When, on the same day, Rio Tinto’s Tom Albanese talks about stripping more than $US5 billion from its operating and support costs over the next two years and BHP Billiton’s Marius Kloppers says it is imperative that costs are at the low end of the US dollar cost curve it reinforces the message that the resource industry settings have changed quite fundamentally.
As Kloppers said, over the past decade the industry had experienced :unsustainably" high prices for some commodities, like ore and metallurgical coal, as the growth from China and other emerging economies out-stripped the rate at which new low-cost supply could be added. At the same time there was very significant cost escalation, compounded by the strengthening in the currencies of some key producing countries.
‘’With the shortage of low-cost supply now well advanced towards being filled, prices for those commodities that experienced the greatest supply-demand shortage, and therefore the greatest price increases, are expected to ‘mean revert’ in the period ahead,’’ he said at today’s BHP annual meeting.
Albanese’s focus, at an investor presentation today, was similar. He talked about ‘’tough action to roll back the unsustainable cost increases of the past few years’’ and put some flesh on those bones by nominating the $US5 billion target and also saying that Rio had saved $US1 billion of capital by reconfiguring the mine plan for its Pilbara iron ore expansion program.
The twin themes of costs and capital intensity are reverberating through the industry as the mines try to unwind some of the profligacy of the boom years, when there was a race to get new production into market as quickly as possible and its cost was made a secondary issue by the prices on offer. Both the big miners are now in a cautious, capital conservation and cost-reducing mode.
The currency issue is a particular one for BHP and Rio, given that so much of their core resource base is in Australia. Albanese made the point that even in Rio’s fabulous Pilbara operation, which has cash costs of only $US24.50 a tonne and delivered costs (to China) of $US47 a tonne, the benefits of a stringent focus on costs were offset by the strength of the Australian dollar.
Given that the currencies’ relativities may have changed structurally, the miners have no option but to act on the premise that it will remain elevated for the foreseeable future and, in an environment of lower commodity prices, will have to be offset by an obsessive focus on costs and competitiveness.
That’s a particular problem for coal, where costs have escalated and will continue to be under pressure as pits get deeper and strip ratios deteriorate even as the emergence of the shale gas sector in the US is displacing coal in that market and forcing it into export markets previously dominated by what used to be low-cost Australian producers.
While it might appear that both Rio and BHP are pessimistic about the state of their industry there was actually a positive, albeit not euphoric, tone to the commentary from both Albanese and Kloppers.
Kloppers said that prices for iron ore and metallurgical coal – which plunged earlier this year – had been impacted by de-stocking within China and lower steel demand in Europe, India and the Middle East. While there had subsequently been re-stocking (and something of a rebound in prices) that was now largely complete and BHP didn’t expect any material pricing upside in the near term.
Over the coming years China’s GDP growth rate was expected to range between 7 and 8 per cent, materially less than the double-digit rates of the past decade but off a far larger base that would still underpin strong underlying growth in demand for commodities.
Albanese is expecting China’s GDP to grow a little above 8 per cent next year, with steel demand continuing to grow toward a peak of about a billion tonnes by 2030, but both the mining heavyweights are trying to reconfigure their businesses for a future which is volume-driven rather than price-driven.
Rio’s Pilbara expansion program, thanks to an extra seven million tonnes a year it has unlocked through de-bottlenecking, has lifted capacity to 237 million tonnes a year and its expansion program to 360 million tonnes per year, and with the productivity programs underway will have minimal impact on the capital intensity of the program.
There is some divergence in strategies. BHP is, of course, more diversified because of its oil and gas interests and is pushing into new commodities like potash that, with its energy interests, will give it an exposure to the next phase of China’s economic development as it shifts from investment-led growth to consumption.
Rio is more focused on hard commodities – iron ore, coal and copper – and, unhappily, aluminium, although it is also optimistic about the prospects for its minerals sands business and is also toying with entering the potash industry.
Despite their differences, in the near term they are reading from the same play book and preparing their groups for a future where growth is more subdued, supply is more abundant, prices shift back towards their long-term trend lines and competitiveness and profitability are determined by the level of capital and costs tied up in their projects.
Not all of those costs, which include taxes, royalties, environmental assessments, third party infrastructure and labour costs and conditions across economies, of course, are within their control.
BHP and Rio revert to a volume vision
BHP Billiton and Rio Tinto are targeting costs and capital intensity as they set about adapting to the reduction in key commodity prices and permanently high currencies in resource countries.
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