The Takeover: Stable China Looks To Volatile Middle East For Investment Opportunities As West Backs Away

China has not been known as a big investor in the Middle East. But that will soon change, as the world’s second-biggest economy learns to flex its newfound foreign-policy muscles, and builds its presence in the world’s most volatile, and most oil-rich, area.

China’s interests in the Middle East span economics, diplomacy, security, and soft power. With much to gain from an increased presence in the region, the Chinese are making an all-out effort to build a base there, including in nations where Western investors have long feared to go.

Most recently, Beijing assumed a bigger role in Middle Eastern geopolitics by inserting itself in the Israeli-Palestinian peace process, a sure signal that China is looking to increase its footprint in the region.

Although Xi Jinping has just begun his term as China’s new president, his early investments -- of both time and capital -- in the peace process between the Israelis and the Palestinians indicate that China has something to gain. Becoming an active party in the attempt to solve that decades-old conflict, a solution that has eluded the U.S. for decades, would solidify China’s clout as a constructive global power while simultaneously improving relations with the Muslim world.

Bill Bishop, a veteran China watcher, figures that China will be able to benefit from the Middle East, whether or not it manages to broker peace.

“China wins in the Middle East regardless of the outcome,” Bishop wrote in his China newsletter, Sinocism. “In fact a ‘recalcitrant’ Israel, however friendly its relations with China may be, might help reinforce the idea that China is aligned with the majority of the Middle East while the U.S. is on Israel’s side.”

This proactive new approach to geopolitics didn’t spring out of nowhere: It is driven by trade and investment. China’s financial stake in the region has grown in recent years. Broadly speaking, however, the Middle East is not a major target for foreign investors.

According to an Ernst & Young report, the region received less than 7 percent of global foreign direct investment, or FDI, in 2011, amounting to about $58 billion. Most of that money came from North America and Western Europe: China accounted for less than 2 percent of the total value of FDI targeting the Middle East.

But those figures are beginning to change as Beijing pushes into the region. “It seems that China has reached a double tipping point: Half of its oil is now imported, and more than half of that comes from the Middle East,” said Barry Naughton, an analyst of the Chinese economy at the Brookings Institution. “So China is now focused on the Middle East in a way it hasn’t seen before, and they seem willing to take a more high-profile role.”

Chinese investors aren’t playing it safe. They’re making big bets not only on stable Gulf states, but also on some of the high-risk and politically volatile nations that pose the biggest risks.

The Old Standbys

Global FDI has not been distributed equally across the Middle East. There is a clear division between countries that are developing and prone to instability -- such as Egypt, Iraq and Yemen -- and those that are member-states of the Gulf Cooperation Council, or GCC: Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and the United Arab Emirates, or UAE. Investors overwhelmingly favor GCC partnerships due to the Gulf states’ oil riches, general stability and welcoming financial regulatory environments.

China is no exception. With a population of 1.3 billion and a rapidly expanding middle class, it is desperate for energy resources, particularly hydrocarbons, to maintain momentum as the world’s second-largest economy. This has driven Chinese leaders and investors to funnel capital into oil-rich nations.

“So far, China’s interest in the Middle East has focused on conventional fuels like oil and gas,” said Guy El Khoury, an analyst and consultant with Carboun, an organization that promotes energy sustainability in the Middle East. “Energy has clearly topped the Chinese investments abroad, with the Middle East naturally accounting for a substantial share of that.”

Although China is willing to venture all over the Middle East, it has already put down roots in states posing the least risk. A 2012 Remark survey published by Latham & Watkins in the law firm’s “The New Silk Road: Investing in and Venturing with Middle Eastern Companies” showed that Saudi Arabia and the UAE were among the top states of interest for Chinese investments. All respondents said that Saudi Arabia was an attractive destination for investment, while 70 percent said the UAE was. Qatar is also on the radar for Chinese investors, piquing the interest of 10 percent of respondents.

According to Heritage Foundation statistics, China invested roughly $3.25 billion in energy and real-estate projects in the UAE in 2008. Total investments dropped over the following three years, but surged again in 2012, when China put $4.9 billion into real-estate investments and another $3.3 billion into energy investments. In addition, China recognizes the growing consumer base represented by the UAE’s 2 million very wealthy people.

Last May, UAE Minister of Foreign Trade Sheika Lubna Bint Kaled Al-Qassimi praised the UAE-China trade relationship, which had seen a remarkable annual growth rate of 35 percent over a 10-year period. Bilateral trade is now around $35 billion annually.

Saudi Arabia has also been a popular target for Chinese investments. The nation has more than 262 billion barrels of proven oil reserves, but is also the target of diverse investments in other sectors, such as metals, transportation and agriculture. In 2012, China put a total of $12.9 billion into Saudi Arabia, $5.2 billion of which went into the metals sector.

China also continues to forge a relationship with Qatar, which is an important source of liquefied natural gas, or LNG, for China. U.S. Energy Information Administration data show that in 2012 Qatari gas exports accounted for about 20 percent of China’s LNG needs. Now, China is continuing to expand its trade presence in other areas of the Middle East, even in areas where political interferences are a potential investment risk.

A Walk On The Wild Side

The political chaos affecting so many non-GCC countries across the Middle East presents major challenges to foreign investors. But the inherent risks that deter Westerners are precisely what pique Chinese interest: They clear the playing field, presenting Beijing with unique opportunities to secure access to growing economies, vast consumer markets and diversified energy resources.

“Chinese investors provide much-needed investments in countries where Western oil companies are not willing to take high exposure, or not able to invest due to restrictions from the international community,” Carboun’s El Khoury said. “Chinese firms also work together to offer aid packages -- financial aid or discounted infrastructure works -- in return for preferential access to resources.”

Egypt is a good case study. According to the Latham & Watkins report, Chinese executives see Egypt as the third most attractive country for investment in the Middle East, right after Saudi Arabia and the UAE. According to the rest of the world, Egypt is much less attractive than that, if at all. Net FDI inflows into Egypt were actually negative in 2011, with divestment hitting $438 million.

But Chinese investors see Egypt’s huge potential as a market. Its 85 million people are a prime target for the cheap consumer products that Chinese manufacturers have perfected over the years. The two countries are also linked by investments. In 2008, the China-Egypt Suez Economic and Trade Cooperation Zone was established under the auspices of TEDA Investment Holding Co. (SHE:000652) in Tianjin. In April, TEDA signed an investment agreement with the Egyptian government for further development in the joint industrial zone, which is expected to see the corporation pour another $500 million into the partnership. That’s on top of the $600 million already disbursed via 38 projects.

This trend is apparent not only in Egypt, but also in various other Middle Eastern and North African countries with less-than-stable outlooks. In Yemen, which had its Arab Spring ouster of president Ali Abdallah Saleh in February of last year, an al Qaeda-linked insurgency remains a threat. So do widespread poverty and deadly water shortages. The U.S. has formed a defense partnership with the new Yemeni government, but the country's biggest trade partner is not America. It’s China.

This year, Chinese officials decided to reduce duties on Yemeni exports to China. They also agreed to donate $5 million in supplies to the Yemeni-Chinese Friendship Hospital, a project that began before the 2012 regime change.

Even Iraq, which is struggling to combat an ongoing insurgency in the aftermath of the American-led invasion and regime change, is increasingly looking East for business partnership opportunities. China has had a large stake in the war-torn country for years: The state-owned China National Petroleum Corp. has invested about $3.3 billion in three oil projects since 2008, according to Heritage Foundation statistics. This year, its share has grown even bigger.

Outside the Arab world, China also has a strong relationship with Iran, and the bond is forged by hydrocarbons. China is the Islamic Republic’s largest trade partner, despite sanctions imposed on Iran by the United Nations and Western countries.

The state-owned Sinopec, Asia’s largest oil company, has invested more than $2 billion in Iranian oil field projects since 2007, while CNPC has invested more than $3 billion. Meanwhile, Beijing has used its position on the U.N. Security Council to soften the sanctions imposed by Western powers.

One Chinese firm has gotten in some trouble for its dealings with the pariah state: Shenzen-based telecommunications giant ZTE Corp. (SHE:000063) was accused of supplying in 2012 equipment that helped Tehran spy on its own citizens, as part of a 2010 deal with the Telecommunication Co. of Iran. Reuters reported that ZTE has now curtailed its business in the country, proof that China cannot always divorce trade from geopolitics.

Changing Of The Guard?

China’s expanding presence in the Middle East is a product of push and pull. Mounting energy demands have driven China into the Gulf, while new opportunities have drawn it into some of the most volatile countries in the Middle East. But, as China’s footprint increases, questions about Beijing’s own sense of agency become increasingly urgent.

Beijing is struggling to find policies that can sustain the nation's long-term growth, amid worries over quickening inflation and sluggish growth in consumer spending. Investments in the Middle East -- and around the world -- could certainly be part of the government’s plan to shore up growth and find new markets, as well as places to employ the enormous amounts of money it makes from selling manufactured goods to the entire world.

“This is all part of a Chinese push to convert their official foreign-exchange reserves into real productive assets overseas,” said Naughton of the Brookings Institution. China has $3.3 trillion in reserves, more than any other nation and about four times as much as the entire European Union, according to the CIA World Factbook.

But in the complicated and often-violent morass of Middle Eastern geopolitics, trade policies and investments cannot exist in a bubble: China is in no way immune to the conflicts and sovereign risks that have spooked some Western investors.

Those risks are liable to increase as the U.S. and others continue to draw down their military presence in the Middle East, leaving China hard-pressed to protect its own assets. Beijing will need to plan carefully to ensure that its investments are kept safe, and spur sustainable growth not only for China, but also for all its partners across the Middle East.