As we roll into the second half of 2014, we reflect on the major trends in the Australian resources sector over the first half of 2014.
Going down, down, down: exploration spending in Australia
Exploration for new mineral discoveries in Australia has now reached historical lows, with recent ABS figures showing that Australian exploration expenditure has declined more than 50% (or in dollar terms, more than $500m) in the two years since March 2012. If the figures were to deduct the exploration spending that the major mining houses (such as Rio Tinto and BHP Billiton) contribute, they become even more alarming.
In Western Australia alone, mineral exploration spending is at its lowest level since the end of Q1 of 2007. What is even more concerning for the industry, is the increasing number of mining companies that have ceased exploration activities altogether.
IPO activity a bellwether for investor sentiment
Whilst Australia is on track to record its best year for IPOs in a decade, most of the recent IPO activity has been centred around the industrial, retail and financial sectors, with many of the larger IPOs coming from private equity exits.
Sadly, the resources sector has been largely ignored with only 4 of the 50 or so new floats in 2014 involving resources companies - 3 in the mining sector and 1 in the oil and gas sector. In order to gauge the current level of investor confidence in the resources sector, compare that number with the 150 floats involving resources companies in 2007!
Anecdotal evidence also suggests that there is an increasing number of attempts to convert existing listed vehicles away from the resources sector and into the technology sector through the use of backdoor listings.
Subdued M&A activity
Mining M&A transactions have been relatively flat, particularly in the public M&A space, although there has been some recent green shoots and increased asset level activity in the oil and gas sector. In the mining sector, the largest public M&A deal involving an Australian mining company in 2014 has been the recently concluded takeover of Aquila Resources by Baosteel and Aurizon, a welcome fillip for the sector and for Chinese investment more generally. BC Iron Ltd has also just announced an off-market takeover bid for Iron Ore Holdings Ltd. We have also seen an uptick in companies looking to divest non-core assets, including companies in the junior-end of the market with expensive foreign operations.
In the oil and gas sector, there continues to be some asset level activity as the major energy houses complete their capital efficiency programs. Shell have been particularly active in this space, as it seeks to reposition some of its portfolio and reduce its balance sheet exposure in several major LNG projects. In the public M&A space, the acquisition of Aurora Oil and Gas Ltd by Baytex Energy Corp for $2.4 billion has been the single largest M&A deal in the sector for some time.
Keeping a lid on costs
As commodity prices soften and profit margins decrease, mining companies have reacted by cutting capital expenditure in order to improve project economics and with it, the return for shareholders. Whilst the cost cutting mantra has been led by the global mining houses, it has well and truly spread across the industry. One only needs to look at the growing number of “For Lease” signs in Australia’s premier mining precinct of West Perth to conclude that austerity measures are being taken at all levels of the industry.
You said what? ASX’s renewed focus on disclosure obligations
The recent changes to the JORC Code (2012) and the disclosure rules in Chapter 5 of the ASX Listing Rules came into effect on 1 December 2013. The first half of 2014 has seen companies adjusting their reporting behaviours to address the new disclosure requirements.
In our experience, many companies are still struggling to fully understand the effect of these changes and there has been a recent spike in the number of requests from ASX for companies to make supplementary disclosures, with most attention being on the reporting of production targets and other forward looking statements, plus careful monitoring of distressed situations, impairments and write downs.
Commodity price volatility: the good, the bad and the ugly
In general, 2014 has seen a continuation of the weakening in commodity prices that were experienced in 2013. Lower commodity prices continue to negatively impact investor confidence.
The good: Nickel, with the price of nickel hitting its highest level in more than two years in May, almost reaching $22,000/tonne, after a ban on unrefined ore exports in Indonesia came into force in January.
The bad: Iron ore, with the price hitting a two-year low in June, falling below USD90/tonne.
The ugly: Uranium, with prices continuing to wallow around the $28/lb mark.
Abbott finally gets to ‘Axe the Tax’
Despite several unsuccessful attempts, the Federal Government has finally abolished the controversial carbon tax with effect from 1 July 2014. In addition, the Federal Government has proceeded with the repeal of the Minerals Resource Rent Tax, a tax that brought down at least two Prime Ministers, raised virtually no revenue and damaged Australia’s longstanding reputation as a country of low sovereign risk.
We expect that the removal of both taxes will lighten the regulatory and compliance burden imposed on the Australian resources industry and improve its overall international competitiveness.
Strengthening the relationship with Asian partners
In the first half of 2014, Australia signed the Australia-Korea Free Trade Agreement and the Japan-Australia Economic Partnership Agreement. Prime Minister Tony Abbott, on his recent visit to China, also indicated the Australian Government’s intention to consider changes to current FIRB approval requirements for Chinese investments by increasing the investment threshold to $1.08 billion, if the Australia-China Free Trade Agreement were to be signed, in line with the current investment thresholds under the free trade agreements with South Korea and Japan (as well as USA and NZ). These changes would remove the impact of the FIRB approval process for transactions under the relevant threshold and are intended to encourage foreign investments.
With traditional debt and equity raisings harder to secure, we have seen an increasing use of convertible notes as a funding source, particularly at the junior-end of the market. We expect that traditional debt funding will remain problematic for the remainder of 2014, but steadily improve in 2015 as market conditions improve.