Wednesday, 22 February 2023
by Berkeley Lovelace
In Oscars parlance none are expected to be award winners. Lower iron ore prices — and in the case of BHP and Rio, copper too — through the second half of last year will trim earnings from last year’s outlandish levels.
BHP made a profit of around US$6.46 billion yesterday, with its dividend falling from US150cps to US90cps year on year.
Still enough to buy a few cartons of Masters choc milk from the corner store, maybe not enough to pay for a Cottesloe rental.
BHP was feeling the pinch of higher costs as well. Inflation lopped US$1 billion off its earnings, a hit of around 12% year on year. Rio will be an interesting read on that front.
Meanwhile, increased spending on M&A ($9.6b OZ deal loading), decarbonisation (US$4b by 2030) and exploration are becoming higher priorities for BHP and other miners who have showered shareholders with payouts in recent years.
BHP’s 69% ratio was not as low as FMG’s still solid 65% ratio from a week earlier, but down from 78% last year it shows capital discipline is creeping back in after 2021’s record iron ore price run made the sky the limit for yield-hungry investors.
There are some green shoots though. BHP is very high on China and its reopening demand, especially for iron ore, while remaining pessimistic on the US and Europe.
“China’s reopening is progressing well with positive social and economic signposts emerging — mobility data, new home prices and business surveys are all showing solid signs of improvement early on in the calendar year,” Henry said on a call with media.
“The pent up demand being released as China opens back up from the COVID lockdowns, coupled with growth promoting policies is expected to drive stronger increased demand for the commodities we produce.
“We now have even greater conviction that China will be a stabilising force for global economic growth over the remainder of this year.”
Even more helpful than management commentary is BHP’s half-year economic and commodity outlook, where chief economist Huw McKay digs into the facts and figures around BHP’s internal numbers.
Positively for BHP and other iron ore producers, he says the run which has seen China deliver more than 1Btpa of crude steel production since 2020 is likely to stretch to 5-6 years.
McKay has sold the idea in recent times that China’s steel industry, rather than peaking as its economy shifts from manufacturing to service amid a growing middle class and efforts to reduce carbon emissions, is in a plateau phase.
The relationship between Chinese steelmakers and Australian iron ore producers, and their relative import and export figures, is the main seesaw on which spot iron ore prices swing.
Yesterday’s Singapore iron ore futures showed traders were bullish indeed, up over 2% to ~US$131/t.
“Our preliminary take on calendar 2023 and 2024 is that the current four–year streak of outcomes in the 1.0 to 1.1 Bt plateau range is likely to extend to five and then six. However, contrary to calendar 2022 when we moved to the lower end of the range, the next two years are likely to move us back closer to the middle of the range,” McKay said.
However, he said the Chinese property sector needs to overcome last year’s weakness to assist in the rebound. Accounting for around a third of steel demand, Commbank analyst Vivek Dhar this month said its bearishness on China’s property market was the main reason behind his assumption iron ore prices would drop this year to US$100/t.
“For (stronger steel production) to eventuate, the systemically vital housing sector needs to progressively leave its annus horribilis behind it,” McKay said.
“It also relies on the Chinese authorities adopting a more flexible disposition towards incremental annual growth than has been the case in recent years.
“Early indications at both a macro and micro level hint that this might be the case for a modest uplift in production – although there are no signs that a more lenient approach to capacity expansion would be countenanced (and nor do we expect any change in this regard).”
Steel mill margins were poor for most of 2022, with McKay saying mill owners lost an average of -US$20/t, not far off the -US$24/t figures before the introduction in 2015 of ‘supply side reform’ (i.e. the restriction in steel output that temporarily tanked iron ore prices).
But 2022 is not 2015, with blast furnace utilisation rates remaining strong and cost support for iron ore found between the US$80-100/t range, where lower grade and lower margin producers struggle to make money.
BHP saw costs at its WA Iron Ore division lift 13% to US$19.28/t on guided exchange rates in the first half (US$18.30/t on actual exchange rates), above its US$18-19/t range, though C1 costs, not including third party royalties, were US$15.50/t (up from US$14.74/t in FY22).
That cost base is important, with McKay warning of rising competition in the iron ore market, including from West Africa where Rio Tinto and Chinese interests are planning to build the massive Simandou mine.
“Our analysis indicates that the long run price will likely be determined by the all-in cost base of the least competitive seaborne exporters (higher narrow cost, lower value–in–use) in either Australia or Brazil,” he said.
“That assessment is robust to the prospective entry of new supply from West Africa, and China prioritising the accelerated development of its domestic resources. This implies that it will be even more important to create competitive advantage and to grow value through driving exceptional operational performance.”
McKay uses the description of ‘feast and famine’ to describe the coal industry in recent years, a key argument floated by malingering miners when they throw the toys out of the pram on phrases like “royalty increase” and “domestic reservation”.
It goes that while miners are enjoying super profits now, there will be periods when coal miners will very much be underwater.
McKay creatively summarises the run up in coal prices that saw thermal and met coal producers alike return from the abyss last year, just two years on from the dark, dark days of the pandemic.
“Metallurgical coal prices have been volatile over the last six months, but relative to the dramatic circumstances that emerged as the Ukraine conflict got underway, the most recent half felt almost tranquil,” he said.
“In the first half of financial 2023, the PLV index ranged from a low of $188/t FOB Australia to a high of around $321/t, averaging $264/t.
“Remarkably, that represents a steep decline from the prior half, when the all–time daily record high of $671/t was established, and the average for the entire half exceeded the previous daily price record achieved during the Queensland floods of 2011.
“That is tantamount to running a full marathon where the constituent 400 metre legs are all faster than world record pace.”
A joke of a craftily inexact character not foreign to the eyeballs of the average Stockhead reader.
The metaphor bypasses the fact there are very clear, physical limitations on runners, anchors of reality and science that don’t seem to apply to what is a broken coal market pummelled by weather, geopolitical tension and trade distortions.
That said, McKay does acknowledge 2022’s coal market was “stranger than fiction”.
“It is not just benchmark pricing that has swung wildly: spreads have also experienced unheard of volatility. The spread between China CFR equivalent and PLV FOB pricing averaged +$4/t in the four financial years prior to the pandemic (FY17–20),” he said.
“In financial 2022, the differential ranged from +$218/t to –$245/t and from +$140/t to –$21/t in the first half of financial 2023. Oh, and despite trading at elevated absolute levels, PLV FOB pricing somehow managed to spend much of the post–Ukraine period trading below FOB energy coal (Newcastle 6000kcal), and at times PLV was trading at a discount to lower–quality met coals.
“These developments were beyond extraordinary. In the coal trade, fact was certainly stranger than fiction in calendar 2022.”
Scroll or swipe to reveal table. Click headings to sort.
McKay says the return of China to the Australian coal trade is unlikely to result in a swift normalisation to pre-pandemic levels, when the Chinese mopped up around 37-40Mtpa of supply.
While he refused to say if BHP had sold any coal yet to China this year, CEO Mike Henry told media the return of the world’s biggest steel producer to the fray (described by McKay as a re-rebalancing) was a positive development.
Yet it hasn’t stopped BHP putting two mines from its 50-50 BMA JV with Japan’s Mitsubishi — Daunia and Blackwater — on the market.
It is understood the 90+ year, 8Mtpa Blackwater South development, currently awaiting underground environmental approvals, is excluded from the offering.
We will see a feast for whoever picks those up if strong pricing continues, which begs the question why BHP wants to further whittle down its coal holdings at all.
Daunia and Blackwater, like BMC, sell lower grade coal than BHP’s premium hard quality product from the Saraji, Peak Downs, Goonyella and Broadmeadow mines.
While BHP suffered the embarrassment of seeing big price rices for semi-soft, PCI and thermal coal make it look like a bit of a mug with the sale prices for BMC and its share in the Cerrejon mine to Glencore, it is taking a long term perspective on the coal market.
That is one that sees stronger long term demand for harder met coal which generates lower emissions in the blast furnace.
This flight to quality is important for BHP, especially in the face of a tougher regulatory environment and stricter royalty regime for Queensland’s coal industry.
“In coming years, most committed and prospective new metallurgical coal supply is expected to be mid quality or lower, while industry intelligence implies that some mature assets are drifting down the quality spectrum as they age,” McKay notes.
“Additionally, the regulatory environment has become less conducive to long–life capital investment in the world’s premier PLV basin – Queensland.
“The relative supply equation underscores that a durable scarcity premium for true PLV coals is a reasonable starting point for considering medium terms trends in the industry.”
Premium hard coking coal futures are currently paying US$377.50/t, with thermal coal down sharply this year from around US$400/t to US$209.35/t yesterday.
Given the history of the Cerrejon and BMC deals is this a case of buyer or seller beware?
Whether the purchaser of BHP’s Daunia and Blackwater mines enjoys feast or famine will be up to the vagaries of the market.
It’s been a generally quiet time for iron ore juniors over the past year or so, with the drop in iron ore prices in the second half making a big dent in the number of small caps actively spruiking projects in the space.
But African iron ore has been a hot ticket this year, with growing momentum around the Simandou development followed by news Andrew Forrest’s Fortescue Metals Group (ASX:FMG) plans to begin a US$200 million, 2Mtpa starter mine at the Belinga iron ore operation in Gabon this year.
Also in Gabon, junior Genmin (ASX:GEN) is planning to begin a small scale 5Mtpa development in mid-2024 at its Baniaka project.
It has taken another step forward, inking a 15-year bulk logistics agreement with Owendo Mineral Port for a mine to port solution using existing and operating infrastructure.
The companies will be able to scale up to 15Mtpa if $65 million capped Genmin is able to ramp up production further, with plans to ship its Baniaka material trough Owendo’s port facilities 15km south of the Gabonese capital of Libreville.
The port is owned by Arise Ports and Logistics, itself a JV between AP Moller Capital, Olam International Limited, Africa Finance Corporation and French investment fund Meridiam.
“The signing of the agreement also delivers another major project development milestone, as we remain firmly focused on commencing production at Baniaka in mid-2024,” Genmin MD Joe Ariti said.
“With both the renewable hydropower supply, and rail and port agreements signed in recent weeks, our next project level priority is the submission and approval of the mining permit application, which is supported by 46,000m of drilling, a feasibility study, and an extensive social and environmental impact assessment based on nearly five years of environmental data collection.
“We are targeting the mining permit being issued in mid to late June quarter.”
Scroll or swipe to reveal table. Click headings to sort.
The post Bulk Buys: BHP’s number crunchers see blue skies in China’s steely reopening appeared first on Stockhead.