This year has been a terrible year to be in the commodity business. The prices of oil, iron ore, copper, gold, silver, coal, platinum and natural gas have all collapsed.
Moreover, of the 24 major traded commodities, only palladium, coffee and cattle have outperformed a risk-free 30-year bond year-to-date. And for miners likeBHP Billiton(LSE: BLT) times are tough.
As the worlds largest diversified miner, BHP is generally regarded as one of commodity sectors better picks. The company has built itself around a four pillars strategy, whereby the group has concentrated its efforts on mining for key commodities iron ore, oil, coal and copper. A fifth pillar, potash has been talked about by management but it seems as if, for the time being at least, the development of this pillar is on hold.
In theory, the four pillars strategy should protect BHP from losses if the price of one commodity falls. But as the prices of coal, iron ore, oil and copper all slide at once, BHP is facing the perfect storm and things could be about to get a lot worse for the company.
Year-to-date the price of iron ore has fallen by more than 40%, the price of oil has fallen more than 30%, copper has fallen 15% and the price of coal has declined by around 20%.
Its difficult to try a put a figure on how much these declines have cost BHP. City analysts have estimated that the falling iron ore price has cost BHP around $8bn in potential profit. Moreover, the companys oil division is still burning through around $4bn in cash per year, although its possible this cash burn could have increased now the price of oil has slumped.
BHPs oil business is focused on the US shale sector. The company has spent $20bn over the past few years to build its presence within the sector and expects its assets to be cash flow positive by 2016.
However, it remains to be seen if this forecast will hold true. Indeed, City analysts believe that with WTI oil trading below $70 per barrel, many some shale oil developments are now unprofitable.
Still, BHPs shale oil production is expected to increase by 50% next year and is expected to hit 200,000 barrels per day by 2017, up from around 125,000 bbl/d during the three months to September. Economies of scale should push BHPs cost of production down, which will increase the producers margins, as long as the price of oil doesnt decline further.
So, BHPs iron ore profitability is evaporating, the companys petroleum division may take longer than expected to generate a profit and income from the groups copper and coal divisions is sliding.
Then theres the value of BHPs assets to consider, many of which were acquired at premium prices during the middle of the commodity boom. As a result, some analysts have begun to speculate that writedowns could be on the cards as asset values fall. Additionally, the companys debt, built up over the past few years could prove to be a burden as income from operations fails to cover capital spending and debt repayment costs.
All in all, things are not looking good for BHP in the near-term.
Nevertheless, as the worlds largest diversified miner,BHP can afford to ride out a weak market for some time. For long-term buy and forget investors, the miner remains agreat pick.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.