Faced with fight or flight, BHP chooses to flee

The confirmation of speculation of an imminent sale of BHP’s petroleum business to Woodside poses a question. What’s the better course for carbon-intensive businesses, fight or flight?

Rio Tinto opted for flight and the sale of its coal mines in 2018. BHP is in the process of exiting thermal coal, with the sale of its interest in the Cerrejon mine in Colombia in June and its Mt Arthur mine in NSW and its 80 per cent interest in the BMC joint venture with Mitsui in Queensland also on the market.

There are a number of reasons for why BHP would consider quitting a sector that has been an important core element of its portfolio since oil and gas was discovered in Bass Strait more than half a century ago.Credit:Arsineh Houspian

An exit from petroleum – Woodside disclosed on Monday, after intense recent speculation, that it was in discussion with BHP about a potential merger that would see it acquire BHP Petroleum by issuing Woodside shares to BHP shareholders – and a successful exit from thermal coal would mean that only BHP’s dominant metallurgical coal division would remain from its most carbon-intensive assets.

It isn’t surprising that BHP is considering selling its oil and gas business.

Decarbonisation not only causes an increasing cohort of investors to shun companies with big exposures to fossil fuels but, even though demand is likely to expand for at least the next couple of decades, creates a question mark over future investment, growth and value.

Moreover, the big end of the oil and gas sector is capital-intensive and low-margin and, for BHP, where once oil and gas provided a source of cash flows where the prices weren’t correlated to its iron ore, coal and copper businesses in the past decade or so their role as diversifiers hasn’t been quite as significant.

Since the 2008 financial crisis all commodities have been increasingly “financialised,” or transformed into an investment class alongside the traditional industrial demand.

Their prices are more correlated than they once were and therefore don’t provide the same diversification benefits that they once did within a BHP portfolio that used to have a floor under the levels of cash flows at risk from external developments.

BHP was confronted with the prospect of continuing to invest heavily in a sector with finite growth prospects in the longer term; one that carries reputational baggage and which doesn’t provide the benefits it once did or cashing out while it could still attract a decent price.

There are, therefore, a number of reasons for why BHP would consider quitting a sector that has been an important core element of its portfolio since oil and gas was discovered in Bass Strait more than half a century ago.

The more general motivation for quitting coal, oil and gas might appear obvious in a decarbonising world and one in which investors are increasingly shunning carbon-intensive businesses. BHP and Rio’s decision to flee the carbon-intensive sectors is, however, at odds with the strategy of one of their peers. While they have been selling, or trying to sell, Glencore has been buying.

Remarkably, despite expanding its coal portfolio in recent years, most recently by taking BHP and Anglo American out of Cerrejon, Glencore hasn’t faced a backlash from its shareholders, ESG investors or environmental groups.

That’s because last year former chief executive, Ivan Glasenberg and his anointed successor and then head of the coal business, Gary Nagle, did something clever.

They committed Glencore to reducing its carbon emissions to net zero by 2050, primarily by simply allowing the mines to deplete until they run down the resources to the point of closure.

There’d be no expansions of existing mines to offset the depletion, Glenore’s total emissions would reduce by 40 per cent (relative to 2019 levels) by 2035 and its ambition would be to achieve net zero emissions by 2050.

That strategy is ingenious because it disarmed the environmental groups and ESG investors without harming Glencore’s prospective profitability.

For those not trapped by the nature of their operations in a fight to maintain them, the simpler decision – and the one BHP appears to be close to exercising – is to grab the flight option while it remains open.

The world’s biggest seaborne coal group had provided a template that they seized on for how carbon-intensive companies should respond to climate change.

Previously activism was aimed at pressuring companies with carbon-intensive portfolios to sell by cutting off their access to debt and, increasingly, ESG-sensitive equity.

At the big end of the resources sector, however, that created the likelihood that responsible companies with reputations and other assets to protect would simply sell their more controversial assets to those who weren’t concerned about the reputational impacts or who were committed, like Woodside, to the particular commodity. Acquiring BHP Petroleum will make Woodside a world-scale player in the industry.

Exercising the flight option means assets are passing from a company that is less likely to invest in expanding production to one where it is almost inevitable that it would invest and expand production to meet demand for coal and oil that is continuing to rise and will probably do so for several decades to come as China and India, in particular, continue to industrialise.

Glencore and former chief executive Ivan Glasenberg provided a template that they seized on for how carbon-intensive companies should respond to climate change.Credit:Bloomberg

Glencore has provided an exemplar with its commitment to depletion of its reserves.

Earlier this month the environmental activist group Market Forces called on BHP to abandon its plans to sell its most carbon-intensive assets and instead wind down their production. The activists have woken up to the reality that divestment simply shifts the latent emissions and probably increases them.

The genius in Glencore’s position is that, as the dominant seaborne energy coal group and the biggest trader of coal via its marketing business it can offset any loss of volume from its promise to allow its resource base to deplete through the impact of that depletion on prices and/or through its trading of third-party volumes.

Last year the price of Australian thermal coal crashed after China imposed a ban in response to a number of perceived slights from Australian politicians. It fell to around $US50 a tonne.
Glencore responded by cutting Australian production, sourcing product for China from South Africa, Indonesia and Russia and subsequently redirecting the Australian coal to the markets that those countries had supplied.

The reduced Australian production was reflected in the 16 per cent fall in Glencore’s coal volumes in the first half of this year but prices have rocketed to near-record levels – they have been above $US170 a tonne – and have set the company up for an exceptional second half, with coal expected to generate close to $US6 billion of earnings before interest, tax, depreciation and amortisation this year.

Glencore is unique in the scale and mix of its mining and trading activities and therefore its strategy of finessing volume and price across that range of activities is difficult for others to replicate without sacrificing profit and value.

For those not trapped by the nature of their operations in a fight to maintain them, the simpler decision – and the one BHP appears to be close to exercising – is to grab the flight option while it remains open.

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