The most obvious reason for these pessimistic figures in today’s token interest rate environment is that the market thinks the Big Australian is too dependent on China and on high iron ore price levels.
In other words, the iron ore profit boom will come off the boil.
But BHP faces other potential challenges that are rarely openly talked about including steelmaking technology change and new management challenges.
As The Australian reported earlier this week, Scott Morrison is expected to adopt a technology target aiming at zero emissions by 2050.
It’s a very sensible idea because we need much better technology if we are going to reduce emissions to anything like the level proposed without an enormous fall in living standards.
Any major global technology spend must focus on steel and cement, which account for about 15 per cent of China’s emissions.
Iron and steel account for 7 to 9 per cent of global greenhouse gas emissions. Australia has a big stake in the outcome of research into steel (and cement) making to reduce carbon emissions. If a substitute product is found for steel then both our iron ore and metallurgical coal industries will have a limited future.
A more likely outcome is the development a technology to slash the carbon emissions in steel production. There are naturally many ideas in the mix. But there are two front runners: hydrogen driven direct reduction and carbon storage. Widespread adoption of direct reduction of iron ore by hydrogen would put the BHP’s (and Queensland’s) metallurgical coal industry into a long term death spiral.
Successful carbon storage would lock in its future.
I am not in the business of picking winners but the fact that in 2017, every ton of steel produced resulted in an average of around 1.8 tons of carbon dioxide and we produced around 1.8milion tons of steel makes this a big issue.
A formidable US group is pooling resources to research hydrogen. It’s made up of the American Iron and Steel Institute, the US Department of Energy, Berry Metal, ArcelorMittal USA, Timken Steel, US Steel and University of Utah. There will also be other global hydrogen research thrusts. .
On the carbon capture side BHP has set aside a fund for investment in the technology but, given the hydrogen push, carbon capture research expenditure may need to be substantially increased. An 0.5 cent allocation of BHP’s turnover to carbon capture research would provide in excess of $US200m annually: not a big percentage outlay.
Given the Queensland coal industry is at stake, and Morrison’s policy, the Commonwealth might match any BHP contribution.
BHP last year invested $US6m in Carbon Engineering Ltd, a Canadian-based company leading the development of direct air carbon capture, a technology which has the potential to deliver large-scale negative emissions by removing carbon dioxide from the atmosphere.
BHP announced at the time that it was committed to accelerating the global response to climate change by investing in emerging technologies that have the potential to materially reduce greenhouse gas emissions.
BHP’s second challenge, the Australian-China relationship, is out of its control. Right now, everyone is more concerned about the coronavirus and China needs BHP minerals.
But outside the virus basic relations between Australia and China have reached a new low. The downward spiral started with the 2008 speech in Mandarin delivered to Beijing University students by the then Prime Minister Kevin Rudd.
The Chinese hate been lectured by westerners and are insulted when the lecture is delivered in Mandarin. When Julie Bishop became foreign minister the lecturing continued, albeit in English.
We also usually embrace US policies in the region. But the real blow came when the Australian government was in turmoil in the week leading up to the 2018 removal of Malcolm Turnbull as Prime Minister.
Australia became the first country in the world to follow the US and ban on security grounds one if China’s largest companies, Huawei, from the 5G rollout. Huawei technology is superior to its European based rivals, so it was an unexpected development.
Both New Zealand and the UK have left the door open to the better technology.
Every Australian trader with China fears that at some point China’s anger will reduce their trade. Miners like BHP hope for an improvement in relations, or that China’s anger will be directed to non-mineral exports.
Finally, historically BHP was a high-cost, often badly-managed mineral producer where unions held great managerial power. It was akin to the motor industry.
In the last decade that BHP has been transformed partly vie subcontracting tasks. Now BHP wants to bring them back in house to maximise the co-ordinated introduction of the new technologies. But BHP needs to have the managerial talent to make sure it does not return to the bad days.
Why is the market pricing BHP group at less than 7 times estimated 2019-20 earnings before interest and tax (EBIT) and giving it an estimated EBIT yield of above 14 per cent?