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BHP’s Olympic growth still financially challenged

It always comes as a shock to see just how uncompetitive Olympic Dam actually sits on the slate of BHP Billiton’s globe of present and future mines.

Presently Olympic Dam makes a 1 per cent return on capital and it will take a whole lot of hard core tweaking of men and machinery between now and 2022 to lift that return to a comparatively more acceptable 6 per cent.

And if that sub-cost of capital rate of return is not telling enough of the long-dated struggle to generate competitive levels of wealth from South Australia’s legendary copper, uranium and gold mine, then look to the value that is being generated by some of the other assets that BHP highlighted in Tuesday long-awaited Minerals Australia investor briefing.

For example, the next five years of asset optimisation in BHP’s infrastructure suite in the Pilbara is expected to see returns surge from 26 per cent this year to circa 40 per cent in FY22. BHP expects its twin Queensland coal businesses to be generating that same rate of return, but its journey is made more spectacular because it starts from a lower point. Queensland coal generates a 23 per cent return on capital employed.

Even the present and future return profile of the single asset BHP NSW energy coal also leaves Olympic Dam sitting at the starting post. The Mount Arthur thermal coal mine (the nation’s single biggest coal project) presently offers BHP’s owners a 22 per cent return on funds employed and that will rise to 30 per cent over the next five years as truck and wash plant productivity improves incrementally, a presently retired but shallow pit is re-started and as output creeps from the current 18 million tonnes a year to about 22 million tonnes.

Through pretty much the entirety of its 25 years of production, Olympic Dam has geologically flattered only to financially deceive. It has operated at nameplate production (circa 205,000 tonnes) maybe twice over its nearly 30 years of hard core digging. And yet, the siren song of the massive copper, uranium, gold and silver continues to lure team after technical team to reflect on the best way to expand Galwer Craton’s biggest beast.

BHP earned stewardship of Olympic Dam in 2006 through its bold and successful $9.2 billion bid for WMC. The underperforming South Australian giant was the jewel in a slightly tarnished but richly studded crown. And pretty much ever since we have been hearing about plans to build production to a level more appropriate to the size of its latent resource. Until early 2012 the thinking on Olympic Dam was very big indeed.

The long-baked plan was to spend up to $US6 billion and five or so years digging a massive open cut over the rich core of the southern part of Olympic Dam’s copper resource and progressively invest up to $US20 billion more on building capacity enough to export 600,000 tonnes of metal and copper-uranium concentrates.

But that plan collapsed under the weight of a busted resources boom that saw BHP endure a cash flow squeeze as BHP continued to roll out a rich suite of growth options as commodities prices and company income contracted.

Confirmation five years ago that the big pit would never happen brought a South Australian premier to tears and left BHP looking for new ways to generate more value from Olympic Dam’s complicated potential.

Back then, the bloke with high level carriage of the Olympic Dam project was non-ferrous minerals boss Andrew Mackenzie. We know he remains as personally committed to the most value-effective stewardship of the South Australia’s most remarkable mineral deposit as he was back then.

But it does feel like a whole lot of slightly different plans to grow Olympic Dam have come and gone and come again since 2012. To some degree, the perception that the project’s future shape is a constantly moving feast reflects the centrality of BHP’s mine to South Australia’s economic vision of itself. Olympic Dam has ever grown up in public. And since crushing a premier’s hopes in 2012, BHP has proved  steadfastly transparent about its options.

On Tuesday BHP presented the latest evolution of its planning with Olympic Dam boss and Big Thinking advertising star, Jacqui McGill, offering detail on the three-step plan to lift production to 330,000 tonnes by 2023 and reiterating the potential for a longer-term growth target of up to 500,000 tonnes.

The first phase of the McGill narrative is already in paradoxical progress. Production has been curtailed since August to allow a refit of the copper smelter and concerted maintenance of the rest of the mine’s processing infrastructure. This restoration campaign is closing and production is expected to ramp up through December. Given all goes to plan, the mine is expected to sustainably increase production to 215,000 tonnes through 2018 and then lift that to 230,000 tonnes through maybe 2021 as the mining moves into the sweetest spots of the southern mine area.

From there a $US2.1 billion two-step called BFX (Brownfields Expansion) will likely kick-in. The idea is to coincidentally lift mine production and ore quality along while delivery upgrades to smelter and refinery capacity enough to swiftly lift copper equivalent output to a 280,000tpa run rate in FY22 and then 330,000 tonnes in FY23.

After that, deep breaths will be taken and management will be able to more keenly assess the economics of taking the next big step up to the 450,000 tonne and beyond mark that would see Olympic Dam really register on the list of the world’s more important copper producers.

That just having an informed big think about that end-game expansion project is a “ways off”, BHP Minerals Australia boss Mike Henry advised on Tuesday. Henry assessed that 75-80 per cent of the thinking time of the Olympic Dam project teams would be consumed by BFX and attempting to assure its progress when it is delivered for board appraisal some time in FY19.

“BFX buys time and does so by adding value,” Henry said. “The bigger decision can then be made on ODEP (Olympic Dam Expansion Project). But we are taking the sweet parts of the Southern Mining Area out of ODEP to fill BFX, so that negatively impacts the economics of ODEP,” he observed.

The “best parts” that Henry was talking to is the richest sweep of the Southern Mining Area. That is a zone boasting an estimated 12 million tonnes of ore with grades of 3 per cent-plus copper. After accounting for the uranium, gold and silver credits, that increases to copper equivalent grades of 4.2 per cent.

The economics of the BFX project have been transformed by the decision to bring forward extraction of this sweet spot. McGill asserted that the $US2.1 billion investment would be highly competitive given its promise of an internal rate of return  of better than 20 per cent and of pushing Olympic Dam to the bottom quartile of global copper’s production cost curve.

But, for all that, the holistic return numbers still look underwhelming. According to the modelling presented on Tuesday, the move to 330,000 tonnes through clever and targeted mining and full optimisation of processing latency would end up generating a return on capital employed of something less than 14 per cent based on consensus copper price forecasts.

Harbour before horse

We have read that Harbour Energy “had planned” to meet with the South Australian government last week to discuss its possible $11 billion or so pitch for Santos. Now, I am not sure why we read that. Because, as it turns out, it is not right.

It remains uncertain yet whether or not Harbour will deliver on plans to engineer a pre-Christmas bid for Santos. Should behind the scenes scheming translate into visible market action, then doubtless Harbour will sit down with the leadership of what could prove its most problematic government constituency.

There is one twist to this deal that sits far more certain though. No matter what happens from here on, Harbour Energy is going to get one or more major shareholders. According to reports in October, the financially destitute Noble Group owns 75 per cent of the equity in Harbour, which might explain why the Hong Kong’s group’s former chairman and founder, Richard Elman, is on the US petroleum investor’s board of directors.

Noble has been selling everything of value to keep its banking wolves at bay and it has been made plain that the Harbour stake sits among the non-core assets. From what we hear, one or  more of the financiers of Harbour Santos musing is going to end up owning a Noble position that has a book value of $US42 million, but is estimated to be worth $US450 million and more based on two related party Harbour transactions over the past 18 months.

Source: Financial Review

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