Fertile ground for BHP growth over time

Andrew Mackenzie’s flurry of appearances on television over the weekend have reignited a debate about BHP Billiton’s planned continuing investment in the Jansen phosphate project. Not all of it reflects the sophistication of the group’s plans and position.

The Jansen project in Canada illustrates BHP’s long-held ‘options’ strategy and provides a focus for the current contest between enhanced short-term returns for shareholders and long-term projections and aspirations.

When announcing BHP’s annual results last week Mackenzie, while committing BHP to an additional $US2.6 billion ($2.88 billion) investment in Jansen ($US800 million a year), made it clear that it would still be some years before a final decision was made on whether to proceed with a full-scale development. The completion of the sinking of the production and service shafts and investment in some above-ground infrastructure won’t be completed until 2017.

At the weekend he reiterated that BHP’s preference was to introduce a strategic partner to the project, one that would share the risk and hopefully add value to it and provide tangible evidence to shareholders and the market-at-large of Jansen’s value.

BHP has long been intrigued by potash and Jansen in particular, the world’s largest undeveloped potash resource and potentially the largest and lowest-cost producer (BHP on the brink of a hot potash war, July 31).

As living standards in Asia and China continue to rise, the long-term outlook for agricultural products (and for fertilisers) is very positive. As the steel intensity within China’s economy declines, potash could present itself as a prospective ‘next generation’ commodity. BHP has referred to potash as a potential ‘fifth pillar’ to go with its iron ore, copper, coal and energy businesses.

The continued spending, not overly significant in the context of BHP’s size, is about protecting and enhancing the option BHP has to develop Jansen in the longer term.

Mackenzie is already cutting back BHP capital expenditures from more than $US20 billion towards $US15 billion in response to the changed resource sector circumstances and shareholders’ demands for increased cash returns.

While BHP is sensitive to those demands, it also has to consider its longer term future in an industry based on depletion of existing resources, and in the context of shifting trends in the demand for particular resources. The outlook for commodities like aluminium, nickel and coal isn’t what it used to be.

If it isn’t to have a finite future, it does need to continue to invest selectively in higher returning projects. Mackenzie and his board obviously believe that in a more capital-conscious environment, potash may be able to produce attractive returns.

The timelines for development of Jansen, if it is to be developed, offer some insurance. BHP has several years to come to a conclusion about whether to spend the big dollars on the project. Full-scale development of Jansen is variously estimated at between about $US12 billion and $US15 billion, although it could take the best part of a decade to fully ramp up production if it did get a go-ahead.

There are those who believe the recent apparent break-up of one of the two associated potash cartels provides an overwhelming argument against the project .

Last month, OAO Uralkali, currently the world’s biggest and lowest-cost producer, split with its marketing partner Belaruskali and announced an independent deal to supply a Chinese importer with about 10 per cent of China’s annual potash requirements.

The two cartels – the Russians and a Canadian marketing joint venture between Potash Corp, Mosaic and Agrium – had previously prioritised the potash price over the volume of potash sold. Therefore, a break-up of the cartels  — or even one of them — is likely to see a structural and significant lowering of the price.

The problem with arguing that the end of the cartels undermines the prospects for Jansen is that BHP has always made it clear it wasn’t interested in joining them if it entered the sector. Instead, it would introduce its own preference for accepting market-clearing prices.

In effect, if the dissolution of the Russian cartel is indeed permanent, the market gets to that point far earlier and BHP has an opportunity to actually know what it looks like when potash is priced according to the relationship between unconstrained supply and demand. That’s a positive for the evaluation of Jansen.

Mackenzie’s commentary on BHP’s desire for a partner for Jansen has both defensive and offensive elements and potential. It would share the risk and create an external arms-length assessment of Jansen’s value and perceived potential, but could also create strategic value and advantage.

Conventionally, resource companies partner with their peers on the bigger and riskier projects  to share the funding and risk and to pool operating expertise.

With Jansen, the range of potential partners and the value they might be able to bring is wider than BHP’s traditional peers.

It is possible that BHP’s invitation to partner might, given the apparent breakdown in the cartels' structure, attract one of the existing players, most likely one of the Canadians. That would introduce expertise and capital and could provide insurance for an incumbent against the impact of market pricing and the entrance of a major new competitor.

It is also more than conceivable that, as has been the case in its iron ore and coal operations, BHP introduces a customer to the project.

China’s Sinochem was once at the centre of an attempt to put together a consortium with Canadian investors to mount a counter-bid to the ultimately failed BHP bid for Potash Corp. China is increasingly focused on agriculture and food security and securing access to potash – and a hedge against its future price – would be strategically valuable for it while securing access to the Chinese market for the project.

Another interesting option would be to team up with Glencore Xstrata, which is a peer and a competitor, but whose agricultural commodities trading and distribution platforms might be valuable.

In any event, there is considerable time and the potential developments in the ownership of the project and in the markets in which it would operate before BHP has to make an irrevocable commitment to it and, given Mackenzie’s measured and conservative approach to capital and costs, no rush to come to any concluded judgement about the merits of the project and of the staged investment in preserving the value of the option to develop it.