Red gold rush

So, BHP has announced a profit of epic proportions. The Age sets the scene nicely:

BHP Billiton has vaulted into the ranks of the world’s top 10 earning companies – and sparked fresh debate over how much tax Australia should collect from its booming mining sector – after the resources giant posted a staggering $A22.46 billion profit for the latest year.

The result, driven by booming exports to China, completely dwarfed all previous profits earned by Australian companies, and was among the biggest 20 in global corporate history.

Only six other companies in the world – including US oil giant ExxonMobil, Royal Dutch Shell and Nestle – have ever posted fatter profits than the Melbourne-based miner did in the 12 months to June 30.

As a quick aside, had BHP merged with Rio in 2007, this would have been in the top five profits of all time, anywhere.

Anyways, the MSM has picked off the low hanging fruit with regard to the result and its political ramifications (see today’s links). I thought I’d just take a quick tour through the preliminary results presentation to give you an idea of the importance of two factors, iron ore and Chinese construction.

Not surprisingly, the leverage to Chinese growth is huge and growing:

And let’s not forget that China consumes very nearly half of the world’s iron ore. Next up, the split of products and respective margins:

That is a mighty fine margin in iron ore and it makes up roughly half of the underlying profit. So far as I know, that is all Australia. Such is confirmed by a chart of price impacts on profit:

And by a chart showing the sensitivity of profits to underlying price movements:

Yes, every $1 move in the iron ore price is equivalent to $90 million profit. And don’t forget that most other commodities are still substantially below their 2008 prices.

Good luck to BHP for making hay while the sun shines. Australia should do to same. Tax iron ore and stick the dough in an SWF for when the boom ends.

The full report is below:

110824_BHP Billiton Preliminary Results for the Full Year Ended 30 June 2011_Presentation

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the fouding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

Comments

      • Heard Swannie say this on radio national the other morning – nearly crashed into the car in front.

        From memory the quote was ‘get your greedy taxpaying eyes of the future fund you mob – that’s for the risk free retirement of politicians and senior public servants – the nerve of you lot’

  1. Yep, as I keep saying, this is not about “Asian demand for our resources” its much more narrow than that. Its about the “Chinese construction sectors demand for our iron ore”. If that driver of demand were to stumble, BHP and Rio’s profits wouldn’t look nearly as impressive, and our terms-of-trade boom wouldn’t be anywhere as spectacular.

    We have become hopelessly leveraged to the Chinese construction boom, which as we all know, is on very sound footings, and will last at least a century.

    Yay Australia!

      • You don’t go through what I’ve been through this past year feeling ‘positive’ about the Australian economy and the wonderful mining boom that’s bringing riches to us all.

    • In all seriousness, when will China reach a saturation point with its fixed asset investment? I imagine you can only build so many train lines, freeways and airports, ghost towns etc. They would already be well into White Elephant territory, but how much longer can it really be sustained for?

      • Also, don’t forget how many Universities they make a year and the maturation curve on their knowledge and experience going home!

        The Education sector has long term threats on the horizon as well not just mining!

        Hmm has nyone looked at that yet reduce both moning and education from Australia’s bottom line.

        Eeek!

        TM.

        • While the elite universities in China is top notch, the quality of other Chinese university are somewhat ‘disappointing’.

        • Your point about their education system echoes one I have made before in regard to the belief that Australia will be one of the education providers of choice into the future (or for that matter any of our tertiary services sector).

          Those thinking that must equally believe the China will not further develop these areas domestically. They can, they are and they will. Goodbye the dream some of our leaders hold that China is a future direction for our services sector – misguided at best.

          • The big test will be whether China can move from a manufacturing economy into an entrepreneurial economy. China knows its system is not creating creative thinkers and is starting to change this… well attempting to (current education 5 year plan is all about creating entrepreneurs). They are also limiting new education partnerships with overseas partners – unless the partner organisation can show that the information is not being offered at another university it won’t be approved. If it works, they will have the ability to become self sustainable in education. But if, as i fear, they continue to be ruled by ‘saving face’ and deflecting blame, I can’t see how anything can change. Without proper analysis of why things go wrong, China will always been a net importer of ideas. This is also the sole reason to not write off America. America has fostered entrepreneurs for ever, while there is no incentive for anyone to rock the boat in communist china.

      • They will over build in a similar vein as the USA did when they went through this. Doesn’t mean the landing needs to be hard, but a correction is inevitable.

        BHP’s recent profit is unsustainable long term, and i think Kloppers and the team know this, which is why they have been on an acquistion spree in gas, one of the commodities that hasn’t boomed as hard as copper, iron ore, metallurgical coal etc, but is likely to have strong demand in the future. After all everyone needs the lights to come on.

        Personally i view thermal coal, LNG and other unconventional gas as good plays longer term. Copper, iron ore and coking coal will be the first commodities to experience dramatic price falls imo.

        Uranium (again imho) is a very good long term play, think 10 to 15 years.

        • I agree a diverse economic base a benefit, as I’ve said many times before, this boom buys time to develop or transition to a more sustainable model. Ideally with some resilience to fluctuating exchange rates and a broader geographical customer base.

    • You forgot to mention that the Chinese construction boom is underpinned by state dictate, financed by state banks. See that’s the beauty of the beijing con-sensus, if the state decides it wants more economic growth it simply commands the economy to grow more; build it and it will grow. We’re in a supercycle, a new normal, pop the champagne let the good times flow!

  2. Do You Feel Lucky Punk?

    And don’t forget that most other commodities are still substantially below their 2008 prices.

    So does that mean that at some point in the future if that scenario reversed you’d drop the iron ore tax and have e.g. a copper tax or zinc tax. And why no met coal tax? Or are you proposing taxes on all windfall prices but currently only iron ore is above your benchmark?

    • Dont forget the need for gold and soft comodities taxes when the comodity prices change.

      NZ dollar is high at the moment too (still about 1.20 to the aussie) but its primary export is SMP a manufactured dairy product.

      • Do You Feel Lucky Punk?

        Met coal is doing better than iron ore these days. Also should have added gas and oil into the mix since these are also non-renewables. It is conceivable that one day Woodside could be experiencing windfalls via gas.

        One would hope that benchmarks would be based on cash cost rather than historical prices but do you reckon anyone would be thinking along those lines CFB?

        • While we’re at it, we could share the love a bit and throw in a nice old fashioned “Window Tax”…. that oughta get things hoppin’

        • Dumb_Non_Economist

          DYFLP,

          The Intelligent Investor thinks it’s unlikely that Woodside will produce windfall profits from gas, Pluto, they is was 5b over budget and is the most expensive LNG plant ever built.

          Cut and pasted…..”Only at very high oil prices will Pluto make a satisfactory return. Even at current historically high prices, a rate of return in single digits is likely—a poor outcome for $15bn of capital expenditure and significant risk shouldered by shareholders. Woodside’s pledge to construct the project solo, and to assume all the risk, hasn’t paid off”.

          • Pluto overruns are the stuff of legend and then to top it off the malicious industrial action, rolling through a range of issues.

            Interesting to see what comes of Browse Basin/James Price Point.

            Little wonder Shell are opting for floating LNG.

          • Do You Feel Lucky Punk?

            DNE,

            Back in 2000 what did the intelligent investor think of BHPs chances of making windfall $ out of iron ore?

            My mentioning of Woodside was not a prediction, just that it is conceivable that its non renewable resource could trade at a premium one day. i.e. that the very high oil prices they refer to may some day exist.

      • Do You Feel Lucky Punk?

        CFB, he’s explained it several million times. You and I should pay more attention. 🙂

  3. No, no, NO, SWF

    It would only be wasted by the govt. We already have a SWF, it’s called Superannuation. There is no need to force people to invest, anybody on the planet can take part by buying shares in the company.

    • Do You Feel Lucky Punk?

      We could use the money to prop up the car industry 🙂

      On a related note, a couple of weeks ago I was walking down a Sydney street with a high profile economist and we came across a Tesla car parked on the street. HPE knew a bit about Tesla motors, gave me some info about the cars performance etc.

      I asked HPE why a Tesla motors never started up here and why the government would spend billions propping up the car industry instead of — given that it is locked in to picking winners — using it for innovation to foster growth industries. The reply would breach the comment rules.

      • The tesla car in australia had over $100k tax on it. In fact the tax on the tesla in australia was almost as much as the total sale price of the vehicle in america. That’s why only one ever came in.

        Greedy greedy government.

        On a similar point, the government subsidising our car industry, which predominantly produces large 6 and 8 cylinders cars, is effectivley taxing samller more efficient cars in order to subsidise the larger higher polluting shite that we put out locally.

        Stupid, stupid government.

        • Do You Feel Lucky Punk?

          $100K tax!! WTF!

          Did only one *really* come. i.e. was the one I saw the only one in the country?!

          So lets discourage the Tesla AND bail out big internal combustion AND impose a carbon tax. Fantastic thinkers we have in guvmint.

          • There was one imported privately before an importer was set up for australia. I don’t know if he’s allowed to drive that vehicle on the road. He wasn’t previously, and the only way he could drive it on public roads was in races, however he set a record for longest distance travelled by an electric car whilst competing in the world solar car challenge.

    • I agree, much better to allow the lions share of our non renewable wealth to go to overseas investors.
      What do we need the income for. It would just get squandered on stuff like hospitals, education, alternative energy, rail upgrades, roads, pensions, and other frivolous crap.

  4. In the mean time can now rescind some of the taxation breaks these companies have???
    What’s that fuel rebate worth these days?
    BHP RIO Xstrata still qualify for a fuel rebate? pffffffftt.

  5. A “…..” moment watching Bloomberg (or CNBC) late last night. Talking heads interviewing Marius Kloppers – to paraphrase:

    Interviewer: “How are you getting on with the huge tax the Austalians want on miners”

    Kloppers: “In its original form it has been modified so we will be paying a slightly lower amount of tax. We understand it will be passed through Parliament”

    Interviewers in discussion together: “Isn’t it funny how some of these governments around the world, when you’re doing well, want an even bigger piece of the pie, all these governments try it” general laughter and head shaking ensues between interviewers. Kloppers with a tight lipped half smile, says nothing.

    Kloppers: “Its very difficult when you have a very successful company” (inference – the demands)

    BHP is a global operation, profits derived from a number of geographic locations. Yes, iron ore was a star performer and Kloppers when questioned about the longevity of high ore prices stated that BHP was confident of these prices for the next 1,2,3 years before any moderation, primarily because Chinese ore was failing to meet internal demand expectations and continued infrastructure development in China.

    On a upbeat note, Kloppers was very positive about the WA iron ore operations and the $4.3 billion rapid expansion in that area.

    Any way, the government has negotiated the MRRT, is satisfied with that, have not heard anyone in this current government indicate any interest in a SWF – I think that will be the end of it.

    • It will if you have your way. Not if If I have mine.

      And, by the way, the standard anchor approach on Bloomberg as well as all other business TV is corporate and CEO worship. It is a closed loop, nothing more.

      I suggest you draw succor elsewhere.

      • Do You Feel Lucky Punk?

        “It will if you have your way. Not if If I have mine.”

        You haven’t even responded to questions about what non-renewables you would tax and under what conditions you would tax them. If you want to play imaginary dictator why not explain to punters what you actually would like to impose?

      • Surely the Federal defecit should be paid off before any government would even entertain the possibility of a SWF? No chance of that happening anytime soon. So seems nonsensical to be discussing a SWF at this point.

        • Do You Feel Lucky Punk?

          Not to mention the SWF vs current account surpluses and deficits debate which this bloke seems to have been silent on.

        • Why does debt have to be paid off first? Please explain.

          We already run a CAD and SWF so what’s to respond to?

          Also, I have explained several million times how I would tax. If you don’t want to read them that’s your problem. Don’t ascribe it to me.

          • Well mathematically and politically, I agree the defecit doesn’t have to be paid off first, but surely it should be, is all.
            Makes no sense for the govt to be paying interest on their debt, whilst pretending to save to a SWF.

          • Do You Feel Lucky Punk?

            CFB that link doesn’t cover the questions raised here about what resources to tax and at what cut off the tax gets imposed.

            In that link H&H never addressed any of the comments about SWF and the CAD.

            He said an objective of a SWF would be to “reverse flow of savings out of Aussie dollars to pressure the currency.” but never explained how that would happen.

            One mechanism would be to set up an aussie Fannie Mae to replace, in part, some of our foreign borrowings. I got no comment about whether or not that was what SWF advocates had in mind.

            …so that doesn’t appear to be the article where the answers can be found.

            H&H, my point was that an asset transfer is different to a tax (assuming that I am correct and the FF was created by an asset transfer. If it was not then the point is moot).

          • Dumb_Non_Economist

            DYFLP,

            If some of those assets or the seizing countries assets live somewhere like the US, yes you would have recourse through the US courts.

          • H&H

            If you’re so intent on fixing the exchange rate, why dont you want to do anything about the carry trade?

        • DYFLP has commented on this several times previous (resulting in a change view re SWF on my part) – have suggested a few times he do a guest post on the topic, hopefully…

          • Do You Feel Lucky Punk?

            It is H&Hs blog and he is a SWF advocate. I have contacted H&H about outlining the case against a SWF 4 times and received no reply.

        • Is there a restriction in the constitution to prevent a creation of a SWF before government debt is paid off?
          .
          No. I thought so – the sovereign is allowed by the law of the land to setup MRRT and fund a SWF.
          .
          As to sovereign risk, is it government’s fault that the miners didn’t read the constitution before they setup shop here?

          • “As to sovereign risk, is it government’s fault that the miners didn’t read the constitution before they setup shop here?”

            I can only assume this is a joke comment.

          • Joke eh? So is the term “sovereign risk” then.
            .
            Constitution is the ultimate law of the land. Sovereign powers are governed by the constitution.
            .
            If you have an opposing argument to that, say it out loud. (instead of calling it a joke).

          • LOL.. Somebody was complaining loudly about “vilification” of miners yesterday. Yet, vilification seems to be the refuge of choice when no rational arguments can be made.

          • Do You Feel Lucky Punk?

            Mav I should have added a smiley but in all seriousness …were you actually being serious about miners should have read the constitution?

            (admittedly extreme case to emphasize the point) If Venezuela permits the state to seize private assets is the sovereign risk nil because private owners should have know a Chavez could come along?

          • Mav, fair suck of the sauce bottle – there’s vilification (as demonstrated by many opposed to the resources sector and their lack of rational argument) and there’s a joke, your sovereign risk comment. It was funny!

          • From the above comments, can I infer that fanboy(s) have nothing of substance to say on the matter? 🙂

          • “If Venezuela permits the state to seize private assets is the sovereign risk nil because private owners should have know a Chavez could come along?”
            .
            Go talk to a constitutional lawyer specialising in Venezuelan constitution. If the constitution doesn’t bar it, there is F#@k all any multinational company can do about that if and when they seek redress in a court of law.

          • Do You Feel Lucky Punk?

            That is true but surely you cannot say that equates to no or little sovereign risk. It means very high sovereign risk.

          • So the miners were aware there Australia represents high sovereign risk BEFORE they setup shop here, and yet they did?

          • Sovereign risk has become the term applied and generally understood to include ‘country risk’. Actions by government that increase sovereign risk (country risk)including ad hoc changes to corporate investment framework that are detrimental to corporate investment activity have the potential to negatively impact future foreign investment. Not a situation most democratic capitalist countries would desire.

          • There is a milder example – Iceland told UK IceSave depositors to basically FO when they seized control of the Icelandic banks.
            .
            Now that is a clear case of sovereign risk to British depositors. The UK government then tried to freeze Iceland bank assets in Britain using some anti-terrorism law!!
            .
            But that proved a little too late and they are now argueing over the matter before some Euro court over whether it violates some multilateral agreements.
            .
            You can argue endlessly over the unfairness of it all. But the bottomline is that the law of the land did not bar Iceland from acting the way it did.

          • Or more colloquially – ideally a nation operates on the basis of a fair, reliable and level playing field, engendering trust in relationships, be they with other nations, corporations or individuals.

          • What is a fair, reliable and level playing field is ultimately decided by a court of law, which decides based on the constitution and any binding agreements that the sovereign may have with other nations, corporations or individuals.

          • Are you saying the majority population of Iceland are commies like me?
            .
            Thanks for the compliment. 🙂

  6. “Yes, every $1 move in the iron ore price is equivalent to $90 million profit”

    That’s likely to work to BHP’s disadvantage, now that stocks and commods have begun the next leg down of the bear market that start in 2007/08.

  7. “hey look, that guy is making money!! how do we get our hands on it?”

    that’s essentially the sum total of the argument for extra mining taxes.

    Its not a bad thing that one of our miners is making massive profits; it would be far worse for us if those profits had been relocated somewhere else (yes a company can pick up and relocate reasonably easily if they choose to).

    I still dont understand why this is thought to be a good thing…to fix a 2 speed economy, you devise ways of improving the slower-speed part of it, not handing to money stolen from the profitable part.

    yeah yeah yeah “but the miners are stealing our resources!”. Guess what, those resources are worthless without the capital of the miners being employed and the risk they take to get it to market. Extra taxes and money-grabbing increases the capital and risk side of the equation.

    • You can’t relocate iron ore deposits. And ours are hugely profitable so they won’t go anyway.

      There’s zero sovereign risk in changing taxes in a reasonable and well argued way.

      The problem with the RSPT was its Byzantine structure in which it used a rebate system to create a kind of 40% virtual ownership of resources that had already been leased.

      I argued at the time at BS that that was akin to appropriation and should be abandoned.

      But that doesn’t mean that no new taxes should be levied on the boom. Just that that structure was inappropriate.

      In fact, I would argue that the miners face increasing sovereign risk by not paying more tax.

      • H&H – to clarify in my mind – you consider the MRRT insufficient and desire amendment to the negotiated proposal; or you desire a further additional tax?

        • I think Saul Eslake’s formulation looks good:

          “Surely a better and simpler way of procuring for the Australian people as a whole a larger share of the value created by the exploitation of the finite resources of which they are the ultimate owners would be for the federal government to legislate that, for as long as the prices of prescribed minerals are above some level (such as their average in 2004-05), the tax rate paid by mining companies will be, say, 33 per cent, while (for example) the tax rate paid by other companies will be, say, 27 per cent. (This would be a mirror image of the income tax exemption which used to apply to gold mining companies from 1933 – another concession to WA – until 1991.)

          It might be necessary to apply some kind of grouping provision to prevent mining companies from diverting income into affiliated entities in order to avoid the higher rate of tax. But that would surely be simpler than the bureaucracy required to establish a brand-new tax – and probably less vulnerable to political criticism on that score as well.”

      • H&H agree with the rest of your argument, but our iron ore deposits are readily substitutable, and only have value whilst being mined.

          • You’re missing nothing HnH.
            Just check the atlas people, we are front and centre as first preference by the length of the straight.
            So we can command a premium for that happy circumstance.
            You know RIO n BHP did just that!

        • For instantanous production yes they are not able to be substituted. Over the time scale of a comodity cycle (or the investment horizion for a mine development) there are other options.

          On an instanatanous production basis just about every resource (mineral, labour and capital) is fixed.

          • Dumb_Non_Economist

            IMO one of the reasons BHP/RIO are against a resource tax is they know other countries will put their hand as was suggested in Brazil not long after the original proposal.

            In addition, sovereign risk. Was it not RIO that was fighting a push to take a large iron-ore deposit in Ghana and hand it to the Chinese around the time of the Hu Stern saga. Sovereign risk talk in this country is just pure [email protected]@t.

          • I think the sovereign risk issue discussed here was in the context of an additional tax being applied to the resources sector overall or to specific commodities; not that this of itself would necessarily constitute sovereign risk, but rather raises the spectre of sovereign risk issues if selectively, opportunistically or randomly applied into the future, as suited political whims.

          • Dumb_Non_Economist

            CFB,

            My comment was in response to a post by MAV, think I ended up in the wrong section!

            However, I’m not talking how the market views it, but for ME to talk sovereign risk re changes in tax where the price is booming etc is nothing but scare tactics, especially in a country where changes over the long term are mild and where miners get a good deal in general.

        • Some of the Indian states had banned iron ore exports. The ban was only recently lifted by the Supreme court.

    • “Its not a bad thing that one of our miners is making massive profits; it would be far worse for us if those profits had been relocated somewhere else (yes a company can pick up and relocate reasonably easily if they choose to).”

      The profits are being relocated. The company is 80% foreign owned.

      Also, they can relocate the company but they cannot relocate the mines.

  8. Seems like the only thing here to be gathered is that our state governments aren’t charging enough for the resources.

    We shouldn’t be trying to apply additional taxes or levies on it, just increase the cost we sell it for. Obviously BHP has a high enough margin they can take it…

    State governments use the extra money to fund their infrastructure projects. Fed government gets out of the game of intra-state infrastructure, reducing some doubling-up of government and increasing efficiency.

      • And agree again. The state government’s should co-ordinate their negotiations to make sure the people get a good price for what is a non-renewable resource.

      • littleguy the problem is more the reverse, state governments lower royalty rates to attract investment. In the same way they offer subsidies to other companies.

        The problem is that now through the redistribution of GST revenues the costs of doing so is shared with the other states, where as perviously much of it was born by increased local taxes.

        • That is why they should co-ordinate. To avoid the divide and conquer strategy of the miners.

          • This isn’t a divide and conquer strategy, the deposits / leases are fixed in location.

            This is weak state governments using federal subsidies to attract investment. The highest royalties generally are in the states with the most mining activity.

            What is needed is a commonwealth stance to stop picking up the bill for doing this.

            This is not only in mining, this is general behaviour for state governments – Think manufacturing, sports events, conferences, corporate offices. But given their current incentives it is logical behaviour.

          • So the system is flawed DD.. how do we fix it? Take royalty rights away from the states and put it under fed control?

            I have no problems with corporations making large profits but in this case it seems like we could be charging a lot more before we start to really eat into those margins…