone is not enough to secure supplies. As more supplies are locked up, geopolitical tensions are bound to rise. What can't be bought might simply be taken by force.
Until recently, off-take deals were generally the preserve of struggling junior companies
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