FIGURE 1: PERFORMANCE OF DIVERSIFIED MAJORS
Description: Figure 1 highlights the performance of the mining industry year-to-date (x-axis) and the performance of the 11 months prior to February 2015.
Shares of major diversified mining companies were down on average 5% since the beginning of the year. So far the mining industry has lost US$ 1.4 trillion of shareholder value. Its like losing the total market value of Apple, Google, and ExxonMobil combined. Having spent nearly a decade of building mines from the Andean mountains to the West African jungle, it’s only bad news when your largest customer, China, is going through a downturn. Investors have been unforgiving and concerns that it will only get worse has pushed mining stocks to new lows.
Anglo American, worth almost US$ 73 billion in 2008, is now valued at US$ 6 billion. The 99-year-old company, which is the world’s biggest diamond and platinum producer and owns some of the best copper and coal mines, is now worth less than mid-tier Randgold Resources Ltd. In order to shore up its balance sheet, Anglo American Chief Executive Officer, Mark Cutifani unveiled a new plan of selling its coal, iron ore, and other assets. The company has no choice but to restructure – its debt was downgraded to junk by Moody’s. But Anglo’s path to this fate was its own doing. It was slow to spot the significance of China’s rapid economic growth and the demand for commodities it would unleash. Its steady, slow-moving culture left it stranded behind rivals.
Anglo isn’t the only one facing financial stress amid the commodities crisis. Glencore is now selling assets to reduce debt. Rio Tinto has cut its dividend after making heavy losses and BHP Billiton is likely to follow. Rio Tinto Group CEO, Sam Walsh, is preparing for a tough year and predicts that the distress from the commodities rout will spread from small mine operators to industry majors, forcing some to sell desirable assets and creating opportunities for others.
Gold, this year’s best performing commodity, is giving miners some hope. Its safe-haven status makes it immune to many of the forces that have weighed on industrial metals and bulk commodities. These kind of fortune shifting opportunities only come around once in every 20-25 years. Prices are strong and the time for mergers and acquisitions in gold is ripe. Private equity groups are circling and the value of private-equity deals is expected to rise this year. X2 Resources, the private-equity firm founded by former Xstrata Ltd. chief Mick Davis, is among companies considering a bid for Anglo American Plc’s Brazilian niobium and phosphate assets. Anglo hired Goldman Sachs Group Inc. and Morgan Stanley to sell the assets as a package valued at $1 billion.
As the saying goes, when you find yourself in a hole, stop digging. A simple lesson that arguably has bypassed a mining industry. It will inevitably take time for supply and demand to rebalance, especially where commodities have been in oversupply. It will also take some time to address the debt burden in many companies. Some of these companies may not survive if they’re unable to meet the Capex / Opex they need to generate sufficient cash flow to service their debt – but this may bring the change the industry needs.
Shares of Anglo American were up 68% year-to-date. The stock has fluctuated wildly in recent weeks and has fallen more than two-thirds over the past 12 months. Anglo American reported a pre-tax loss of US$ 5.5 billion for 2015 as sinking commodity prices affected the mining giant. That was more than double the reported loss in 2014. Presented with one of the most significant challenges, CEO Mark Cutifani is planning to sell assets worth US$ 3 billion to US$ 4 billion to clean up its balance sheet. The disposals would include Kumba Iron Ore, South Africa’s biggest miner of the steelmaking ingredient. Anglo intends to sell its coal mining assets as well. Joining other mining players such as Rio Tinto, Glencore, and Vale, Anglo American is also suspending its dividend to conserve cash. The 2015 earnings results were better than expected but many analysts nevertheless said the underlying performance was not impressive.
Oil & Gas:
FIGURE 2: PERFORMANCE OF OIL AND GAS MAJORS
Description: Figure 1 highlights the performance of the oil and gas industry year-to-date (x-axis) and the performance of the 11 months prior to February 2016.
Brent Crude and WTI Crude prices are down 8 % and 10 %, respectively, since the beginning of year. The oil & gas sector has come under considerable pressure over the past 18 months as the price of oil dropped more than 70% from a high of $110 a barrel at the end of 2014. The lower price sent a tidal wave through the industry – since more than $100 billion has been slashed from expenses and the operations of an estimated 1,000 oil rigs have been suspended. Few Wall Street firms saw the oil glut that has caused prices to collapse coming. Goldman Sachs infamously predicted in 2008 that an oil shortage would cause the commodity to skyrocket to $200 a barrel.
But doom-and-gloom was all the rage in January as price estimates kept falling. It had gotten so bad that investment banks were practically falling over themselves to predict just how low crude will go. Morgan Stanley had warned that super strong US dollar would drive oil to US$20 a barrel, RBS predicted US$16 was on the horizon, and Standard Chartered thinking those predictions weren’t dark enough, suggested prices could go as low as US$10 a barrel. However, as evidenced, it’s notoriously difficult to predict when oil prices will rise and fall. It’s not a one-way price movement anymore and we continue to see a period of high volatility.
Meanwhile, reeling from the drop in the oil prices, world’s biggest oil companies posted earnings that showed that the industry was going through the biggest downturn since the 1990’s. BP, ExxonMobil, Chevron, and Royal Dutch Shell, slashed capital spending and announced reductions in staff. While the cost cutting has been brutal for the big oil giants, it’s been even more difficult for smaller oil firms. Forty oil and gas companies have filed for bankruptcy protection.
Now nearly halfway through February, oil prices have been risen more than 14 % over the last three days after a plan by Saudi Arabia and Russia, endorsed without commitment from Iran, to freeze oil output at January’s highs. The Saudi-Russian production freeze plan, also joined by Qatar and Venezuela, is the first such deal in 15 years between OPEC and non-OPEC members. However, there is a bigger story behind the agreement. Saudi Arabia has revealed that it can no longer unequivocally play the role of “central banker” of oil prices. U.S. shale oil production has permanently changed the rules of the game. The oil price war has failed to put U.S. shale out of business. And, it will not succeed because large energy companies, hedge funds, and private equity groups will buy distressed U.S. shale producers. The bottom line is that U.S. shale is now the monitor of oil prices. When the oil price pushes past $50, U.S. shale operators will start producing again. Thus, if the new agreement succeeds in raising oil prices to $50, then shale production will kick in again halting the price rise.
Shares of Chesapeake Energy are down 62% since the beginning of year compared to the broader market which was down 5%. Chesapeake’s CEO, Robert Lawler, is not in an enviable position. Worries about Chesapeake Energy’s burdened balance sheet have come to the foreground last week when the company’s market valuation plummeted ~50%. Just a week ago Standard & Poor’s also downgraded Chesapeake Energy’s corporate credit from ‘CCC+’ to ‘CCC’ with a negative outlook, adding to investors’ worries that the highly levered energy company won’t be able to ride out the downturn. The natural gas driller has a $500 million note coming due in March, but should have no problem coming up with the cash to repay the debt. At the end of the September quarter Chesapeake’s balance sheet showed $1.76 billion in cash and cash equivalents and the company has access to a $4 billion credit facility. The shale oil and gas boom in the United States is effectively over since low energy prices have made drilling uneconomical. Chesapeake Energy’s fortune hinges on a sizable rebound in commodity prices. But with prices showing not the slightest signs of a fundamental recovery, investors have been taking their chances and betting on the company’s failure.