BHP: The fossil fuels vs. future facing commodities debate

The BHP (ASX: BHP) we know today has changed dramatically over the past two years following its acquisition of Oz Minerals, the BHP Petroleum merger with Woodside Energy, and continued divestment of its coal assets.

However, resource companies in the fossil fuel space have some of the most profitable in recent times – Buoyed by higher prices, a demand imbalance and chronic underinvestment into new supply.

While the long-term prospects for future facing commodities are clear and well-documented, the near-term path has been a bumpy one. In this wire, we’ll take a closer look at BHP’s plans for the future, recent M&A, and a broker’s take on where the stock is headed.

“Meeting an accelerated energy transition”

“At BHP, we're focused on the resources the world needs to develop and decarbonise. Copper for renewable energy. Nickel for electric vehicles. Potash for sustainable farming. Iron ore and metallurgical coal for the steel needed for global infrastructure and the energy transition,” notes the company’s website.

But battery metals have not exactly been the most profitable space (ex-lithium). 

Let’s take a look at the earnings profile of BHP’s copper and nickel projects.

Copper (FY23):

• Production: 1,717kt, up 9% year-on-year

• Average realised price: US$3.75/lb, down 12%

• Underlying EBITDA: US $6.7bn, down 22%

• Escondida unit costs: US$1.40/lb, up 17%

• Spence unit costs: US$2.11/lb, up 24%

Nickel (FY23): 

•  Production: 80kt, up 4% year-on-year

• Average realised price: US$24,021/t, up 3%

• Underlying EBITDA, US$0.2bn, down 61%

• “Controllable cash costs increased by US$0.2 billion driven by inventory drawdowns to mitigate disruption caused by the heavy rain event at Mt Keith, unplanned outages and third-party ore delivery issues.”

What does the data tell us: Copper earnings fell 22%, far more than the 12% drop in average realised prices (and higher production). Likewise, nickel prices fell by almost two-thirds despite higher production and spot prices. This suggests the two divisions are facing a challenging combination of inflation, higher-than-expected capex and operational headwinds.

Selling more coal assets

In May 2022, BHP completed the sale of its 80% interest in BHP Mitsui Coal (BMC) to Stanmore Resources (ASX: SMR) for US$1.1 billion.

Stanmore Resources 5-year price chart (Source: Market Index)

And now progressing the sale of its Blackwater and Daunia metallurgical coal mines, which contributed to approximately 24.3% of Group metallurgical coal production in FY23. Its worth noting that the two mines produce some of the lowest-quality metallurgical coal within the BHP portfolio.

The company’s metallurgical coal division generated US$10.3 billion in revenue in FY23 or 15.7% of Group revenues. 

UBS retains a Sell rating

UBS reiterated a SELL rating for BHP and left its valuation unchanged at $36.00 ($45.68 open on Monday, 18 September) on a cautious view towards iron ore.

BHP 12-month price chart (Source: Market Index)

In terms of the Blackwater and Daunia divestment, the investment bank expects the assets to fetch US$1.7 billion (based on BHP’s 50% ownership) in gross sale proceeds, with net proceeds to go towards reducing the company’s net debt position (FY23: US$11.6bn).

“We flag upside risk to the sale price from higher assumed LT met coal prices, but equally point out recent history of coal assets transacting at discounts on ESG factors,” the analysts said.

This dynamic presents a conundrum where fossil fuels are trading at substantial discounts due to ESG factors while future-facing commodities are struggling to generate meaningful profits amid capex risks and operational challenges. 

So which side of the coin would you rather be on?