Fifteen months ago, when commodity prices were in the stratosphere, the dilemma for the big resource groups like BHP Billiton and Rio Tinto was how quickly they could deploy the torrents of cash pouring into their coffers on their ever-expanding portfolios of mega-projects. Then the eurozone crisis emerged, China’s growth slowed, commodity prices began tumbling and the tide of cash dwindled.
For the two Anglo-Australian miners, iron ore is their key commodity. Iron ore prices were nudging $US180 a tonne last September and are now closer to $US130 a tonne. If sustained and annualised, with every $US1 per tonne movement in the iron ore price impacting BHP’s earnings by $US90 million, that would rip $US4.5 billion from BHP’s bottom line and slightly more from Rio’s. Commodity prices generally are down about a third from their peaks.
No wonder BHP and Rio have become progressively more cautious as this year has unfolded and have backed away from talking about their pipelines of new projects.
BHP’s Marius Kloppers has said that no decision on any of the three mega-projects that were originally scheduled to face a final investment decision this year – the Olympic Dam expansion, the Outer Harbour development at Port Hedland and the Jansen potash project in Canada – will be taken before December and no-one expects him to green flag all three. Indeed it is conceivable that all will be deferred.
While both the major miners, and their peers, remain confident about the longer term outlook for commodities, with the eurozone teetering and China now trying to stimulate after being too successful in slowing its economy, the near term outlook, indeed the medium term outlook, is now far more cloudy than it was a year ago. It isn’t helping that BHP and Rio’s major asset bases and expansion projects are in Australia, where costs continue to escalate even as prices have deflated.
The combination of prices and question marks would explain a report in the Financial Times overnight that said BHP has trimmed its outlook for commodity prices over the next three to five years in a review of its internal forecasts.
That would confirm that the "super" element of the China-inspired resources boom and the massive cash flow windfall the peak prices generated are behind us, a view now routinely expressed by Federal Treasury and the Reserve Bank. That would suggest the future for BHP and Rio is all about volumes and costs.
The big miners guard their frameworks for assessing projects, and the hurdle rates they use, closely.
Broadly, however, they plug the current commodity prices and near-term outlook, based on the forward price curves for the commodities, into their models for the next 18 months or two years and then assume a reversion to something closer to long-term averages.
The structural shift in demand created by China’s growth and the emergence of India would complicate those calculations – it is improbable that prices will retreat to anything like their pre-boom levels.
Nevertheless, the extent to which prices have fallen from their heights last year would, when factored into the models, have a material impact on the net present values of the projects in the big miners’ pipelines. Last year $US17.2 billion of BHP’s $US32 billion of earnings before interest and tax and $US6.7 billion of Rio’s record $US15.5 billion of underlying earning came from higher prices.
It would be remarkable, given the change in industry circumstances, if the big miners hadn’t changed – lowered – their price assumptions when assessing new capital spending.
Given the extent of the retreat of the prices of key commodities, particularly iron ore, from their peaks, it would be equally remarkable if that hadn’t led to the fundamental reappraisals of their new project pipelines that are now clearly occurring.
Sun setting on iron's golden age
As BHP Billiton trims its commodity prices forecast amid growing international concerns, the outlook for it and peer Rio Tinto is markedly different to that at the peak of the boom 15 months ago.
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