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COLUMN-Commodity companies' cost-cutting stampede yet to work: Clyde Russell
May 20, 2013 / 7:10 AM / 5 years ago

COLUMN-Commodity companies' cost-cutting stampede yet to work: Clyde Russell

--Clyde Russell is a Reuters market analyst. The views expressed are his own.--

By Clyde Russell

LAUNCESTON, Australia, May 20 (Reuters) - If you ever needed an example of the corporate herd mentality, then look no further than the stampede of cost-cutting among commodity producers started by BHP Billiton.

Since the Anglo-Australian miner moved last August to scrap or delay projects and slash operating costs, mining and energy companies have been rushing to do the same.

In the past few months, no less than $15 billion of cuts in capital and operating expenditures have been announced, and this is likely just a small percentage of reductions still to come.

What started as concern among investors in BHP Billiton and its fellow Anglo-Australian miner Rio Tinto over excessive capex amid slowing demand growth for commodities from top consumer China has spread across the world.

In recent weeks several Canadian miners have announced cuts to capex, and newly-merged Glencore Xstrata has promised aggressive cost-cutting, with some investors confident it will exceed its target of $500 million in reductions.

And it’s not just miners joining the cost-cutting frenzy, with Singapore-listed commodity firms Olam International , Wilmar International and Noble Group announcing cuts up to about a combined $2 billion in capex.

Wilmar isn’t a mining company at all, rather being focused on agricultural commodities such as palm oil and soybeans, and while Noble and Olam both own assets, their core strength is in supplying commodities to customers.

Even energy companies have been trimming costs despite not being as adversely affected by the concern over slowing growth for Chinese demand for resources, which has mainly focused on metals such as copper and bulk commodities like iron ore and coal.

Heavyweight Exxon Mobil has said it would lower capex 4.5 percent to $38 billion this year and for the “next several years” from 2012’s $39.8 billion, while U.S. oil and gas explorer SandRidge Energy said in early May that it would cut spending by $300 million to $1.45 billion this year, revising a February estimate.

Cutting costs has replaced developing new projects as the mantra of resource companies, and it’s likely that far more is to come.

While Australia has $188 billion of liquefied natural gas projects approved and under construction, the chances that more will be sanctioned are dimming.

Already Woodside Petroleum, the nation’s largest oil and gas producer, has shelved its Browse LNG project in Western Australia, saying the economics no longer stack up.

Speculation is also mounting that Royal Dutch Shell and its partner PetroChina will defer their $20 billion Arrow LNG project in Queensland, on Australia’s east coast.

The Arrow venture is the last of the four coal-seam gas to LNG projects planned for Queensland and rising costs and difficulties in securing adequate gas supplies may make it more viable for Shell to scrap building its own plant and instead sell gas to a rival operator in exchange for an equity holding or offtake agreement.


The reasons for the rise of cost-cutting and spending controls follow two broad themes.

These are concern about over-investment leading to a glut of supply just as China’s economy matures and the developed world struggles for growth momentum, as well as increasing labour costs and taxes undermining the profitability of new ventures.

There was also the demand by investors for higher returns to shareholders from resource companies, which generally used the windfall profits from the boom years from about 2004-08 and 2009-11 to invest in boosting supply rather than dividends.

BHP Billiton, the world’s biggest miner, has pledged to increase returns to shareholders while cutting capital and exploration spending to $18 billion in the current financial year, down a fifth from the year before.

If the $4 billion in savings was added to the bottom line for the year to June 2012, it would have boosted BHP’s net income 26 percent to $19.4 billion.

That’s obviously too simplistic a view, but even those figures gave an idea of the scale of what BHP is trying to do, namely deliver a significant increase in cash available to return to shareholders in an environment of declining prices for many of its key commodities.

The jury still appears to be out on whether BHP, and indeed other resource companies, will succeed in boosting returns despite price pressures.

BHP has the biggest market capitalisation in the S&P ASX 200 index, the Australian benchmark, with the second spot filled by Commonwealth Bank of Australia.

Since BHP’s announcement on Aug. 22 last year that it was entering a new era of austerity, its share price increased 3.7 percent to close at A$34.41 on May 17, while over the same period Commonwealth Bank has jumped 32 percent to A$73.21.

And it’s not just that Commonwealth Bank is an exceptional performer, as the overall index has risen 18 percent, its gains being held back by commodity companies like BHP.

Rio Tinto is up 2.2 percent since August last year, and modest increases aren’t only limited to Australian-based commodity producers.

Wilmar is up 6.9 percent, Exxon Mobil by 5 percent and Shell by 0.4 percent, all of them underperforming their respective indexes.

But it could be worse, if London-listed Anglo American is anything to go by. Its shares have declined almost 18 percent since August last year, and it also happens to be one of the few major mining companies yet to announce a cost-cutting and restructuring drive.

New Anglo American Chief Executive Mark Cutifani has promised such a review by July, and it will interesting to see if the company’s share price can post gains, assuming the former South African company also follows the cost-containment route.

If you believe that the resource companies will be able to cut costs by more than commodity prices decline, and furthermore will return capital to shareholders, then they are probably a good buy.

Currently, they may seem too risky compared to the higher dividends already being offered elsewhere in the equity market.

Disclosure: At the time of publication Clyde Russell owned shares in BHP Billiton, Rio Tinto and Commonwealth Bank as an investor in a fund. He may also own other shares mentioned as an investor in a fund.

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