Cost Pressures Loom Over Miners As Revenue Slows In 2014-15

By Glenn Dyer | More Articles by Glenn Dyer

If you have thought that times can’t get any tougher in the resources sector, then 2014-15 holds out the prospect of an intensification of the pressures on costs and operations, especially in the huge iron ore sector.

Further mine closures and production cuts have been forecast by the Federal Government’s main resource forecaster across the sector.

Don’t be surprised if some marginal iron ore miners cut production or even stop mining if the global price remains well under $US90 a tonne, as it could very well do for periods in the next 12 months.

In other words, miners large and small will be forced to get tougher on costs than they have been over the past 18 months – slashing jobs (as reports this week suggest with BHP said to be looking at sacking 3,000 from its permanent and contracting staffs in iron ore) and cutting back spending wherever they can.

We already have had a spate of mine closures (especially in thermal coal), job losses (in every sector) and the dramatic damage done to the services companies in resources (job losses and at least one major collapse in Forge) with contracts cancelled, curtailed or dropped.

Aurizon’s third major revamp in eight months revealed this week and rival Asciano’s reported decision last week to cut 500 jobs in its businesses, especially rail is the start of the next round of cuts.

And the toughest area will be in iron ore where the boom times peaked in the first quarter of this year and are going to slow as revenues come under pressure.

As we reported yesterday the outlook for iron ore will go well and truly off the boil in 2014-15, unless there’s a significant fall in the value of the Aussie dollar.

From the macro, economy wide point of view, that’s not good news – despite what some economists might argue about the mining industry not being very big relative to the rest of the economy – it is the major driver of exports, and generator of national income.

And for that reason, with drought (El Nino) stalking the rural sector, and the high dollar still hurting the export of manufactures, mining will still be the big driver of export income in 2014-15. But the increase won’t be much – an extra $5 billion or so according to BREE (the Bureau of Resource and Energy Economics).

And nearly half that increase will come from iron ore, with much of the rest coming from LNG and other oil products, and falls for some other mineral exports such as thermal coal.

Income from iron ore exports are forecast to rise to just over $76.4 billion, from an estimated $74 billion in the year to next Tuesday June 30. That $3 billion or so in extra income is how much our big miners and will have to play with in 2014-15 – so to generate higher cash flows and try and protect profit margins, more cost cuts, including fewer jobs will be needed.

The need for the resource sector to be tough on costs was recognised in the statement accompanying BREE’s report yesterday. It is a big hint for investors as they examine their resource investments for the coming financial year.

“Looking forward, price pressures will continue to impact of domestic producers in 2014-15 with falling commodity prices and a persistently strong dollar impacting on export values.

"This will draw a sharp focus towards managing costs and enhancing productivity in the sector," BREE said.

"Throughout 2013–14 Australian mineral and energy commodity producers have been challenged by declining commodity prices.

"Although world consumption of almost all mineral and energy commodities has increased, substantial increases in supplies have put pressure on most suppliers to cut prices to remain competitive in international markets.

"Most commodity markets are now well supplied and still undergoing a shakeout that is forcing the highest cost suppliers to exit the market.

"Australian producers are not immune from this and there have been several mines, notably in the coal industry, that have been forced to close in the past twelve months. Further closures and production curtailments are expected in the next year.

"Even though Australian producers have been successful in delivering productivity and cost reduction programs they still find themselves at the wrong end of the cost curve.

"In some cases, the cost reductions of Australian producers have been negated by the stubbornly high Australia dollar which has appreciated since the start of 2014 while the currencies of competitors have depreciated," BREE said.

In other words Australia and the resources sector can’t put its trust in the Australian dollar to save the industry and the sector in the coming year.

It’s a curse of the AAA credit rating and the continued search for yield by big global investors trying to offset the impact of quantitative easing on returns in the US, Japan and across Europe.

A drop in the dollar might resume sometime in the second half of calendar 2015 when and if the US Federal Reserve starts inching its key interest rate higher, but that remains a big ‘if’.

So the message from BREE and the mining industry for the next financial year is ‘don’t expect miracles’ and hunker down to ride out what could be some tough news stories on mine closures and job cuts.

One casualty of the tougher times ahead might be the abandonment of capital management measures by BHP and Rio Tinto, according to Macquarie.

“The most pertinent question is whether Rio will be bold enough to proceed with a much-mooted share buyback in early 2015 if iron ore ends 2014 on a weak note,” Macquarie analyst Jeff Largey wrote in this week in a report.

But he said “A weaker-than-expected iron ore price and a share buyback may limit future funding flexibility.

"If the price of iron ore averages below $US100 a ton this year, as it has been for much of the past six weeks or so, the Macquarie analyst said BHP and Rio “may struggle to justify a share buyback program and expect to meet credit metrics," Largey wrote.

But the price recovers towards Macquarie’s $US108 estimate, buybacks could still come from both companies.

Other analysts are forecasting a rise in dividend payout from BHP when it revealed its full year profit in August.

And keep a watch on the Western Australian and Queensland economies – they are the most exposed. WA’s 2014-15 budget is based on a high iron ore price well above the BREE forecast. WA has spent its royalty gains, not saved them.

The same applies to Queensland where higher royalties on coal were introduced to ruin the mining tax for the then Federal Government.

Those taxes are now too high for global thermal and coking coal prices and the government will be under pressure to cut or defer them or face more mine closures and job losses.

About Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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