Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

What does $13 billion of burning money smell like? Commodity investors are getting a nose for it.

Japanese trading houses Mitsui, Mitsubishi, and Sumitomo have announced 767 billion yen ($6.8 billion) of writedowns on assets this year, including copper, nickel, iron-ore and natural-gas projects. PetroChina wrote 25 billion yuan ($3.8 billion) off the value of oil and gas fields that have ``no hope" of making a profit at current prices, President Wang Dongjin said last week, while Citic posted a HK$12.5 billion ($1.6 billion) impairment on an Australian iron-ore mine. Cnooc's annual results last Thursday count as a good news story against that backdrop, with impairments of 2.75 billion yuan that were lower than the previous year's.

Investors might hope after all this that we'd be reaching the level where mining and energy assets have been written back to normal levels, allowing companies to start the hard work of rebuilding. It doesn't look that way.

There's certainly been a reality check of late. The balance sheets of major mining and energy companies have shrunk by $856 billion over the past 12 months, putting the value of their total assets at their lowest level since 2011, according to data compiled by Bloomberg.

Right Down
Value of total assets at mining companies and oil & gas producers with at least $1 billion in total assets
Source: Bloomberg data
Note: Companies with incomplete data over the period have been excluded.

That looks dramatic until you compare it to the performance of the Bloomberg Commodities index. Companies are still more asset-rich than they were in 2011, which was the peak of a once-in-a-generation commodities boom.

A Bigger Crash
The Bloomberg Commodities Index closed 2015 at the lowest level since 1998
Source: Bloomberg data

This delayed response to lower prices isn't surprising. Non-financial companies should have a high bar for reassessing their asset values to prevent manipulation of earnings (revaluations upward count as income, just as writedowns count against profit). 

Delayed Response
The value of total assets in the S&P 500 didn't bottom out until 18 months after the 2008 financial crisis
Source: Bloomberg data

That means a degree of inertia: after the 2008 financial crisis, the value of assets in the S&P 500 index didn't bottom out until June 2010. Even if you blame weak-kneed accountants for that delay, an analogous pattern can be seen in the real economy. Default rates in the U.S. tend to peak well after economic slowdowns begin:

I Didn't Recognize You at First
Default rates don't move past their peaks until some time after an economic slowdown starts
Source: Bloomberg data

To some extent, equity investors are already taking this in their stride. Price-to-book ratios of the Bloomberg World Energy Index and the Bloomberg World Mining Index are at their lowest levels since at least 2003, suggesting the market doesn't believe companies' balance sheets are worth as much as they appear on paper. For energy companies, the price-book ratio is about 31 percent below its 10-year average, while the discount for miners is 44 percent.

Don't Believe the Books
Price/book values for indexes of major mining companies have already priced in further asset writedowns
Source: Bloomberg data

If that sounds like a buying opportunity, it's worth taking a pause. Returns on invested capital for this sector will continue to be meager as long as commodity prices are low and capital is valued so richly.

There's also the issue of debt. While gross mining and energy assets in the top chart now stand at $6.55 trillion, once liabilities are netted out there is only $3.28 trillion of shareholders' equity left. That gives the companies net gearing of about 29 percent when compared to their $1.37 trillion of net debts, an uncomfortably high number that's only going to rise if those mines and oil fields get written down further. A company can change the value of assets with the stroke of an accountant's pen, but its debt remains fixed.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Companies use a range of different terms to announce the embarrassing business of impairments, so it's hard to work out the value of writedowns alone. But measuring the change in total assets is a decent proxy, especially as some write-offs get cloaked as amortizations and asset sales in any event.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net