So the big bad BHP news is out, dividends are down, the company’s turned in a loss for the year to June (and a much smaller underlying result) and there’s a bit of gloom and doom about. So what about the next year or two?
Nearly $US 8 billion of exceptional items were the drivers behind the net loss of $US6.39 billion in the year to June, and the company expects the volatility in commodity prices to continue for a while yet, and prices to remain low.
That means the company’s cost cutting will continue (as it has been telling everyone this year about its cuts to investment spending over the next two years).
Exceptional items topped $7US.7 billion (after tax), including costs associated with redundancies and closures across its businesses, impairments in its coal unit and also the recognition of a $US1.2 billion cost or the deadly collapse of a dam at its Samarco joint venture in Brazil.
Dividend was cut sharply, as promised, but there was also the hint that surplus cash would be used to invest in new growth businesses. The company has talked a lot this year about seeking out new investment projects in petroleum and copper.
According to CEO, Andrew McKenzie:
"The strength of our cash flow generation and balance sheet is reflected in the final dividend of 14 US cents per share, which comprises the minimum implied by our payout ratio and a top up from excess cash in line with the capital allocation framework.
"We continue to pursue capital-efficient latent capacity opportunities which will support volume growth of up to four per cent next year, excluding our Onshore US assets where we continue to defer activity to maximise value.
"In addition, we have progressed high-return growth projects, with investment decisions on the Mad Dog 2 and Spence Growth Option projects expected by the end of next calendar year.”
And this is as well telling investors that next year "we expect another $US1.8 billion of productivity gains as our new operating model helps sustain momentum, delivering more than $US7 billion of free cash flow based on current spot prices and a forecast reduction in net debt".
Mr Mackenzie said the past 12 months have been challenging for both BHP and the industry, but the company’s portfolio remained resilient.
"Over the past five years we have actively reshaped our portfolio, and we are confident we have the right mix of commodities, assets and opportunities to create substantial value over time.
"While commodity prices are expected to remain low and volatile in the short to medium term, we are confident in the long-term outlook for our commodities, particularly oil and copper.
Prices for iron ore and oil – two of the company’s key commodities – both hit multi-year lows in 2015-16 and both have since rebounded sharply.
Average iron ore prices declined 28% year-on-year, while prices for copper and West Texas Intermediate crude oil were down 24% and 36% year on year. Prices for Australian coking and thermal coals fell 22% and 15% respectively. But iron ore, coal and oil prices have since rebound from lows set during the year. Copper hasn’t though, although zinc and nickel have rebounded strongly in recent months.
Iron ore prices hit a multi-year low below $US40 a tonne in December. But so far this year, prices are up 35%. Oil hit a 12-year low, below $US30 a barrel in January, But have peaked at $US52 and currently is around $US45 a barrel. And the company’s share price has reacted as well, rallying more than 40% in the past six months as iron ore and oil prices have recovered from those early lows.
The company forecast in its report that production of iron ore, copper, coking coal and nickel will rise in the 2016-17 financial year, but petroleum volumes are forecast to fall 15% from 2014-15. That’s a bit more than expected.
The final production figure for petroleum will depend more on oil and gas prices, especially in the huge US market – BHP no doubt is cheering on the current rebound in prices, especially of oil on talk of some sort of agreement involving OPEC members next month.
But several analysts believe that production of oil and gas during fiscal 2017 will be highly dependent on commodity prices, with BHP expected to quickly boost production if prices strengthen significantly.
In the report, BHP again included its comprehensive look at its major commodities and their outlook:
Crude oil prices fell at the start of the 2016 calendar year on growing OPEC supply, rising inventories and resilient United States production. The market has since begun to rebalance due to declining production in the United States, unplanned supply outages elsewhere and strong non-OECD demand growth.
While the market will continue to rebalance in the short term, economic uncertainty and high inventory levels are likely to keep prices volatile but range bound. The long-term outlook remains healthy, underpinned by rising demand from the petrochemical industry, a growing transport sector in developing countries and natural field decline.
The domestic gas price in the United States weakened following strong production and subdued heating demand due to a mild winter. This resulted in record inventory levels. In the short term, seasonal demand for cooling offers some price support, but high inventories are likely to prevent significant price appreciation.
Longer term, natural field decline and increasing demand underpinned by the environmental, operational and economic advantages of gas in power generation and other applications will support higher prices.
Copper prices continue to be affected by growing supply on the back of improving levels of productivity and slightly weaker rates of demand growth. In the short to medium term, new and expanded production should keep the market well supplied, notwithstanding announced cuts to higher-cost production.
Longer term, the copper outlook remains positive as demand is supported by China’s shift towards consumption in addition to the scope for substantial growth in other emerging markets.
A deficit is expected to emerge as grade decline and limited high- quality development opportunities constrain the industry’s ability to cheaply meet growing demand.
Global steel production has been weak in the first half of the 2016 calendar year compared to the prior year as most regions saw a contraction in output, with the exception of India. Chinese steel production increased in the June 2016 quarter aided by improving construction demand,
However this is expected to soften over the rest of the calendar year. Longer term, Chinese crude steel production is expected to peak between 935 Mt and 985 Mt in the middle of next decade. Global scrap availability will also increase over time and substitute pig iron as a steel making input.
The iron ore price has trended higher since the conclusion of the Lunar New Year holidays, driven by a rebound in the Chinese construction sector, region specific output restrictions and the moderation of seaborne supply growth.
The appetite of mills to build iron ore inventories will remain low in the near term due to the availability of port stocks. In the short to medium term, the cost curve should continue to flatten as new seaborne supply ramps up. In the future, the marginal producer’s cost structure should determine the long-term price.
The recent rise in metallurgical coal prices has been driven by seasonal demand, China’s domestic coal capacity controls and temporary supply disruptions in Queensland.
Near term, prices are expected to trend lower as new projects come online in Australia and Mozambique and more than offset the withdrawal of uneconomic high-cost seaborne supply.
The longer-term outlook remains robust as the supply of premium hard coking coals is projected to become scarce and demand is driven by steel production growth in emerging markets, particularly India.
