How the big miners blew the boom
Running through old supply-demand equations should not be the key task for mining executives looking to learn from a wasted decade.
The Glencore chief executive blamed the ‘’big guys’’ – presumably BHP Billiton, Rio Tinto, Vale, Xstrata and Anglo American – for introducing too much supply into the market and creating a surplus of metals that had damaged earnings.
‘’We’ve always been wanting to keep building and keep putting the cash which we generate into new assets. That’s what we’ve got to stop doing as a mining industry. We’ve got to learn about supply and demand,’’ he said.
‘’Now (after the axing of Rio’s Tom Albanese and Anglo’s Cynthia Carroll, the imminent displacement of Xstrata’s Mick Davis by Glasenberg himself and last week’s BHP announcement that Marius Kloppers will be replaced by Andrew Mackenzie in May) we have a new generation of CEOs. I hope CEOs have learned their lesson. They built, they didn’t get the returns for their shareholders. It’s time to stop building.’’
In fact the major miners have more or less stopped building. Sam Walsh at Rio, Mackenzie at BHP and Mark Cutifani at Anglo have made it clear that their priorities are lowering costs and improving the productivity of the capital already invested in their businesses. The expansionary era in the resource sector is, for the moment at least, over.
If one goes back to the early part of the last decade as the commodity price boom started to develop momentum as China’s growth rate and demand for commodities took off, however, the big miners, mindful of the mistakes they had made in the past, were slow to add significant new capacity.
It was the tardy supply-side response that caused commodity prices to surge from 2003. They fell back as the global financial crisis emerged but then surged again to stratospheric levels before China’s economic slowdown caused them to tumble. Subsequently they have recovered, albeit not to the levels they had reached before last year’s correction.
The big miners’ investment patterns effectively followed the commodities price paths, but lagged them, and the financial crisis also saw most of them – BHP was the exception – temporarily freeze their spending before it picked up significantly in 2010.
It is true that, as a group, the big miners have largely wasted the boom. Again BHP, despite spending about $US90 billion from the end of 2007, is the exception. Its total shareholder returns from that period have been almost 50 per cent. By comparison Vale’s has been 17 per cent and Rio’s a meagre 4 per cent, while Xstrata (in which Glencore had a 34.5 per cent shareholding before it made its takeover offer last year) returned a negative TSR of 41 per cent and Anglo a negative 47 per cent.
The critical question is what they might have done differently (other than Rio not making its disastrous offer for Alcan on the eve of the crisis or Anglo not acquiring its troubled Minas-Rio iron ore project in Brazil).
Should they not have invested in expanding their production in response to the dramatic increase in demand from China? The answer to that question is far from straightforward.
While there are some particular issues around the supply of thermal coal, where supply has been unexpectedly swollen by the displacement of coal by shale gas in the US, forcing some US coal into Asian markets, generally the miners appear able to sell virtually all that they can produce at prices that by historical standards remain elevated.
That’s not indicative of a market experiencing oversupply.
There is, of course, a lot more supply – particularly of iron ore and particularly from the established iron ore provinces in the Pilbara and Brazil – in the pipeline. That ought to have a moderating impact on price but volumes from those regions will drive out higher-cost production in China and elsewhere and deter investment in new production. It is the marginal producers which, by being forced out of the market, will bring the supply-demand equation into balance.
There aren’t many obvious examples within the key commodities of the big miners investing in projects at the upper end of the industry cost curves. Those curves have, of course, been shifted up structurally by the rampant cost inflation the industry has experienced in the past few years, but that’s an industry-wide phenomenon and the low-cost providers generally have remained lower cost relative to their competitors. All the big miners are now, of course, trying to force their cost bases back down.
Could the big miners have hung onto their capital, or given it back to shareholders, rather than invest the windfall profits generated by the spike in commodity prices?
There was a scramble by miners, large and small, to bring new supply to the market after the financial crisis receded, driven by the prospect of the super-profits that were (temporarily as it turns out) on offer and the ability to get a remarkably quick payback on their investments. It was a generational opportunity that was almost impossible to ignore.
Had the ‘’big guys’’ all sat on the sidelines and preserved their capital the supply shortfall would still have been met, albeit perhaps not at the same rate. They would have created a vacuum that others would have filled and also created a new generation of competitors in the process.
They also risked one of their peers acting differently and establishing a lead over them – BHP, in fact, by continuing to invest through the crisis, established a substantial gap in scale and performance relative to its peers.
Now that the era of double-digit growth rates in China is over and its economy shifts towards a somewhat less commodity-intensive future, prices will fall back but it does need to be recognised that China’s economy today is more than twice its size ahead of the financial crisis – its demand for commodities might not grow at the same heady rate but the base level of demand is vastly higher than it was at the onset of the commodity price boom.
The real lesson from the crisis wasn’t the supply-side response to demand, which was tardy and which was interrupted by the financial crisis and last year’s price dives, but that a number of the big miners got sloppy in assessing and executing the investment opportunities into which they ploughed their booming profits.
The changing of the guard at all the major miners and the significant drop in profitability flowing from China’s slowdown will produce a period of introspection and reduced investment and therefore eventually result in prices higher relative to what they might otherwise have been.
The next time there is a commodity price boom – if there is a next time – however, even if the big guys do as they did in the last decade and slow their responses it is almost inevitable that they will ‘’screw up’’ and respond by adding a lot more supply. They know that if they don’t someone else almost certainly will.