As the global commodities cycle crashes with a reverberating thud, undercapitalised mining and energy companies are collapsing, mines are being closed to shore up cash flows and startup projects are being put on indefinite hold.
After a decade in which prices and demand seemed destined to move ever upward, the slump is now affecting even Australia’s BHP Billiton, the biggest miner in the world by both market capitalization and revenue.
BHP’s share price has fallen about 30% over the past four months, but analysts expect it will recover next year. Those at Australian investment bank Macquarie forecast a full rebound by the end of 2015.
n Nov. 24, BHP said it would cut capital spending by $1 billion to $13 billion in the financial year ending in June 2016 and target an additional $500 million in annual productivity gains for the following year.
The benchmark price of iron ore has fallen almost 50% this year from $134 in January, while oil — another key commodity for BHP — has sunk more than 35%. Each $1 fall in the iron ore price cuts the company’s net profit by $135 million, while a similar fall in the oil price has a $50 million impact.
BHP’s strategic nous has been widely questioned in recent years, especially after the group botched a number of potentially transformative deals under former chief executive Marius Kloppers, who was replaced by Andrew Mackenzie in May 2013.
Kloppers was more successful in laying the groundwork for a productivity drive for when the next downturn arrived, as it has with such a bang this year. The company’s market valuation and ability to pay dividends now depends on the execution of this strategy.
“What we did is, about five to seven years ago, we recognized that we needed to have a platform in place that would allow us to drive productivity on a sustainable basis,” Mike Henry, BHP’s marketing and technology chief, told the Nikkei Asian Review.
The core of the productivity platform, which standardizes the treatment of company projects across divisions that were previously run separately, is a multimillion-dollar deployment of information technology developed by Germany’s SAP.
BHP is also planning to spin off a group of high-cost, low-growth assets into a separate company to be named South32, a reference to the 32nd line of latitude, which runs through parts of Australia and South Africa where BHP is mining nickel, manganese and other commodities that will be included in the new venture.
However, BHP shares have continued to fall in tandem with commodity prices, indicating that investors see little upside in the move for shareholders.
Henry admitted that BHP failed to keep costs in check during the commodity boom as it chased market share and expanded production to maximize the impact of rising demand, mainly from China.
He insisted, though, that the future will be different. “What you are seeing with our more systematic approach, particularly in terms of systems and processes, borrows a lot from the manufacturing industry,” he said.
“The results the company is seeing from our productivity initiatives in every part of the business — from iron ore to onshore petroleum — are being driven by standardization of roles and responsibilities and equipment.”
Henry said BHP began working hard to cut costs about 18 months ago, when it became clear that the boom had peaked. He added: “It’s not just cost reductions, but also how do we go about increasing volumes and so on.”
Some analysts are unsure whether even a relentless productivity drive will be enough to sustain shareholder value, given that other iron ore miners are also seeking to cut costs, potentially reducing the break-even price for the industry as a whole. “Price support could remain elusive,” Macquarie analysts wrote in a recent client note.
BHP gains a measure of protection from the diversification of its commodity portfolio, which includes natural gas, coal, copper and uranium, as well as a mining project in Canada that will produce potash, a sought-after agricultural fertilizer.
Coal prices have fallen heavily alongside iron ore and oil, but other elements of the portfolio have held up better, with copper predicted to be on the verge of a supply shortage.
The International Energy Agency, which monitors energy trends for advanced economies, cut its forecast for demand growth in 2015 on Dec. 12, saying that the big falls in oil and gas prices in 2014 have failed to stimulate fresh demand.
The IEA’s comments sent crude oil prices to a fresh five-and-a-half-year low and brought the decline for the week to more than 10%, suggesting that BHP’s hopes of an energy price rebound as supply and demand return to balance may be misplaced, at least in the short term.
This story was originally published by Nikkei Asian Review, asia.nikkei.com, 18 December 2014