BHP: It’s US Gas That’s The Danger, Not China.
April 13th 2012 – Australasian Investment Review – (AIR)
There’s a litany of worries and woes being trotted out at the moment to try and bury the BHP share price.
It is having an effect because BHP shares hit a three year low on Wednesday, thanks to the conventional wisdom that China is going sour, meaning bad news for the company’s big profit centres, iron ore and coking coal.
BHP’s share price closed at $33.85 yesterday, up 26c from that low on Wednesday of $33.59.
Investors are nervy ahead of the company’s third quarter production report midway through next week.
As well, the decision to declare force majeure over the rich coking coal exports from the BMA joint venture in Queensland will hurt second half sales and profits (but as coking coal prices weaken in global markets).
And rather than being a positive, the decision to close indefinitely the high cost Norwich park mine in the BMA joint venture because of cost problems, weaker prices, the long wet in Queensland and the impact of the campaign of strikes and stoppages by unions, also hit the share price.
Aluminium is weak and there are growing concerns about the company’s big US shale gas play.
But as we also report today, the outlook for gold is still solid, despite some near term price weakness fears.
China’s economy souring is the main story for many in the markets at the moment, and every bit of economic news from China (as we have seen with inflation and trade data this week and will see with the GDP figures later today) is being interpreted negatively so far as the BHP outlook and share price are concerned.
But the reality is that BHP will struggle more in the depressed US gas market than it will in the Chinese economy.
The outlook for the Chinese steel industry is on the improve and that is flowing into rising iron ore prices.
World spot iron ore prices rose above $US150 a tonne for the first time in six months this week (up from $US147.60 just before Easter).
Iron ore prices fell to a low of $US116.75 in October, a move that many analysts and others in this country seem to still think is where world prices are located. Prices have risen by a quarter since then.
In fact demand is a bit stronger than BHP Billiton’s retiring iron ore boss Ian Ashby suggested in February at a conference in Perth.
He said then that the growth in Chinese demand was “flattening”.
That warning sparked a turn in sentiment against BHP, Rio and other Australian resource stocks (and those listed elsewhere).
In fact iron ore prices are up 8.8% since the start of 2012 and have risen as world oil; aluminium, US gas, copper, gold and other commodity prices have fallen.
On Wednesday, one of the benchmark ores, Australian 62% Fe (delivered to northern China) traded at $US151.25 a tonne according to the Platts pricing agency.
And why the improvement?
Well the Chinese economy hasn’t crashed in a hard landing, steel production hasn’t slumped.
On top of this too many analysts ignored the usual seasonal impact of the timing of the Lunar New Year/Spring festival in China and failed to take account of the impact of this week long shut down for China.
The festival fell in January this year, which meant Chinese steel mills and other commodity buyers boosted orders from November into December to stockpile, then lifted imports in February into March to rebuild stocks for the approaching Spring and Summer peak demand period. Last year the festival fell in February, meaning the impact on demand and supply was from January through March.
As we reported yesterday, figures out earlier in the week confirmed the continuing strength of demand for iron ore.
While China’s iron ore imports fell 3.2% from February, they were still more than 5% higher than March of last year when there was restocking after the Lunar festival the month before.
Imports amounted to 62.87 million tonnes last month, compared with 64.98 million tonnes in February and 59.48 million tonnes in March last year.
China’s total iron ore imports for the March quarter were up 6% at 190 million tonnes, but that was cut by a 20% plus drop in Brazilian imports, a small fall in shipments from Australia in January and a slump in imports from India.
Those declines were driven by wet weather in Brazil (for a second March quarter) and by cyclones in WA (for the second year as well).
More importantly, exports from India have fallen for a third year, something that is helping support the global price at levels much higher than many analysts had figured. In fact Indian exports fell 60% in February from the same month in 2011.
Stocks of steel products have fallen to around a month stockpile, down 20% in the past few weeks as steel mills curbed production in the belief demand would be weak.
All this has seen forecasts for a price rise to around $US160 a tonne for ore in the next month.
If that happens, it will produce a surprise rise in quarterly ore prices for the September quarter for BHP, Rio and Vale, the huge Brazilian miner.
So if the outlook for iron ore is improving (for the next few months anyway), why the weaker share price for BHP?
Well look at the US shale gas sector where BHP has invested upwards of $US20 billion, building a major presence.
US gas futures prices yesterday fell below $US2 a million BTU (the standard pricing method for gas) for the first time in a decade.
The price fell to just over $US1.98 per million BTUs.
At that rate US analysts doubt many producers are making a return.
Consumers though are making hay, especially those power stations burning gas and those companies using it as a feedstock in manufacturing processes.
BHP says it has recognised that fall in gas prices by boosting production of liquids from its US shale holdings (that’s a form of oil).
But even that ploy is under pressure as shale gas and liquids fields in the US Midwest flood the market with oil.
BHP isn’t the only company doing that, but it’s a move that has boosted output of gas, because it comes with the liquids.
Last year US production grew by 4.8 billion cubic feet of gas a day, the biggest increase ever according to an update this week from the US Energy Information Administration.
And, US marketed gas production in 2011 was the highest ever, surpassing a peak set in 1973.
Low prices have prompted producers including Chesapeake Energy to cut back and drilling rig use has dropped by around a third since last October.
However, the EIA expects supplies will still expand by 3 billion cubic feet a day in 2012, faster than consumption.
That’s because companies have moved to exploit wet gas with liquids, rather than dry gas.
As a result, the US state of North Dakota is now producing more oil than the OPEC member Ecuador does: over half a million barrels a day.
US oil is trading around $US101 a barrel at the moment, Brent crude in London is around $US120 a barrel.
The difference represents the impact of the oversupply of crude and liquids in the US Midwest.
It’s a problem BHP is going to struggle with and some analysts are wondering whether the multi-billion dollar play might have to be written down later this year.
Investors should be more worried about that investment and the returns BHP won’t get at these prices, than China and the price of iron ore and coal.
And there’s gloom in aluminium for BHP, despite Alcoa’s surprise small profit in the March quarter.
While better than the big loss in the December quarter, it was sharply lower than the profit for the first quarter of 2011.
The outlook for the metal is worsening. BHP may be running its aluminium business for cash (meaning it’s trying to break even on a cash flow basis and not worry about profit), but the industry is facing continued over-capacity, weak prices and falling returns.
The prices of bauxite and alumina are falling (Alcoa cut global alumina production a week ago).
Norsk Hydro, Rio Tinto Alcan and Alcoa have closed smelters and refineries in several countries and mothballed capacity at others.
Close to 800,000 tonnes of capacity has been shut in recent months.
In Australia the Alcoa-owned Point Henry Smelter near Geelong is in danger of closing.
Overcapacity has kept prices subdued and led to a huge build-up of inventories – now estimated at more than 12 million tonnes around the world.
And with the price of energy, which accounts for as much as half of aluminium production costs, rising, industry-wide profitability is flat at best, unprofitable at worst.
China is causing much of the damage – it saw output rise 18% in the first two months of the year, according to International Aluminium Association figures.
That’s boosted the surplus and pushed world prices down 22% in the past year.
China will add another 2.9 million tonnes of output in 2012 as it builds plants at a faster rate than it shuts older ones.
Global aluminium use will be 43.9 million tonnes this year, assuming Chinese consumption of 17.6 million tonnes.
Supply will be around 46 million tonnes, resulting in a 2-million tonne surplus.
Global stocks held at exchanges like the LME have jumped 11% over the past year to around five million tonnes.
That’s adding to the pressure on prices.
Earlier this week Alcoa kept its forecast for aluminium use in 2012 at 7% growth (down from 10% in 2011).
But it trimmed its estimate of Chinese demand to 11% from 12%. Chinese consumption rose 15% last year.
BHP’s aluminium business ran at a pre-tax loss in the December half year, and the outlook is for more losses.
The company and investors have more to fear financially from this stuttering business and the low prices for US gas, than from the health of the Chinese economy.
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