Resources firms were matter of fact about cutting capital expenditure when conditions took a turn for the worse in emerging markets. For too long, energy and base metals giants used their big diversified structures to bamboozle investors about returns stretching across vast geographies, while shoveling cash into more projects to achieve scale. That’s all changing. Industry giants are now facing the fact that they must act like lean, mean manufacturers.
Resource groups have reacted slowly to the end of the super cycle. In 2013, I argued that the mining hub of Perth was in denial that the best days were behind it. Mining giants have since cut capital expenditure, divested non core assets, and put the expansion of large projects on hold. But that hasn’t proved enough in the face of persistently low prices. In the case of iron ore, many blame Chinese higher cost producers for hanging in there longer than anyone would have expected.
Last week in Perth, the world’s largest resource company folded first. BHP Billiton threw in the towel on being a resources supermarket. Shareholders voted for a slimmer company, focused on iron ore, copper and energy, with the rest of its assets to be spun off into a separate company South32.
BHP Billiton chief executive Andrew Mackenzie argued that the giant needs to be managed like a manufacturing firm, with output optimised to something akin to the 90 per cent production levels that manufacturers target.
The thinking is similar in Norway’s energy industry. Statoil’s numbers man believes the decades-long commodities cycle allowed industry players to escape cost discipline, while manufacturers feel the pressure to cut back every few years with market peaks and troughs.
“Commodities companies have not been under pressure for long enough,” said Torgrim Reitan, chief financial officer at Statoil. “They need to be more consistent through the cycle with their focus on costs.”
But in BHP’s case, has the manufacturing model gone too far? Is there just a hint of the dealmakers at work, as advisers lust after fees? It’s no secret that resource giants were some of the better fee payers for investment banks. Many still reminisce about the lucrative fees from the merger of BHP and Billiton. One wonders if the spin off is the result of limited success in shopping assets around for sale.
In the meantime, pension funds, large holders of BHP Billiton who liked its diversified structure in a cyclical industry because returns seemed safer, are right to question the way they view BHP. Manufacturers have bad years too. Less diversification can mean more sleepless nights for those investors that like a little spice but not too much.