A BHP brain-teaser looms for Mackenzie

For more than a decade it has been an article of faith within BHP Billiton, and the foundation stone of its corporate strategy, that diversity equals strength. Despite some question marks as to whether that still holds true, the group's incoming chief executive appears to share that conviction.

It was notable that BHP chairman Jac Nasser highlighted the uniqueness of Andrew Mackenzie's curriculum vitae when announcing last week that Mackenzie would succeed Marius Kloppers as chief executive.

‘'He is a rare executive because he has experience in the oil and gas, petrochemicals and minerals area of this business. And that fits us perfectly, because when you look at Andrew's experience and you look at the diversification and diversity of our portfolio, the fit is remarkably good,'' Nasser said.

Mackenzie himself referred to BHP's "fabulous" strategy and said there were lots of things that were great about the company that he had no intention of changing. He also said he believed there were quite powerful synergies that could be unblocked between mining and petroleum and that petroleum had a fundamental part to play in the company.

Subsequently, he has indicated he was very comfortable with having shale gas in the BHP portfolio. He has said shale will be a fundamental part of the world's future energy supplies and that, while it sits at the centre of things that BHP should do as part of its strategy, he wants to maintain a balanced portfolio and wouldn't unduly tilt it towards oil and gas.

Ever since Paul Anderson cleaned up a destabilised BHP at the end of the 1990s and then merged it will Billiton in 2001 BHP has been pursuing quite a sophisticated diversification strategy in the belief that its portfolio – unique among global resource groups – gave it a base level of cash flow in almost any circumstances that would enable it to continue investing and maintaining its progressive dividend policy through resource industry cycles.

In the dozen or so years since that strategy was actively adopted, the resilience the diversity of its operations and jurisdictions has provided has differentiated the group from its peers, which are more exposed to particular commodities or groups of commodities with high correlations and therefore which have more volatile cash flows and earnings.

Or at least that was the case until relatively recently, when traditional relationships between currencies and commodities started to break down in the post-global financial crisis environment.

The most obvious one has been in what used to be the tight correlation between the Australian dollar and commodity prices. Where previously they moved in tandem the dollar is now being driven by forces and sentiments that have nothing to do with commodity prices. When iron ore and coal prices plummeted last year the dollar barely budged.

It also used to be the case that the correlation between oil prices and hard commodity prices was relatively loose. In recent years, however, it has tightened.

In may be – indeed, probably is – the case that the post-GFC environment is an aberrational one and that at some point historic correlations may again reassert themselves.

Given some of the long term structural issues confronting, not just Europe and the US but even China, however, that may take some time and unless and until they do BHP will need to look at its portfolio and its resilience slightly differently to the way that it did pre-crisis.

If, for instance, the current relationships were seen as likely to be maintained into the medium terms and diversity were still seen as a major competitive advantage, Mackenzie might need to think about whether he should try to accelerate BHP's move into potash in Canada to add another dimension of real diversity to the portfolio. He might also consider whether there were advantages in retaining the existing portfolio or whether more value might be created by spinning some assets out.

The issue of whether BHP should be as diverse as it is if that diversity isn't delivering the lower volatility in its cash flows that it once did might also need revisiting – that hoary old question, shelved in recent years, of whether the combination of oil and gas and minerals does add value might resurface.

Mackenzie isn't, at this point, questioning the BHP strategy. Indeed, he has essentially confirmed that he will continue to pursue it.

His focus is on lowering costs and raising the productivity of the capital tied up in the business. In some respects that is, for the next couple of years at least, a focus dictated by circumstances.

The slower growth rate in China and the shift in the industry settings as the belated supply-side response to China's demand has kicked in means that the emphasis is now on low-cost volumes rather than price and that the era of windfall cashflows and super-profitability from stratospheric prices is over.

In BHP's case, its cash flows are fully committed to its existing pipeline of new projects until at least 2015, which means that Mackenzie's stated prioritisation of costs and productivity is exactly what is required in the first part, at least, of his tenure.

BHP and its peers were necessarily spendthrifts during that period when there was a mad and competitive scramble to get more supply into the market; now they've got to bring the fundamentals of their projects back into line with the more sober settings.

Once he's got the portfolio into the shape he wants, however, and he has more financial flexibility and therefore options about how to best manage the portfolio to maximise longer term returns and shareholder value, some of the more fundamental questions about BHP's structure and strategy within what appears to be a different industry framework may have to be reassessed, or at least revisited.