$20 bn Olympic Dam mine project: Too big to dig?

LONDON,: Once again BHP Billiton has spoken and the world has listened.
Back in March a comment from Ian Ashby, then head of the resource giant’s iron ore division, about flattening steel growth rates in China caused a brief global risk-asset sell-off.
Last week’s announcement it was pulling $ 40 billion of investments caused an even greater panic, not least in Australia, the location of both “mega projects” in question.
The deferral of the Olympic Dam copper mine expansion and the Outer Harbor iron ore project has unleashed a torrent of anguished debate about the end of Australia’s mining boom in particular and the end of the “supercycle” commodity boom in general.
But is this really what BHP Billiton said?
Well, much depends on what you thought the commodities “supercycle” meant in the first place.
It has become market short-hand for the industrialization and urbanization processes in emerging countries, first and foremost China.
Those processes have required massive raw material inputs, from iron ore to make the steel to build the new cities to copper for the cabling to supply the new cities with power.
So far, so uncontroversial.
But somewhere along the way the “supercycle” came in many minds to mean that raw materials prices would just keep rising. Higher, faster, stronger.
Remember all those forecasts that the copper price would simply keep sailing into the blue yonder above the $ 10,000 per ton level? Analysts vying to out-bull each other with ever higher price calls?
Yet quite evidently markets do not and should not work like that.
The Great Global Contraction of 2008-2009 showed that even China is unable to immunize itself from recession in the rest of the world.
Sure, Beijing unleashed a shock-and-awe investment program that pulled industrial metal prices up from their bombed-out levels.
But it has been trying to tame some of the forces unleashed ever since, particularly a commercial property market that appeared to be in danger of becoming a massive bubble.
That engineered slowdown, combined with renewed recessionary forces elsewhere in the world, has once again deflated metal prices.
Those of aluminum and nickel are below marginal production costs.
Which is why, overlooked in the general “supercycle” brouhaha, BHP took a $ 355 million write-down of its Australian nickel operations and why also, according to Chief Executive Marius Kloppers, “clearly, the alumina and aluminum assets were subject to impairment testing.”
If the “supercycle” truly meant ever higher, faster, stronger pricing, we didn’t need BHP Billiton to tell us it was over. The prices of most industrial metals have been saying just that for many months.
If, rather, it means the continuing requirement for raw materials to meet a once-in-a-generation build-out of industrial and urban infrastructure in the likes of China, BHP’s Kloppers and many of his counterparts would argue the “supercycle” remains fully on track.
It’s just that it doesn’t override all other business cycles.
When those other cycles turn down, as is currently the case, resource companies such as BHP will understandably trim capital spend accordingly.
Which is why it has pulled its two “mega projects” in Australia.
Except that it hasn’t really pulled the Outer Harbor project at all.
In a statement released subsequent to its results BHP said the project “remains attractive” and “continues to be an important part of our long-term strategy.”
It’s just that the company reckons it can get a lot more out of its Inner Harbor ore-handling facilities before it reaches constrictive capacity.
Which means that what has generated all this “supercycle” doom-and-gloom is the decision not to go ahead with the $ 20 billion Olympic Dam mine expansion. But this may say as much about Olympic Dam as the long-term outlook for industrial commodities.
BHP has been looking at expanding Olympic Dam, the world’s fourth largest deposit of copper, ever since it picked up the project with the acquisition of WMC Resources in 2005.
In an October 2006 presentation the idea was to lift production from around 200,000 tons per year to around 500,000 tons per year of contained copper.
The project’s price tag at that time was widely reported to be around A$ 5 billion.
Fast forward seven years and the scale of the expansion had increased to 750,000 tons and the headline price-tag to $ 20 billion.
But then the biggest problem with Olympic Dam has always been its sheer size.
As Roger Higgins, head of BHP’s Australian operations, told Mining Weekly back in May 2006 in response to a question about the long lead time to potential development, “the resource is so large we are still attempting to find its limits.”
BHP’s proposed solution to this problem of scale was itself massive in scale, as spelled out in the summary of the project’s environmental impact study. As well as converting the current underground mine to a giant open-pit mine and extending smelter and refinery capacity accordingly, the project envisaged massive infrastructure build.
A new desalination plant to supply water, new power lines and/or a new gas power station, a new rail link, a new airport, new landing facilities at Port August in South Australia, new port capacity both in that state and in Darwin in the Northern Territory, a new workers accommodation village and expansion of the Roxby Downs township.
The whole would have meant 11 years of continuous construction work and added around A$ 45 billion to the gross domestic product of the state of South Australia over the mine’s lifetime.
Look no further to understand the very public hand-wringing in Australia about the end of the country’s mining boom.
And look no further to understand why BHP Billiton has rejected on cost grounds the project as envisaged.
Compare the price tag with, for example, the $4.5 billion expansion of the Escondida copper mine in Chile. BHP Billiton’s pro rata spend will be “just” $ 2.6 billion.
The project will boost production at the world’s largest copper mine to over 1.3 million tons in 2015, a full 500,000-ton lift from output last year.
OK, so Escondida has existing infrastructure.
But the new Oyu Tolgoi mine in Mongolia, being developed by Rio Tinto, doesn’t and its price tag is “just” $ 6.2 billion for first-stage completion, at which time it will be producing around 450,000 tons per year of copper.
Whichever way you look at the numbers, $ 20 billion was still a lot of bucks for the expected copper bang.
Particularly, when the main by-product is uranium, a market that has had a long-term question-mark placed over it since Japan’s nuclear disaster last year.
A question-mark that appears to be one reason for BHP divesting another uranium asset, the Yeelirrie deposit in Western Australia.
All of which explains why the company has decided to go back to the Olympic Dam drawing-board, or as Kloppers told analysts on the company’s conference call, “we have to go back, find a solution to put less capital in.”
That doesn’t mean that the commodities “supercycle” is suddenly over, just that BHP is still struggling to find a way efficiently to mine one of its biggest assets. That asset isn’t going anywhere.
By the time BHP comes up with a workable, lower-cost way of tapping Olympic Dam’s huge resource there will still be plenty of demand for its copper.
And, barring a series of worst-case scenarios, the main buyers of that metal will still be industrialising and urbanizing countries like China.

— Andy Home is a Reuters columnist. The opinions expressed are his own