BHP : economic and commodity outlook

Six months ago, at the time of our half year results for the 2020 financial year, we had little conception of the size of the shock that was about to shiver the foundations of the world economy.

The result has been an extremely challenging demand, supply and price environment for many of our key commodities.1

For the 12 months ahead, we assess that weighted directional risks to prices across our diversified portfolio are mixed, albeit with the worst of the physical demand shock from COVID-19 hopefully behind us. How the likely re-emergence of COVID-19 outbreaks are managed by major societies is the main source of uncertainty in the outlook.

Within that portfolio wide judgement, we expect iron ore prices to ease from the spot levels observed at the time of writing, with considerable two-way volatility in prospect. Metallurgical coal still has to navigate a difficult period as major importing regions manage their re-openings in the first half of financial year 2021. COVID-19 permitting, sustained improvement is possible in the second half of the financial year.

Oil and copper prices are both highly susceptible to swings in global policy and economic uncertainty. Aside from this common trait, the fundamentals of the two commodities under COVID-19 have been very distinct.

Oil has suffered through a calamitous demand collapse, with the downdraft in pricing that this created only forestalled by a combination of very large withdrawals of supply and the partial normalisation of terrestrial mobility conditions. Copper demand has been much more resilient, reflecting the nature of its end-uses and its greater exposure to China’s recovery. Coupled with profound COVID-19 related difficulties on the supply side of the industry, this has enabled copper prices to recover quickly from the trough they initially fell into amidst the financial panic of March.

The over-riding caveat for all of our commentary is that while we hope that the COVID-19outbreak is speedily contained everywhere that the first wave is still extant, and that elsewhere all subsequent waves are managed without a major impact on societal well-being, it would be unwise to be adamant about these matters. While we are all forced to live with these unknowns, there will be an uncertainty discount in the risk appetite of households and businesses. The impact this will have on real world decision making will constrain the global economy from running on all cylinders.

Looking beyond the immediate picture to the medium-term, we continue to see the need for additional supply, both new and replacement, to be induced across most of the sectors in which we operate: notwithstanding the reality that COVID-19 has significantly lowered the starting point for demand across most of our exposures.

In many cases, this could require higher-cost supply to enter the cost curve.

In isolation, the demand shock associated with COVID-19, some aspects of which can be reasonably expected to endure beyond the immediate horizon, is likely to delay the rational timing of such entries by a number of years versus pre-COVID estimates. This timing must then be adjusted based on the expected duration and scale of the direct and indirect impacts of COVID-19 on the supply landscape in each industry.

The combined impact of these factors could well delay the onset of inducement pricing in some industries but at this very early stage we do not feel that inducement prices themselves are in need of substantial revision.

COVID-19 has altered many things but it does not alter geology or define the frontier of operational efficiency in each commodity sector. Besides demand, these are the two most critical factors for identifying marginal sources of long run supply.

The projected steepening of some industry cost curves that we project, albeit delayed from prior expectations, can reasonably be expected to reward disciplined owner-operators with higher quality assets.

In the medium and long term, on the demand side, we continue to see emerging Asia as an opportunity rich region. China, India, ASEAN and the multi-decadal impact of China’s Belt and Road initiative are all expected to provide additional demand for our products.

As the true costs of a partial retreat from economic openness and a lack of climate action are progressively recognised, we anticipate a popular mandate for a more open international trading environment will eventually re-emerge, along with a concerted effort to confront climate change as a basic imperative.

We note that the younger generations that will define our future – both Millennials and Generation Z – are not only more concerned about a lack of action on climate change than their elders in both East and West, they are also more favourably disposed towards globalisation.2

On that uplifting note, we confidently state that the basic elements of our positive long-term view remain in place.

Population growth and rising living standards are likely to drive demand for energy, metals and fertilisers for decades to come.

We firmly believe that our industry needs to grow in order to build a better, Paris-aligned world.3

New centres of traditional demand will emerge where the twin levers of industrialisation and urbanisation are still developing today. Investment that seeks to adapt to, insure against and mitigate the impacts of climate change may eventually rise to become a material element of demand for parts of our portfolio. The electrification of transport and the decarbonisation of stationary power are expected to progress rapidly, as will the desire to tackle harder-to-abate emissions elsewhere in the energy, industrial and land-use systems. Comprehensive stewardship of the biosphere and ethical end-to-end supply chains will become even more important for earning and retaining community and investor trust.

The ability to provide and demonstrate social value to our operational and customer communities is both a core enabler of our strategy and a source of competitive advantage.

Against that backdrop, we are confident we have the right assets in the right commodities in the right jurisdictions, with attractive optionality, with demand diversified by end-use sector and geography, allied to the right social value proposition.

Even so, we remain alert to opportunities to expand our suite of options in attractive commodities that will perform well in the world we face today, and will remain resilient to, or prosper in, the uncertain world we will face tomorrow.

Source: Marketscreener

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