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Asian miners take on the old guard amid slump

Australia's Minerva coal mine

BANGKOK -- The commodities bust is reshaping the industry with mining companies from China, India and other developing nations on the rise as former leaders such as Anglo American and Freeport-McMoRan struggle to survive by selling assets at fire-sale prices.

In its annual Mine Report, released in June, consulting group PwC calculated that the world's top 40 mining companies by market valuation at the end of 2015 posted a collective loss of $27 billion for the first time in the survey's 13-year history.

"The market capitalization of the top 40 dropped 37% in 2015, a drop disproportionately greater than that in commodities prices," the report said. "Investors were concerned by liquidity and punished the top 40 for poor investment and capital management decisions and, in some quarters, for squandering the benefits of the boom."

Both Anglo American and Freeport-McMoRan tumbled out of the top 10 this year, while U.S.-based coal giant Peabody Energy -- now in bankruptcy protection -- also slipped down the rankings. In their place are Chinese groups. These include Zijin Mining Group at 13th place and new entrants Shaanxi Coal Industry and Sichuan Tianqi Lithium in 21st and 31st place, respectively. Indian companies, such as Indian Coal that is now number four on the list, are leading others in the developing world.

China is the world's largest consumer of mined commodities and in many cases the world's largest miner of commodities such as coal, gold and rare earths. As such, its government has been eager for many years to create companies that would rival the world's biggest.

Mining groups have been early movers in the country's strategy of outward expansion, as underscored by Aluminum Corporation of China's (Chinalco's) 2008 investment in Rio Tinto; China Minmetals Corp.'s $1 billion-plus takeover of Oz Minerals; and Yanzhou Coal Mining's purchase of Macarthur Coal at the crest of the boom. Yanzhou has fallen from 26th to 32nd place on the PwC top 40.

"This was my baby; I didn't want to do this ... it breaks my heart in a lot of ways," said Freeport-McMoRan CEO Richard Adkerson in May after his company sold its 56% stake in the Tenke Fungurume copper-cobalt mine in the Democratic Republic of the Congo for $2.6 billion to China Molybdenum. The Chinese company is also paying $1.5 billion for Anglo American's Brazilian niobium and phosphates business.

Financial constraints

Yet, there is little room left for expansion, with the combined market capitalization for the top 40 reaching its peak in 2010 and exceeding the combined book value by 65%, or more than $1 trillion, according to PwC. By the end of 2015, this gap had shrunk to just $18 billion, or 4%. Essentially, mining companies were paying the price of a "lack of capital discipline," PwC said.

So it is only logical, as the mining cycle founders, that megadeals to improve market share are no longer in vogue -- balance sheets cannot support them and banks prefer to finance other sectors such as technology, healthcare and logistics.

At its 2007 peak, consultancy EY estimated that there was more than $200 billion in potential deals in the mining sector, with a small number of proposed deals at the time valued well in excess of $70 billion. It was this frenzy of debt-fueled deal-making that exposed so many miners to a downturn whose severity has been merciless.

Yet the world's best managed miners are cautiously beginning to reinvest. Anglo-Australian miner Rio Tinto, the world's second biggest mining group, signed off on the long awaited $5.3 billion expansion of its Mongolian Oyu Tolgoi copper mine in April.

That same month, the world's largest mining company, BHP Billiton whose regular shares like Rio's are quoted in Sydney and London, recently unveiled plans to invest $12 billion Australian dollars ($9 billion) during 2016 and 2017 to expand its copper mines in Chile and South Australia's Olympic Dam as well as its Australian iron ore mines.

Switzerland's Glencore, forced by a sudden collapse in its share price last year, has conducted asset sales and debt restructuring to halt the decline in market capitalization, while partnering with Asian groups in recent bids.

BHP and Rio have been able to retain their top spots in the PwC index, along with the third-ranked China Shenhua Energy Co., the vertically integrated coal giant that owns mines, chemical plants, transportation and power stations.

Volatile markets

Mined commodities markets remain volatile. There was an unexpectedly strong rebound in prices in March and April, on the back of a fresh round of multi-billion dollar stimulus from Beijing. But recently, Chinese policymakers have signaled a shift back toward reform rather than stimulus, which has "seen commodities markets drift lower," analysts at UBS noted.

Iron ore has fallen from almost $70 per metric ton in April to $53.40 on July 1 on Platt's The Steel Index and copper has fallen from a high of almost $5,100 per metric ton in March to close at $4,798 on June 28 on the London Metals Exchange, close to its two-month high. But analysts believe ore and other base metals would remain range bound for some time as rising inventories balance an uptick in Chinese demand

UBS reflected the market consensus in forecasting that prices for most minerals and metals will head lower in the second half of the year.

"After a strong start to the year, dark clouds are appearing on the horizon for commodities markets," according to an ANZ Research note published on June 16, adding that the gloom was coming after stronger-than-expected growth in industrial activity in China earlier this year.

At the same time, markets have turned volatile after the U.K. voted to leave the European Union on June 23. Gold is the only commodity to have significantly gained from the U.K.'s Brexit decision. Economists also said that the global fallout from Brexit is likely to spur the U.S. Federal Reserve to delay any interest rate hike.

It is in this environment that counter-cyclical investment can be effective in consolidating the position of miners able to undertake such investments in particular commodity markets.

This time, big mining companies have made it clear they are carefully selecting the assets and commodities in which they investing. Brownfield developments -- the extension of existing mines -- are the main focus rather than the relatively more expensive and risky "greenfield" mines.

Conservative strategy

This is the strategy both BHP and Rio are using as they continue to increase iron ore production in Australia's remote Pilbara region. It is also the logic behind Rio's fresh investment in Oyu Tolgoi, having done the hard work of creating a major mine in the extremely inhospitable condition of the Gobi desert as well as finally completing years-long negotiations with a series of Mongolian governments prone to tinkering with foreign investment rules.

Rio's other major investment, now underway, is the $1.9 billion Amrun bauxite mine in Queensland, Australia, approved in November 2015.

At a Bank of America Merrill Lynch conference in May, Chris Lynch, Rio Tinto's chief financial officer, said the company was only targeting investments with an internal rate of return in excess of 15%.

Along with state-backed Chinese miners, the big Australian companies are among the few well-managed ones to consolidate their position at the top through a cautious return to capital investment, while dozens of other big mining companies are struggling just to remain afloat.

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