A BHP pointer to meaner mining
Although a good result, BHP Billiton's production report also reveals the challenges pulling at mining such as the dollar, shareholder demands and cashflow concerns. It points to a meaner and leaner period ahead.
Within what was a very solid set of production numbers BHP said the release of latent capacity at a number of its highest-margin businesses and strong growth across it broader portfolio was expected to deliver a compound annual growth rate of 10 per cent in copper-equivalent terms over the two years to the end of the 2013-14 year.
If it can deliver on that promise BHP would be presiding over a very substantial increase in volume from its core portfolio of mining and oil and gas interests.
In an environment of volatile and generally lower prices for most hard commodities BHP and its peers may not be able to control, or even forecast with any precision, it becomes imperative that they shift their emphasis to volume.
It is also critical, however, that unlike much of the past decade as the bull market/bubble in commodities developed China-inspired momentum and heady prices, that volume isn’t pursued at any cost.
All the major miners have committed to re-basing their costs at lower levels and paying far more attention to the intensity of the capital they deploy than they did during the mad scramble to maximise their exposures to those record commodity prices.
Within its iron ore business, having shelved the notion of spending $US20 billion-plus developing the Outer Harbour at Port Hedland in favour of investing in getting more throughput within the existing Inner Harbour port facilities, BHP is starting to see the twin benefits of higher throughput with less capital intensity.
Its West Australian iron ore business now has the infrastructure to push 220 million tonnes a year through the port and expects to deliver volume growth of 5 per cent this year.
In a metallurgical coal business that has been affected by flooding and industrial disputes in recent years and hurt by the steep decline in coal prices, BHP said Queensland coal production was now approaching full supply-chain capacity and that the increase in productivity, broader economies of scale and the closure of some high costs mines were expected to deliver a ‘’substantial’’ reduction in costs in the second half of this financial year.
Copper concentrate production from the Escondida copper mine in Chile was up 70 per cent in the half, with higher grade ore feed and the completion of a large and disruptive maintenance program.
With record production from its US shale gas business (which is now starting to demonstrate why BHP is so upbeat about its sometimes criticised $US20 billion US shale gas strategy) BHP also achieved 5 per cent growth in its output of crude, condensate and gas liquids.
The problem the miners face is that even as the capital and operating cost-inflation that raged through the sector in recent years finally starts to subside the Australian dollar remains elevated, which is a major depressant on earnings and returns for BHP and Rio Tinto in particular. Without the attack on costs and efforts to strip capital from their operations, of course, they’d be under even more pressure.
BHP needs to get leaner in its operating costs and meaner in its allocations of capital because it has a pretty full slate of development projects under way that will absorb most of its free cash flows over the next couple of years in the absence of a major rebound in commodity prices. It has about 20 projects under development, mainly relatively low-risk and prospectively high-return ‘’brownfields’’ developments.
It is improbable that it, or any of the major miners, will sanction any big new projects this year or, indeed, next. The industry has entered a period of searching introspection as it tries to strip out the excesses of the boom years and recover some of the margins that have been compressed by the sharp falls in commodity prices last year.
BHP and Rio in particular will also have to reconcile this new era of austerity and cashflow preservation with the ambition of cash-hungry shareholders still seething that they didn’t get a bigger direct share of the windfall profits generated by the commodity bubble.
Rio, after unveiling another $US14 billion of writedowns last week, forcing the exits of two of its most senior executives, including its chief executive and turning to a 63-year-old to fill the key vacancy in a clear signal of a major breakdown in its succession planning, will be under extreme pressure to take action to placate its shareholders by increasing their returns.
BHP, having held a steadier course and having made fewer and far smaller mistakes during the heady years, isn’t as obviously under pressure but, having committed most of its reduced cash flows, BHP doesn’t have much flexibility to respond to shareholder pressure.
The sale of its interests in the Richards Bay minerals sands joint venture (to Rio) and its Ekati diamond business to Harry Winston will release some cash and capital and is probably the start of a tougher scrutiny of its portfolio to pare it back to its core and release cash.
BHP does have some difficult assets of its own, notably its aluminium assets in South Africa and its nickel interests. As Rio has discovered so painfully, the aluminium industry is experiencing structural change that is probably permanent and something quite similar has happened within the nickel industry.
While BHP’s South African aluminium interests are far smaller than Rio’s Alcan operations, it isn’t easy to see a potential buyer of either its smelters or its nickel projects, which are essentially being run for cash (and which at last report were still cash-positive) while the group tries to determine their longer term futures.
But the reality check the big miners received last year when commodity prices tumbled is probably in their long term interests.
It did, for instance, stop BHP from committing tens of billions of dollars to the Outer Harbour project and an Olympic Dam expansion that would have drained cash and capital for years before making any contribution to group cashflows and earnings.
It also has forced the sector to reverse the cost inflation that was, with the rise in the relative value of the Australian dollar, rapidly undermining the competitiveness of a sector that was, pre-boom, generally at the lower end of the industry cost curves.
There might be some vestiges of those inflated costs still to flow through to some of the incomplete projects but there is now a full-scale assault on costs occurring that will include mine closures, lower margins for contractors and a reduction in the boom-time largesse the miners threw around in response to the competition for a limited pool of available skilled employees.