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Diversified Miners
$200bn capex ambition of mining majors under spotlight
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25th May 2012
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The great China-led economic supercycle that has been boosting global economies for a decade is falling below its expected trajectory, which is giving rise to questions regarding super- cycle slippage and demise.

First to counteract the changing paradigm by publicly reining in its well-publicised capital project growth ambitions is the world’s biggest mining company, BHP Billiton.

In quick succession, Billiton CEO Marius Kloppers put the amber light on iron-ore growth investment and BHP Billiton chairperson Jac Nasser spoke of the investment climate having changed since the company announced that it would be spending $80-billion on project growth by 2015.

Kloppers was addressing a Bank of America Merrill Lynch conference in the US and Nasser was addressing the Australian Institute of Company Directors in Sydney.

In between, equities researcher Liberum Capital, of London, headlined that investors had begun to price in the end of the resources supercycle and shortly after the speeches of the BHP Billiton top brass, investment analyst firm RBC Capital Markets upgraded BHP to the status of ‘outperform’ the day after it had given notice that it would be deferring some of its capital projects.

RBC, which forecasts that BHP Billiton will cut its capital expenditure (capex) by 30% in 2013 and 34% in 2014, gave the mining major an ‘outperform’ pat on the back.

Liberum, which also researches Rio Tinto, Anglo American, Xstrata and Glencore, reports that the combined planned five-year $200-billion capex spend of the five main London-listed mining majors is coming under downward pressure from investors, who fear that unbridled project building will lead to unwanted supply and low capital return.

Both report that shareholders, in the main, want capex programmes to be shelved and some of the cash saved to be returned to them in the form of higher dividends and share buy-backs.

As the international economic picture begins to look deeply worrying once again, the bulls are pulling in their investment horns and foreseeing falling commodity prices outside of copper and oil, higher inflation and lower profit margins.

But will mining project cutbacks be followed by relatively quick project resusci- tations, as happened in the wake of the 2008 global financial meltdown? Is what is being construed as the beginning of the end of the resources supercycle really a significant upcoming dip within what will turn out to be an ongoing period of stronger-for-much-longer secular demand?

Structural Shift

In his speech to the Australian Institute of Company directors, Nasser hypothesised that the 2008 global economic meltdown was not a mere short-term glitch, but a structural shift.

Rather than the world settling down, he said, it was facing increasing uncertainty: “It’s going to feel as if the ground is shifting under our feet,” Nasser said.

Kloppers had stated earlier that a lower rate of demand growth was on the way in China for global seaborne iron-ore but that incentive remained for investment in copper.

Lower Chinese demand growth, he added, equated to a lower 650-million-tons-a-year rate of growth in the demand for global seaborne iron-ore, compared with the 800-million tons a year of the last ten years.

The outlook for China’s iron-ore demand growth was lower in both percentage and absolute terms.

The combination of a plateau in steel use in China and the increasing availability of ferrous scrap was likely to result in a protracted period of low-to-negative growth for the seaborne iron-ore market, which has been BHP Billiton’s main profit engine for several years now.

While BHP Billiton’s continued invest- ment in iron-ore has contributed to Australia’s low unemployment, copper invest- ment will be far more beneficial for jobs in Chile.

There is a strong business case for ongoing investment in copper, however, where there is a need for copper miners to meet a 5%-a-year growth in production.

Kloppers has committed BHP Billiton to continuing to exit those commodities and operations that fall outside the company’s pursuit of simple and scalable businesses and said the pending sale of the company’s interest in Richards Bay Minerals, in South Africa, currently exemplified that commitment.

In fact, BHP Billiton has been particu-larly tough on South Africa in upholding this commitment, which led to its exit from the Koornfontein and Optimum coal operations, Samancor Chrome, Pering and Zululand Anthracite Colliery.

This divesting has been doubly hard, given that South Africans played a key role in the merging of BHP – which was doing so badly at the time that its initials were said to stand for ‘Broken Hearted People’.

But since that partly South African-engineered merger of BHP and Billiton 11 years ago, the combined entity has delivered a return of a whopping 353% to its long-term Australian investors.

As Australia’s biggest taxpayer at an effective tax rate of 42%, BHP Billiton contributed more than $6-billion in royalties and taxes to Australia’s local, state and national governments last year, when it also spent $12-billion on goods and services from Australian suppliers – many of them small businesses that depend on the mines for most of their income.

Curtailment of iron-ore capex will thus be a massive blow to Australia and ongoing capex in copper a big boost to Chile.

But that will take place against the background of what Nasser bemoaned as a fourfold deterioration of the investment horizon.

Firstly, Australia was increasingly one of the higher-cost countries in the world.

Secondly, a more difficult industrial relations environment had lowered productivity, exemplified by BHP Billiton’s Queensland coal business alone having faced 3 200 incidents of industrial action last year, with the company receiving 1 000 industrial- action notices and then 500 of them being withdrawn less than 24-hours before the due date.

Thirdly, taxes and royalties had gone up, and, fourthly, there had been global uncertainty since the 2008 financial crisis, which has left in its wake the resignation of the Prime Ministers of Greece, Italy and the Netherlands; the voting out of governments in the UK, France and Spain; the declaration by the governor of the Bank of England of an end to 50 years of rising living standards; and the emergence of changes in the troubled eurozone that were previously considered unthinkable.

In response to Nasser’s comments, Australia’s Construction, Forestry, Mining and Energy Union national president, Tony Maher, pointed to BHP Billiton’s hefty profit position and said it was time BHP Billiton stopped “whinging”.

“BHP can’t blame unions, or industrial laws, for its failure to work with employees and successfully implement a change programme.
“It’s not our job or the government’s job to convince workers they need to accept longer rosters or have contractors on lower pay,” Maher said.

Headlong into Cash

Meanwhile, major global investors in antirisk mode are even selling off gold, the traditional safe haven, to move into dollars, US treasuries and sovereign debt.

Investors are raising their cash weight-ings, a World Gold Council official explained.

Moreover, Liberum analyst Dominic O’Kane says that, with the exception of copper and oil, all major commodities are close to marginal cost and equity valuations have already fallen and have been derated.

O’Kane says that mining majors are rethinking organic growth plans and looking to merger-and-acquisition alter- natives as valuations fall.

He says that this is taking place against the background of the cost of building new projects rising by 20% to 25% year-on-year and the cost of buying producing assets falling by 25% to 50% year-on-year. Buying also has the benefit of not adding incremental supply at a time of falling demand.

Markets, he adds, are in the grip of macro concerns in Europe, which will make it difficult for the sector to rally soon, at a time when China is bottoming out under its transitional political year.

In March, China lowered its gross domestic product (GDP) target for 2012 to 7.5% from the 8.0% targeted in 2011.

China’s first-quarter GDP of 8.1% was its lowest in 11 quarters, down from 9.7% in the first quarter of last year.

Plus Points

On the plus side, Liberum thinks that China’s regime change at the end of 2012 may be a catalyst for a new wave of Chinese domestic infrastructure spend as well as increased foreign investment to secure raw materials.

Large Brazilian iron-ore producer Vale is also keeping its faith in China and refusing to go into cutback mode.
Vale CEO Murilo Ferreira has told the media that those who have been betting against Chinese growth since the 1990s will be wrong again.

His view is that China is just getting started and says that the company’s Serra Sul operations, due to start producing in 2016, will raise the company’s overall output by almost a third to nearly 400-million tons a year.

South African-created Anglo American is another continuing to stand firm for the time being on its $100-billion programme of approved and unapproved projects that include iron-ore, coal, copper and niobium.

However, China’s iron-ore imports have been falling and there is currently a relatively widely held view that the resources sector is unlikely to have the benefit of the halcyon commodity prices of the past decade.

UK investment analyst firm Fairfax comments, in the main, mining majors are “no longer competing with each other on the lengths of their project pipelines but rather competing to see who can conserve capital best”. “What is critical now is how much capital is firmly committed and how much can be held back to weather the forth-coming financial storm.”

But, as was the case after the 2008 global financial meltdown, mining project cutbacks were quickly followed by project restarts, because raw material demand remained firm. What may be now be construed as the beginning of the end of the resources supercycle may well turn out to be a significant dip within an ongoing period of stronger-for-much-longer secular demand that will be looked back on as a note- worthy but short-lived aberration.

Edited by: Martin Zhuwakinyu


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