(The opinions expressed here are those of the author, a
columnist for Reuters.)
By Clyde Russell
LAUNCESTON, Australia Feb 23 Anytime you hear
the mantra "this time it will be different," it's probably best
to assume the same old cycle will repeat itself.
This is especially true for commodity producers, who often
appear to lurch from boom to bust and back to boom with little
regard for learning from past mistakes.
Perhaps this is because commodity cycles can take decades to
play out, meaning institutional memory is lost over time,
allowing executives to repeat the mistakes of their
But more likely it's because most chief executives in listed
commodity majors are either forced by investors to be seen doing
something to boost growth, or by nature are driven to build and
buy new mines.
The strong gains in many commodity prices last year,
including a doubling of iron ore and coal, have given rise to
optimism within the industry that the down cycle in commodities
is finally over after five long years of falling prices.
Assuming this optimism is justified and prices are at the
start of new up cycle, how should commodity producers respond?
In the down cycle that started in 2011 most companies
responded by cutting costs to the bone and curtailing
exploration, while also boosting output to lower the outlay per
This did lead to a dramatic lowering of the cost curve, but
the tactics also likely deepened price declines as they resulted
in more low-cost supply reaching well-supplied markets - iron
ore, coal, aluminium and crude oil being good examples.
If we are at the start of a new cycle of stronger commodity
prices, the prudent thing for companies to do is to remain
focused on costs, while also paring debt and steering
exploration spending towards markets with the best long-term
prospects for supply constraints or strong demand growth.
Global consultancy Deloitte captured the essence of the
challenges in its "Tracking the Trends" mining report earlier
this month, with the top issue being how companies should focus
on "understanding the drivers of shareholder value."
The report said mining companies delivered poor total
shareholder returns (TSR) in the period of falling prices from
2011 to 2015, in contrast to strong returns in the earlier
period of higher prices and significant investment.
While this seems obvious at first glance, Deloitte said the
main issue is that miners shouldn't rely on rising prices to
boost shareholder value.
"There are numerous levers and metrics management can use to
influence TSR, such as costs, gearing, capex and portfolio
composition," the report said.
"However, to generate greater value to shareholders by
improving return on invested capital and return on equity,
miners must exercise financial discipline."
Put another way, commodity producers should resist the
temptation to embark on an open chequebook approach to new
projects just because they are now generating large cash returns
as higher prices boost revenues.
REASONS FOR OPTIMISM
So far the signs are somewhat encouraging, with major miners
expressing caution in their recent results presentation.
Top miners BHP Billiton, Rio Tinto and
Anglo American all committed to boosting shareholder
returns through higher dividends, and in Anglo's case by
They also all committed to using their extra cash to pay
down debt and maintaining a focus on keeping operating costs
Perhaps this is because the company executives aren't quite
yet convinced about the sustainability of the current rally in
prices, but it's also to be hoped that this generation of
leadership can resist the temptations of embarking on marquee
projects or overly-ambitious M&A deals.
The main risk is that the longer the price rally does go on,
the greater the pressure will become from equity analysts for
plans to boost growth over the longer term, a situation that in
the past has resulted in massive commitments of capital that has
not delivered its promised returns.
BHP's shares trading in Sydney have rallied strongly
recently, gaining 82 percent from the post-2008 recession low of
A$14.21 reached in January 2016 to Wednesday's close of A$25.78.
But even with these gains, the shares are still more than 40
percent below the April 2011 peak of A$44.89, hit just as
commodity prices started their extended losing run.
What this shows is that there is still some way to go for
BHP to deliver the returns to shareholders promised by the
billions of dollars spent boosting its production of top earners
such as iron ore and crude oil, if you use the share price as
the main method of judging the success of management.
While I am always wary of saying this time it will be
different, there are some good reasons as to why this might be
Firstly, the massive spur in investment that helped drive
the oversupply of commodities and the resulting declining prices
doesn't really exist anymore.
Much of the optimism behind the last investment boom was
that China would simply buy everything that commodity companies
While China remains the world's top commodities importer,
it's become apparent that its appetite isn't unlimited, even
though there are still areas of robust demand growth, such as in
This alone should make companies more wary of re-starting an
investment cycle, but it's also worth noting that the current
chief executives of most of the top miners tend to be more
focused on operating rather than building.
For example, BHP's current boss Andrew Mackenzie sounds very
different from predecessors like Marius Kloppers and Brian
Gilbertson, and not just because of his Scottish accent.
Mackenzie tends to focus on BHP's achievements in driving
down costs and running operations as efficiently as possible,
while Kloppers and Gilbertson liked to talk about deals and
building new mines.
Yes, the times have changed, but at this stage of the cycle
where cautious optimism abounds, it's probably better to have an
operator rather than a deal-maker in charge.
(At the time of publication Clyde Russell owned shares in
Rio Tinto and BHP Billiton as an investor in a fund.)
(Editing by Tom Hogue)