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BHP – turning coal into cash

Both main forms of coal remain an important pillar of BHP Billiton’s new strategy but the focus has turned to optimising existing assets to maximise cash flow, rather than further expansion. That’s more good news for shareholders.

China’s economic growth clearly remains important to BHP’s coal business but the manic compound annual growth rate of 15.5% in Chinese crude steel production from 2000 to 2010 will moderate to around 2.7% pa over the next two decades, according to BHP.

Even so, Chinese crude steel production will increase from just under 700 million tonnes in 2013 to a peak of 1.1 billion tonnes in 2025. Growth in India and other emerging markets will also contribute to demand.

Most of the new supply of metallurgical coal will come from Australia, particularly due to its high quality.

BHP noted that more customers are using index-linked pricing in contracts as the number of price providers increases. This has also led to more spot sales, creating liquidity and more transparency in pricing.

BHP’s coal profitability in the last few years has been hurt by a number of factors including a big drop in prices from previously very high levels – almost a boom to bust scenario.

Higher royalties in Queensland and the Carbon Tax haven’t helped along with the higher Australian dollar. Higher operational costs in labour, contactors, consumables and accommodation have tipped the scales further to the point where the company has now revised its strategy.

Taking cost out of the coal business has become the top priority. Reducing headcount, especially contractors and closing high cost operations such as Norwich Park are among the measures being implemented.

The other key element of the profitability equation is the peak in capital expenditure in FY13. BHP said no new major projects are being considered so as the tail of the existing project expansions runs out, divisional capital expenditure will fall.

BHP has enormous coal resources in Australia (NSW and Queensland), Indonesia, USA, South Africa and Colombia and is therefore not in need of further exploration expenditure.

While pricing remains out of BHP’s control, productivity and efficient use of capital is certainly within the company’s reach. After the splurge in the last couple of years, the race is now on to reduce unit costs to historic levels to reinvigorate the profitability of the division.

There is no question of the long term economics of the coal business, but BHP has a job ahead to get coal profits back to where they should be.

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