Colin Lea's  Instablog

By Malcolm Maiden

Yesterday's statement is intended to send a clear signal that the board still backs Kloppers.

ON A really uncharitable interpretation, BHP Billiton chairman Jac Nasser damned Marius Kloppers with faint praise yesterday.

Nasser said that the group's decision to invest in US shale was the right one, and that BHP's chief executive and his petroleum division boss, Mike Yeager, were doing the right thing in shifting their shale development effort to liquids that take the oil price rather than the ravaged US domestic gas price. BHP was ''fortunate to have Marius' leadership'' and the management team he led, he added.

Nasser also said, however, that BHP's $US2.84 billion US shale write-down was ''very disappointing'' and said the board agreed that Kloppers and Yeager should hand back their June 30 year short-term bonuses. He also stopped short of stating flatly that there were no plans to quickly bring the curtain down on the Kloppers era.

That was a considered omission, however. The view was that it was impossible to reject suggestions that Kloppers had lost favour without simultaneously raising them. Yesterday's statement is intended to send a clear signal that the board still backs Kloppers and his team.

Yesterday's write-down is nevertheless also a confession. Kloppers can point to the relative outperformance of BHP's share price in the past year, but he made a mistake with the first leg of his US shale invasion, the $US4.6 billion acquisition of Fayetteville, Arkansas, shale gas assets in February last year.

The Fayetteville leases are gas-only and already extensively developed. They were fully exposed to the US domestic gas price, and BHP is one of more than a dozen oil and gas majors who have bought into US shale with plans to use their financial strength to rapidly increase production.

The US gas price had fallen from $US14 per thousand cubic feet in 2005 to $US3.88 per thousand cubic feet in February last year when BHP bought its Fayetteville leases. It had edged up to $US4.27 per thousand cubic feet by July when it paid $US15 billion for listed US shale company Petrohawk - but by April this year was below $2 and at a 10-year low in the face of over-supply and a warm US winter that undermined demand.

It has bounced back above $US3 since, but gas futures are about $US1.50 lower than they were when BHP first bought in, and it is that slide that has generated the $US2.84 billion write-down of Fayetteville's carrying value.

The leases that BHP subsequently picked up with its $US15 billion takeover of Petrohawk are less extensively developed, and capable of producing both gas and liquids that take the oil price instead of the gas price.

As the gas price weakened, Kloppers and Yeager pulled drilling rigs off the Fayetteville leases, and put them to work on Petrohawk leases that are less heavily developed, and liquid-heavy. By 2015, Petrohawk's liquids production will account for about 50 per cent of total shale production, and about 80 per cent of revenue - and it is the re-weighting towards liquids that has shielded Petrohawk from the write-down Fayetteville has taken.

Details of the write-down were put before the risk and audit committee of BHP's board on Thursday, and BHP's board signed off on it yesterday morning. The decision to immediately announce the hit rather than wait until August 22 when the group posts its June year profit result reflects heightened awareness on all boards this year that continuous disclosure means just that, continuous disclosure.

BHP is dual-listed in Australia and Britain, and the Australian market's continuous disclosure regime is toughest.

''We've seen a couple of companies here get involved in continuous disclosure issues - it's fair to say that the level of awareness of continuous disclosure issues has been elevated,'' Kloppers said yesterday. He did not name names, but Leighton's payment of a $300,000 fine for tardy disclosure would have been in mind.

MARIO Draghi didn't come out on Thursday night and single-handledly solve the European sovereign debt crisis, and share and bond markets plunged in response, but traders were actually discounting their own unrealistic expectations.

The European Central Bank president was never going to follow up his comment a week ago that ''whatever it takes'' to defend the euro would be done by doing everything in a single day, and the ECB can't do it alone.

Draghi's idea is that the ECB will buy Spanish and Italian bonds in the secondary market at the same time as the European Union commits bail-out fund money to primary bond purchases, in return for expanded fiscal powers in both countries. It potentially creates enough buying power to head off a selling attack, making bond market intervention itself unnecessary.

His hint that bonds the ECB bought would rank equally with ones held by private sector investors was also important, because private holders will sell into ECB buying and undermine its effectiveness if they risk being relegated to second-rank creditors behind the central bank.

Germany needs to back increased financial assistance, and Italy and Spain need to agree to cede control over their economies in return for bail-outs. But all that would happen quickly if Europe's crisis flared and in that respect Draghi has outlined a plan. It will take longer to turn it into action, but it's a positive development.

Read more: http://www.smh.com.au/business/faint-praise-is-no-recommendation-at-bhp-20120803-23l0k.html#ixzz22aT5CuKu

Disclosure: I am long BHP.

Interesting article on Blackrock Inc's new take on direct investment in Commodities.

By Peter Ker, Sydney Morning Herald, 1 August 2012

There was a sign of things to come in London this week, and it had nothing to do with the waning fortunes of Australia's swimming team.

Across town in the offices of BlackRock Inc, a fresh way of doing business was being unveiled, and Australia's mining and resources sector might want to take note.

Already the world's biggest investor in resources stocks with an estimated $36 billion sunk into the sector, BlackRock announced that it was investing $110 million in an iron ore company.

Nothing unusual there, except that BlackRock was not buying shares in the miner - London Mining - but rather securing a 2 per cent royalty on all future iron ore sales from the company's Marampa mine in Sierra Leone.

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The mine is already producing more than 1 million tonnes of iron ore each year, and the funding injection from BlackRock will help expand that nine-fold in coming years.

In a rare sortie before the media, BlackRock's top fund manager Evy Hambro revealed the company had been reviewing the way it invests for some time, and royalty arrangements had become more attractive as sources of funding had dried up for mining companies.

"It's an attractive deal to BlackRock because BlackRock can borrow at well below the cost of debt that is available to mid-tier to junior miners and earn a return on investment that's well above that level," he told reporters in London.

"In today's financial environment, the banks' ability to lend has been vastly reduced," Hambro went on. "Bank capital is scarce and when available, more expensive."

He said the new model gave BlackRock exposure to iron ore without direct exposure to the sort of rampant cost inflation that has become the norm in the mining sector, because the royalty is set on sales revenue not overall profits.

Nor would BlackRock be beholden to the executives whose annual whims decide dividend returns, and Mr Hambro indicated that this investment would not be the last of its type.

"We continue to evaluate a number of other opportunities that are similar in nature to this royalty," he said.

Frustrations mount

For those that have watched BlackRock in recent years, it will come as little surprise that the investment giant is looking at fresh ways to invest its billions.

The company has made no secret of its frustrations with the big diversified miners, which always seem to have yet another growth project to fund rather than returning a bigger slice of profits to shareholders.

When private lobbying got them nowhere, BlackRock last year resorted to questioning in public the likes of BHP Billiton over their growth strategies and approaches to shareholder returns.

BlackRock has since delivered on their warnings, reducing their stake in several big miners, including BHP and Australia's biggest listed gold producer, Newcrest Mining.

Mid-tier hopefuls

While the $110 million punt on London Mining is smaller beer than the billions BlackRock has invested in BHP, Hambro's indication that it plans more royalty-based may give hope to mid-tier Australian miners.

These miners are often caught between the current scarcity of finance and the market's sudden reluctance to invest in resource stocks.

Such deals have proved successful in Australia in the past: back in 2006, Manhattan-based investor Leucadia National bought a royalty note on production at certain iron ore mines being developed by a tiny aspirant called Fortescue Metals Group led by one Andrew Forrest.

Fortescue famously went on to become one of the world's biggest iron ore producers, and while the terms of that royalty note are now subject to a legal dispute, the deal has still been wildly successful for both parties.

Royalty and off-take focused companies in North America like "Silver Wheaton" and "Sandstorm" have this week indicated that they too believe the conditions are primed for royalty-type deals to take centre-stage. Tim Schroeders, the Melbourne-based fund manager of Pengana Capital, agreed there is a lot of merit in the concept.

"It's an interesting model as you are exposing yourself to operational hiccups but not necessarily cost over-runs or expenditure increases, because you are taking a royalty on revenues," he said.

"It's pleasing there is this sort of innovation occurring from one of the biggest global investors in mining (BlackRock) so it's a good outcome for all parties concerned I would think," Mr Schroeders said.

"It makes a lot of sense," he adds. "I've no doubt we will see more of it."

Read more: http://www.smh.com.au/business/mining-and-resources/blackrocks-change-of-tack-creates-waves-20120801-23erd.html#ixzz22IWm2ezZ

Disclosure: I am long BHP.

An interesting article by Michael Pascoe from the Sydney Morning Herald, 30 July 2012

http://www.smh.com.au/business/bhp-billiton-in-a-dark-place-20120730-2392b.html

Disclosure: I am long BHP.