BHP's Neglected Cash Cow

Iron ore is starved of capital despite churning out returns that support investment in weaker businesses.

For all the scale of the world's biggest mining company -- assets on six continents, $30 billion-odd in annual revenues, better Ebitda margins than Apple or LVMH -- you can get a pretty good idea of BHP Billiton by looking at just three holdings.

The Escondida copper mine in Chile, the Pilbara iron-ore pits, and its Australian petroleum wells together accounted for 87 percent of underlying Ebit in 2014, and 104 percent in 2015 -- when the rest of the company lost money in aggregate.

This year, it was even more dramatic -- the Pilbara alone accounted for 105 percent of Ebit, and the three units together 167 percent of the total.

All That Matters

These three assets account for more than 100 percent of BHP's underlying Ebit

Source: Company reports

That's not an ideal outcome for Chief Executive Officer Andrew Mackenzie, because all three of those divisions are out of favor at the moment.

Escondida is far and away the world's biggest copper resource, but the rock that's going to be accessible over the next few years is lower-grade, saddling the company with higher costs at a time of weak prices.

There are similar issues at BHP's domestic petroleum fields. Output at its Bass Strait venture with Exxon Mobil is in decline after five decades in operation, and the unit was put up for sale in June. Its wells off the Pilbara coast must sell into Asia's glutted markets at a time when U.S. LNG is crossing the Panama Canal to enter the Pacific for the first time, and Saudi Arabia and Russia are battling for Chinese market share in oil.

That leaves iron ore. Mackenzie has made no secret of the fact that he's lukewarm on the commodity, in spite of its 38 percent price rebound this year. "Prices for iron ore have more risks to the downside going forward," he told a media call after the results.

Best in Class

Iron ore has had the best price performance of BHP's major commodities this year

Source: Bloomberg

Note: Figures have been rebased. Dec. 31, 2015=100.

A decade of expansion by major miners has created supply-demand imbalances that may take another 10 years to settle back to equilibrium, he said in June. While output will keep edging up over the next four years, the company has stopped investing in the business, Mackenzie said in May.

Of course, there are plenty of other assets in the portfolio, but the problem is how to make money from them at current prices.

BHP spent almost $20 billion on staking out a position in the U.S. fracking business in 2011 and has since dedicated another $17.5 billion to capital spending. The result? A $7.18 billion Ebit writedown announced Tuesday and about $3.7 billion of aggregate Ebit losses, even at the most generous underlying level. 

Southern Discomfort

BHP's investments in onshore U.S. oil and gas have been a disaster

Source: Company reports

While acreage in the central-southern Permian basin counts among the hottest spots on the U.S. oil map right now, even there Mackenzie doesn't expect to invest much south of $60 a barrel.

BHP's Queensland coal business has the best resources globally of higher-quality steelmaking coal, but prices are so low that it's barely contributing to the bottom line.

Potentially massive copper projects in holding patterns at Spence in Chile and Olympic Dam in Australia will require vast expenditure to unlock. And the other units -- Brazilian iron ore, Colombian and U.S. coal, Australian nickel -- look more like liabilities than assets these days.

For a company that's spent most of the past decade boasting about its peerless suite of best-in-the-world resources, this dearth of options is somewhat embarrassing.

Mackenzie could do well to think about the quality assets he has, and not the ones he dreams of. He continues to expect great things one day out of that U.S. onshore petroleum business, but it's been a rolling disaster for the company for five years now and is still burning a hole in net income. 

Meanwhile the iron-ore business that's supporting all this spending languishes unloved and starved of capital, despite Mackenzie's confidence that it will continue to churn out high margins.

His skepticism about the longevity of China's steel boom makes sense -- Gadfly has argued the same, again and again -- but at some point both executives and pundits need to mark their views to market. A low-cost producer like BHP should invest a little more in its stronger businesses and a little less in its weaker ones, rather than hoping the market will come round to its way of thinking.

China's steel boom may be irrational, but at this point it's putting real cash in BHP's coffers -- and the market can always stay irrational longer than you can stay solvent.

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

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    David Fickling in Sydney at

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    Matthew Brooker at

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