Rock-solid logic backs Glasenberg's stand

Ivan Glasenberg is being hailed by cash-hungry investors as an industry leader because of his declared antipathy towards greenfields investment and his intense focus on carving into Glencore Xstrata’s cost base and capital expenditures. Given the nature of the portfolio he acquired through the takeover of Xstrata, however, he probably doesn’t have a lot of choice.

Xstrata’s former chief executive, Mick Davis, built the company essentially from scratch, initially through an aggressive acquisition spree and more recently via a massive investment program. He turned Xstrata into the world’s largest thermal coal, zinc and lead producer and the third-largest copper producer.

Xstrata’s addiction to growth was a winning strategy through the years of the commodity boom – Davis seemed to appreciate the implications of China’s growth ahead of most of his peers – but the legacy of that frenzied expansionism was a portfolio of projects that are in the wrong half of the cost curve and an exposure to a thermal coal sector that has been hardest hit by the slump in prices over the past year and a half.

Glasenberg’s response, outlined in detail at Glencore Xstrata’s investor day yesterday, has been decisive.

He’s wiped out almost half the group’s corporate and divisional headquarters’ staffing and closed 33 offices within three months as part of a cost reduction program that he now says will produce synergies of at least $US2 billion in 2014.

He’s also slashed capital expenditures by $US3.5 billion between 2013 and 2015 and plans to hold ongoing capital expenditure at around $US4 billion a year. Xstrata had a project pipeline of $US21 billion when Glencore took control earlier this year but Glasenberg has already suspended 44 of the 88 projects planned (including the massive Wandoan coal mine in Queensland) and cut back seven others.

Glasenberg plans to shift the Xstrata mines from generally the third quartile of the cost curve to the second, with an intense focus at the asset level on the next phase of his program.

What differentiates Glasenberg’s strategy from similar cost-cutting and cutbacks to capital spending among the major miners is the strength of his stand against greenfields expansion. He referred to the "Glencore Way," which eschews greenfields projects and favours lower-cost and lower-risk brownfields expansion of existing projects.

‘’We are not focused on replacing depleting assets. If it does not make economic sense and does not give us a return on equity we will not do it. If our company gets smaller, then so be it,’’ he said.

There is a distinction between his philosophy and that of most of his peers who, while responding to the current industry circumstances, still want to invest for long-term growth. BHP Billiton, for instance, ruffled some shareholders’ feathers recently when it committed another $US2.6 billion to its potential Jansen potash project in Canada.

The Glencore team, of course, have major ownership interests in the merged group and see themselves as – and indeed are – owner-managers rather than conventional executives. Their interests are very much aligned with the institutional pre-occupation with immediate shareholder returns.

There is some intellectual justification for Glasenberg’s hard-line stance.

His view is that the steep falls in prices reflect over-investment by the mining sector and not declining demand.

There was a slide in yesterday’s presentations that showed there had been $US348 billion of capital expenditure by the majors between 2005 and 2012 but only $US126 billion of net cash returns, creating an excess of supply over demand that has still been rising across the range of key commodities this year.

The truncation of the project pipelines by Glencore Xstrata and the other big miners will, if demand continues to grow, ultimately bring supply and demand into a better balance and provide the foundations for stronger prices, or at least stable prices.

It should probably be noted that it is disproportionately in Glencore Xstrata’s interests to tighten supply because Glencore’s traditional commodity marketing businesses, its key point of competitive difference with the other big miners, would be advantaged by any shortfall in supply.

It is also worth noting that, despite the attack on the project pipeline, Glencore Xstrata is still in the midst of a significant expansionary phase and will invest $US26 billion through to 2015.

That’s because Davis embarked on a massive growth agenda in 2009 aimed at increasing its production capacity, in copper-equivalent terms, by 50 per cent by the end of 2014.

Much as he might like to revisit history, there’s not much that Glasenberg can do about those projects already too far advanced to be halted other than focus on their costs and capital intensity.