Boom Times for Mining Giant Signal Deep Changes in Sector [WSJ]
BHP and its Peers Go Slow On New Projects, Buoying World Commodity Prices
Bad News for Manufacturers
By PATRICK BARTA
April 13, 2006; Page A1
MELBOURNE -- For years, Broken Hill Proprietary was a broken mining company.
The company once known as "The Big Australian" had been one of the world's largest mining players. But low commodity prices and a series of disastrous missteps -- including a $2.4 billion investment in failed U.S. copper mines -- had taken their toll.
BHP reported nearly $3 billion in cumulative losses in 1998 and 1999. At one tense annual meeting, an angry shareholder accused BHP of "the most colossal blunders in the history of Australian companies."
Today, the company -- now called BHP Billiton Ltd. -- is the largest mining company in the world. It has a larger market capitalization than Coca-Cola Co. It posted $6.5 billion in profit in the year ended June 30, 2005.
Although few consumers might recognize BHP Billiton by name, its products -- including aluminum, iron ore, nickel and copper -- are used in everything from cars to microwave ovens to beer kegs. China's rapidly industrializing economy augurs even more good times, as its 1.3 billion people clamor for more highways, apartments, air-conditioning units, and high-tech gadgets.
BHP Billiton's turnaround reflects a broader reversal in the world's beleaguered mining sector, which struggled for years to right itself after decades of declining commodity prices.
The shift is underpinned by important changes in the companies themselves. In past booms, mining companies quickly adopted a gold-rush mentality, rushing to dig up more rocks whenever prices stirred -- even if it yielded too much supply.
This time, they're trying to manage the upswing to last. If they succeed, which is an open question, prices for key industrial commodities could stay higher for longer, with important implications for the global economy. Already, this cycle has run far longer than any commodity boom of the past 50 years. The rising cost of basic raw materials has carved deeply into the profit margins of manufacturers everywhere, and threatens to drive up prices for consumer goods like cars, houses and cellular telephones.
Like their Big Oil brethren, BHP Billiton and its peers are spending hefty chunks of their profits on share buybacks or acquisitions that please investors but don't necessarily add more raw materials to the world's supply. In some cases, consolidation may have given mining companies more power to set prices. Roughly three-quarters of the world's seaborne iron-ore trade is now controlled by three giants, including BHP Billiton. These producers have a strong advantage in current negotiations with steel makers, who already absorbed a 72% price rise last year.
The mining companies are also using more sophisticated risk-analysis tools to understand supply and demand trends. That discourages them from giving a green light to more speculative projects. In many cases, the companies are now run by investment bankers or other financial types who are wary of excess risk, instead of the swashbuckling entrepreneurs and engineers that steered them astray in past booms.
"Engineers like to build things -- that's what they do," says BHP Billiton Chief Executive Charles "Chip" Goodyear, an American Yale graduate who earned his stripes as a banker at Kidder Peabody -- not digging up ore. "My job is to make money," and sometimes that means steering clear of hot prospects that pose big risks.
There's still plenty of debate about the future of commodity prices, and some analysts believe the old boom-and-bust cycle will still play out eventually. "It's easy to grow a company when you have the wind behind you -- every commodity [Mr. Goodyear] has has gone to a record high," says Peter O'Connor, a mining analyst at Credit Suisse in Sydney. He agrees mining companies are more disciplined than before, but "they're still bringing on more supply," he says.
Some big projects are on the drawing board and numerous "junior" mining companies are emerging with dreams of cracking open giant new mines around the world.
The growing role of Wall Street speculators, including hedge funds, has also added some uncertainty. These investors are pouring billions of dollars into commodities, and as that money sloshes through the industry, it could tempt some companies to abandon their hard-won discipline.
BHP Billiton has two-dozen projects in various stages of development around the world, at a total projected cost of more than $10 billion. But much of the spending is focused on a handful of oil and gas projects. Some of the company's core copper, iron ore and other mines are still struggling to keep up with demand.
Meantime, the company recently announced plans to return some $2 billion to shareholders in the form of stock buybacks. It also lifted its dividend by 30%.
Rio Tinto PLC, the world's No. 2 miner by market capitalization, is following an even more conservative script. It has said it will give back $4 billion in profits by the end of 2007, in dividends and share repurchases, on top of $1 billion in buybacks last year. The London-based company hasn't developed a new copper mine in more than a decade, even though copper prices have quadrupled since 2001 to an all-time high of more than $2.50 a pound.
Some of the industry's caution is born of necessity. Shortages of labor and equipment are making it harder to develop new projects. But the companies also have long memories of how bad the industry looked just a few years ago.
For much of the past century, commodity prices after adjustments for inflation have been on a downward slide. Large customers such as the U.S. and Europe were trimming back their metals consumption as they increased recycling and moved away from heavy industry.
That triggered a big round of consolidation. A generation ago, there were 10 major copper miners in the U.S. Today, there are just two. A similar phenomenon swept across other materials sectors, leaving a handful of bigger and stronger global conglomerates that have interests in a wider array of commodities, giving them more diverse portfolios to help weather commodity-price volatility.
BHP Billiton is a case in point. The conglomerate traces much of its history to the 1880s, when an Australian ranch hand stumbled upon tin in an area called "broken hill" in southeastern Australia.
The discovery spawned Broken Hill Proprietary, or BHP, which mined silver, lead and zinc. The company later diversified into iron ore and steel mills and expanded overseas. In the 1960s, it discovered oil and natural gas off the Australian coast.
In its heyday, BHP was one of the biggest mining companies in the world. Its top executives operated from luxurious suites in a 50-story office tower in downtown Melbourne and were fixtures on the social scene.
As BHP got bigger, it took more risks. The company became famous for championing projects that excited its engineers but didn't always make technical -- or financial -- sense.
The idea was, "let's build it, and figure out how to solve it later," Mr. Goodyear says.
One of the company's ill-fated ventures involved making "hot briquetted iron," a type of iron used in steel, in western Australia. The project relied on unproven technology. When testing it, the company's engineers tried different ores than the ones they actually intended to use. The $1.7 billion project didn't work and was permanently abandoned last year.
Another big BHP bust involved the $2.4 billion purchase of Magma Copper Co., a Tucson company that had mines in Arizona and Nevada. At the time, in the mid-1990s, one BHP executive described the deal as "an ideal marriage" that would make BHP the second-largest copper producer in the world.
The mines turned out to be a financial sinkhole. When copper prices tumbled in the late 1990s, BHP closed the mines at a huge loss.
BHP's board set out to remake the company. It recruited Paul Anderson, a top executive from Duke Energy Corp., a U.S. natural gas and power company, to be its chief executive.
It also tapped Mr. Goodyear, who had worked at Freeport-McMoRan Copper & Gold Inc. of New Orleans in addition to Kidder Peabody, to be its chief financial officer. The son of an Exxon executive, Mr. Goodyear was also familiar with the ways of Big Oil.
BHP bosses got rid of company cars, trimmed head count and moved the Melbourne headquarters to a smaller building. Mr. Anderson says he recalls walking past a photo gallery of board members from the past 100 years, and thinking it was "depressing" to focus on the company's past. He got rid of them.
The company sold off noncore assets, including engineering and computer-services divisions, and began unloading its steel businesses.
In 2001, BHP merged with Billiton PLC, a London-based mining house with interests in nickel, coal and aluminum. Although the merger carried many risks, executives believed the a wider array of products would make the company less vulnerable to swings in prices for individual commodities.
Mr. Goodyear took over as CEO in 2003 and continued his push to apply more analytical rigor. The company beefed up its forecasting department, including hiring more economists to study commodity supply and demand in China.
It also worked on a sophisticated risk-analysis method akin to "Monte Carlo analysis," a technique once used by Los Alamos, N.M., scientists in the 1940s to understand the behavior of atomic particles. More recently, oil companies have adopted it to gauge the probability of different outcomes with new wells.
At BHP Billiton, executives used the system to make more-rational decisions about how to spend their money. Analysts plug in dozens of variables -- including commodity prices, currency values, and interest-rate scenarios -- that can affect the financial performance of a new mine or investment. The computer model then runs all the permutations, resulting in thousands of possible outcomes.
Company officials use that data to track whether the outcomes are skewed toward a big return for investors, with relatively little risk, or if they're skewed toward trouble.
For example, the system's results might suggest it's too risky to build a large new copper mine -- even if the mine is a success. A giant new copper mine might make money, but it could also make the company too dependent on a single commodity, exposing BHP Billiton to too much downside if copper prices fall.
The Monte Carlo system helped BHP Billiton pull off one of the biggest coups of the mining world last year, when it acquired WMC Resources Ltd., a major Australian mining company.
A rival miner, Xstrata PLC of Switzerland, put WMC in play by offering to pay $6 billion for its assets, which included some of the world's prize reserves of copper and uranium at an active mine called Olympic Dam in the southern Australian desert.
BHP Billiton executives had been quietly running their Monte Carlo models, which told them they could pay significantly more for WMC -- even if they assumed copper prices fell to significantly below their current level.
One reason: BHP Billiton didn't previously mine uranium, which is used to fuel nuclear-power plants. Since uranium prices can move in the opposite direction of BHP Billiton's other products, owning WMC could give BHP Billiton a natural hedge against price declines in its other business, helping reduce its overall risk profile. The company offered to pay $7 billion -- and won.
At first, many analysts thought BHP Billiton overpaid. Most have since changed their minds, as commodity prices have stayed strong.
Mr. Goodyear says BHP Billiton might spend several years and as much as $500 million in analysis before deciding whether to expand Olympic Dam further. Even then, it might hold off.
"We can afford to do that," because BHP Billiton is so large and diversified, Mr. Goodyear says. At the old BHP, he says, officials would have approved a mine after spending as little as $25 million, leaving them with many unanswered questions, and much more risk.
BHP Billiton's discipline also surfaced in June when the company said it would delay completion of a $2.7 billion project to expand iron ore mines in western Australia by at least a year. It made the decision even though demand for the commodity is red hot.
Of course, BHP Billiton's risk models are only as good as the assumptions programmed into them, and it's possible they could prove wrong. Skeptics cite Ravensthorpe, a big nickel mine in Western Australia that BHP Billiton approved in 2004 amid the highest nickel prices in more than a decade. Nickel is used to make stainless steel.
BHP Billiton said last September that the project's costs had blown out by 28% to $1.8 billion, due to higher labor, raw material and other expenses. At that price, the project could be less profitable, and is at greater risk of becoming a money loser if nickel prices fall sharply.
BHP Billiton says it still expects Ravensthorpe to make money. Although Mr. Goodyear and his colleagues at BHP Billiton are bullish about the foreseeable future, they expect that prices for certain commodities will likely resume their downward march someday. This, they say, is because technological advances are making it cheaper and cheaper to extract minerals from the ground. All that means mining companies will have to be even more disciplined.
"There is still risk -- silly money [is] being attracted to silly projects," says Chris Lynch, the president of BHP Billiton's iron ore and coal business. "There's not a lot you can do but play your hand well." |
