Rio Tinto and other miners have been facing tough questions from shareholders over ever larger and more capital intensive projects at a time when robust commodity prices have cooled. The top mining stocks have had a troubled few weeks, with the UK-listed sector sliding by almost a fifth between the start of February and mid-April and valuations languishing at almost half their 10-year average, hit by concerns over cooling demand and the cost of an organic growth pipeline totalling some $180 billion.
“Shareholders are desperately concerned about capex inflation. Capex inflation without a concomitant increase in the underlying price of the commodity is not good and at the moment we are seeing commodity prices flat to down,” an analyst in London said. “Every time you spend an extra billion, it is an extra billion that isn’t there for potential dividends and the average return on the investment goes down.”
Rio has been in the spotlight overrising costs at Oyu Tolgoi, a project it controls through its majority stake in Ivanhoe Mines. A 513-page technical report – recently published by Ivanhoe but not publicised or officially endorsed by Rio – put the capital costs for one of the industry’s most anticipated greenfield projects at $13.2 billion, up from $9.55 billion. Costs for both the initial phase and the mine’s expansion have risen, with the cost for expansion more than doubling to $5.1 billion. The news hit Ivanhoe shares, but Rio analysts and investors are more sanguine, given the scale of Rio’s investment to date.
GOOD CAPEX?
The soaring cost of producing an ounce of gold or a tonne of iron ore has been the reverse side of the commodity boom, with the rising cost of labour, materials and power denting profits. However, analysts say both Rio and larger rival BHP Billiton have signalled they are listening to shareholder concerns over capex and cost escalation and could phase or stage their spending – for BHP that would mostly affect its US shale gas plans, while for Rio it could mean slower growth in Simandou, Guinea while it focuses on Australian iron ore.
Rio has a projected capital investment of some $20 billion to expand iron ore operations inthe Pilbara region of Western Australia from 220 million tons to 353 million tons by 2015.
BHP, meanwhile, has told shareholders it will be “living within its means”, partly in answer to worries that its four major projects – the Olympic Dam expansion and the Outer Harbour iron ore project in Australia, U.S shale gas growth and the Jansen potash project in Canada -- would mean frenzied spending. The four “mega projects” will require more than $120 billion of capex over the next 15 years but only increase returns from 2023, according to Deutsche Bank estimates.
“You have got to be certain that the quality of the assets you have is really good and that they are going to earn good long-term returns over 20, 30 years. You have to have the capability and the confidence to keep investing through all cycles, all the way through,” said James Laing, deputy head of UK and European Equities at Aberdeen Asset Managers, a top 10 investor in Rio and BHP. “There’s a element of trust and the fact that prices are good at the moment, and these projects stack up quite nicely. When they make these capex plans, they do ask themselves that if prices came back 25% or 50%, will these projects still be viable?”