The breadth of the impact on BHP’s diverse portfolio of resources was evident from the fact that six of its nine customer segment groups suffered earnings declines. The exceptions were petroleum, up 0.3%, energy coal, up 8.7% and iron ore, up 6.6%.
The aluminium division is, like most aluminium businesses, losing money ($US291 million in the year) the diamonds and speciality products business’ earnings were down 66% to $US199 million and the manganese business experienced a similar fall to $US235 million. Metallurgical coal operations were hit by both industrial action and price falls. Base metals, hurt by production interruptions at Escondida, saw earnings fall 54% to $1.64 billion.
It hasn’t helped that the price declines have occurred even as costs were rising. Costs, excluding inflation and exchange rates, were $3.14 billion higher and inflation added a further $US764 million. The impact on underlying earnings was about $US2.7 billion with BHP saying labour and contractor costs accounted for about a third of the impact.
Had it not been measured against last year’s remarkable result, BHP’s performance would have been more than creditable. At a production level it is performing quite solidly and with margins of 39% and an underlying return on capital of 28% whilst still in a growth phase it is by any measure a highly performing group.
The project still being pushed through the investment pipeline are regarded as high-quality, low-risk incremental expansion programs, like the planned increase in iron ore production from the Pilbara, which can continue for some time without the “big bang” expansion of Port Hedland with the ambitious Outer Harbour project.
Shelving the Outer Harbour project, or delaying Jansen, or putting Olympic Dam on hold while BHP tries to develop a less capital intensive approach to a project that would otherwise be returns and cashflow-destructive for six years while the overburden was removed are sensible and cautious responses to the environment. The options to proceed in future remain intact and valuable.
There will, of course, be disappointment in South Australia that the Olympic Dam open cut expansion isn’t going to go ahead and underwrite the state’s economy.
The investment, however, is so vast and the cashflows so distant that in an environment of lower prices, where operating and capital costs have blown out and with a strong Australian dollar it would have been madness for BHP to proceed. It deeds a radical change in the project’s economics.
The safety net for BHP and Rio in a more uncertain environment and one of weaker prices is that their existing operations are high quality and low cost and the investments underway are largely incremental expansions and will deliver relatively low-cost volume growth. BHP’s diversity provides further insulation.
Given the sea-change in conditions, however, the big miners in general are fortunate that the raft of mega-projects they were all contemplating are still on the drawing boards rather than underway, as they would have been had the super-cycle lasted another 12 months.
This article first appeared on Business Spectator.
