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Hubris led to destruction of investors' money by mining groups

The onset of boom led the world's leading mining groups to be on a capital expenditure binge to dig out new mines

Kunal Bose 

Inspired by one single factor of voracious Chinese appetite ranging from oil to all minerals used in making metals, the now-ended commodity boom began in 2003. The onset of boom led the world's leading mining groups to be on a capital expenditure binge to dig out new mines. But the slowdown of the world's second largest economy, as Beijing turns focus from investment to consumer-led growth, gives the feeling that earlier, long years of high mineral prices supported by growing demand led miners to drink Chinese potion to reach iridescent highs.

Their thought then was Chinese demand would continue to grow at high rates far into the future to justify colossal investments in mines' capacity building. Chinese growth has now downshifted to a level not seen in a quarter century and that is proving to be a hard awakening for miners from their hallucinatory past.

Not very long ago, mining chief executives thought their investment in dredging more and more iron ore from the earth stood no chance of going wrong, since China was expected to be a one billion tonne (bt) steel producer by 2030. Rio Tinto's iron ore business chief Andrew Harding said earlier this year that China needed annual steel demand growth of only one per cent to reach that goal in the next 15 years.

Investment bank UBS disagrees with the proposition, saying, "Our analysis shows that Chinese steel production has already reached a turning point". Finding China at a crossroads in its development, UBS has cut its forecast for compound annual steel production growth rate for the next five years for the country from 1.4 per cent to zero per cent.

For iron ore producers, Chinese steel reality is turning out to be more damning. In the first seven months of 2015 up to July, Chinese steel production was down on a year-on-year basis by 1.7 per cent to 476 million tonnes (mt). China has around 70 per cent share of an estimated 1.3 bt global iron ore seaborne trade and any weakness in its steel industry, which is now seen in growing abundance, cannot but hit ore producers hard. BHP Billiton, which like some of its peers is hooked on to China for most of its products, now says Chinese annual steel demand will range from 935 mt to 985 mt in the mid 2020s against its earlier forecast of 1 bt.

This, however, appears to be optimistic to most experts. So also is BHP chief executive Andrew Mackenzie's observation that "overall, the Chinese economy has begun to bottom out. The second half of the year will be better than first half". Mackenzie thinks China remains on course to hit the 2015 growth target of seven per cent against last year's 7.3 per cent.

This stands against the most pessimistic forecasts of about five per cent. But must he not sound as positive as possible about China to reassure its shareholders who have suffered much value destruction in recent periods? In a move to pacify shareholders, BHP is rewarding them with a higher divid- end for the year ended June 2015 despite a 61.7 per cent fall in pre-tax profit to $8.7 billion.

A Boston Consulting Group report says, of the 101 mining groups with market values in excess of $3 billion as of last year-end, all but 11 lost investors' money. In this context is to be seen Mackenzie's sharp retort "over my dead body sounds a little strong, but it's almost right" when a fund manager wondered if the company would ever cut dividend. Reality has dawned on miners that their immediate response to price collapse should be by way of reining in capital and exploration expenditure.

Their response to price falls squeezing margins is to get more volumes of minerals through productivity improvement. BHP is confident about increasing iron ore capacity from 254 mt to 290 mt over time with "minimal investment". But how in the first place did the mining industry inflict pain on long-term investors? Ian Mcveigh of Jupiter Asset Management has identified two principal investor value destruction factors: "First, the hubris that marked many of the mergers made at the peak of the boom; second, the excessive nature of much of the capital investment that went to increase output as financial discipline went out of the window." Rio Tinto will never forgive itself for its arrogance-driven purchase of Alcan at $40 billion and then write off half of that.

CHINESE CHECKERS

  • Chinese growth is down to a level not seen in a quarter century
  • UBS said, Chinese steel production has already reached a turning point
  • Between January and July 2015, Chinese steel production was down 1.7 per cent, year-on-year, to 476 mt
  • BHP Billiton has revised its projection down to say Chinese annual steel demand would be 935-985 mt in the mid 2020s against its earlier forecast of 1 bt
  • Miners; immediate response to price collapse would be to rein in capital and exploration expenditure

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First Published: Mon, September 07 2015. 22:32 IST
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