External factors and trends affecting our results
3.4 External factors and trends affecting our results
The following section describes some of the external factors and trends that have a material impact on our financial condition and results of operations. We operate our business in a dynamic and changing environment, and with information that is rarely complete and exact. We primarily manage the risks discussed in this section under our portfolio management approach, which relies on the effects of diversification, rather than individual price risk management programs. Details of our financial risk management and financial instruments outstanding at 30 June 2008 may be found in note 26 ‘Financial risk management’ in the financial statements.
Management monitors particular trends arising in the external factors with a view to managing the potential impact on our future financial condition and results of operations. The following external factors could have a material adverse effect on our business and areas where we make decisions on the basis of information that is incomplete or uncertain.
3.4.1 Commodity prices
The 2008 financial year has seen higher average prices for most of our major commodities than in the prior year. Demand for raw materials in the emerging market economies has remained strong. In particular, China remains a key driver of global commodity consumption through its position as a net importer of raw materials. China’s competitiveness and ability to innovate in downstream processing has been demonstrated again with sustained nickel pig iron production.
In light of differing activity for the developed and emerging market economies, there have been mixed spot prices for key commodities. In particular, bulk and energy related commodities have tended to outperform the LME traded metals. We expect the effects of current weaknesses in the developed economies on demand for our commodities to be offset by ongoing demand from the emerging economies. Supply side pressures remain high and price outcomes have regularly been underestimated by industry observers. In the short-term, we expect prices to remain high relative to historical levels, albeit with higher volatility.
Looking to the longer term, demand for our commodities is expected to remain strong. We expect that higher long-run raw materials and energy prices and stronger producer currencies should place upward pressure on industry supply costs, and hence, prices of minerals commodities. We continue to expect that commodity prices will be driven by long-run marginal cost of supply.
The following table shows prices of our most significant commodities for each of the years ended 30 June 2008, 2007 and 2006. These prices represent the average quoted price except where indicated otherwise.
| Commodity | 2008 | 2007 | 2006 |
|---|---|---|---|
| Crude oil (WTI) (US$/bbl) | 96.98 | 63.00 | 64.41 |
| Aluminium (LME) (1) (3mth) (US$/t) | 2,718 | 2,699 | 2,260 |
| Copper (LME) (1) (cash) (US¢/lb) | 353.10 | 321.47 | 228.58 |
| Nickel (LME) (1) (US$/lb) | 12.93 | 17.15 | 7.03 |
| Iron ore (2)(3) (US$/dmtu) | 1.4466 | 0.8042 | 0.7345 |
| Metallurgical coal (3)(4) (US$/t) | 300 | 98 | 115 |
| Energy coal (API4) (US$/t) | 94.6 | 51.52 | 47.63 |
- Refer to section 10, ‘Glossary’ for definitions
- Newman fines price in Japan.
- Price represents that set in April of the relevant fiscal year.
- Prime hard coking coal worldwide.
The following summarises the trends of our most significant commodities for FY2008.
Oil: Crude oil prices continued their rise, to an average of US$96.98/bbl, up 54 per cent from a year ago. This is due to a confluence of factors such as sustained weakness in the US dollar, speculative activity, strong geopolitical factors in Iran and Nigeria and tightness in global refinery capacity. We believe that fundamentals remain supportive of the higher prices, as weakness in oil demand growth in the OECD region was offset by key players in the non-OECD region, namely by China, India and the Middle East. These non-OECD parties contributed strongly to the overall 86.6MMbbl/d in oil demand. Although we expect an easing in fundamentals in 2009 on positive non-OPEC supply outlook and softening global demand caused by higher oil prices, prices should continue to be well supported in the short to medium term.
Aluminium: The aluminium market remained strong throughout FY2008. The benchmark three-month price on the LME for the final month of the fiscal year was US$3,005 per tonne, up from a price of US$2,788 per tonne for the opening month. For the fiscal year as a whole the LME three-month price averaged $2,718 per tonne compared to $2,699 per tonne in FY2007. Official LME stocks have risen over the course of FY2008. Prices have been supported by a combination of concerns relating to supply interruptions and rapid increases in production input costs, with energy being a central theme.
Copper: Copper demand, driven by China, grew close to four per cent year-on-year during the 2007 calendar year, with the International Copper Study Group (ICSG) estimating total global copper demand at 39.9 billion pounds. However, in the first three months of calendar year 2008, refined copper demand is estimated by the ICSG to have fallen by around one per cent year-on-year. Combined exchange stocks at LME/Comex/Shanghai fell during FY2008 by 134 million pounds, from 497 million pounds to 363 million pounds. LME cash prices in the first half of FY2008 averaged 337.9US¢/lb and despite weaker fundamentals in the second half of FY2008 prices averaged 368.3US¢/lb.
Nickel: Nickel prices have continued to demonstrate greater price volatility than most other metals, and the last year has been no exception with sharp falls in prices. The nickel price began FY2008 with a price of US$16.76/lb. A bearish outlook driven by a boom in nickel pig iron production in China and de-stocking in the global stainless steel industry led to a price decline through the first half of FY2008, with an average nickel price of US$13.54/lb. During the second half of FY2008, bearish sentiment in the investment community combined with a sustained increase in LME stock made the nickel price fall further to an average price of US$12.38/lb. The nickel price closed at US$9.83/lb at the end of the year. LME nickel stocks increased from 19.5 million pounds at the start of the financial year to 103 million pounds at the end of FY2008.
Iron ore: Demand for iron ore continues to surge with imports by China expected to be higher by approximately 60 million tonnes in calendar year 2008 compared to 2007. However, supply is now beginning to catch up with demand at the close of FY2008 as expansion volumes from Vale, Rio Tinto, BHP Billiton, Fortescue Metals Group and Indian suppliers reach the market. Benchmark prices increased 96.5 per cent for lump and 79.9 per cent for fines effective from 1 April 2008, reflecting the continued optimism in the steel and iron ore markets. Spot market prices remain higher than benchmark prices for Australian suppliers with the newly established forward curve for iron ore prices currently showing US$170—175/dmt CFR China for the period to June 2009.
Metallurgical coal: Markets remained very tight due to strong Indian demand and tightening Chinese markets, leading to a record contract price settlement for metallurgical coal, with an average price increase of 206 per cent effective from 1 April 2008. Chinese coke prices hit another record in excess of US$650 per tonne.
Energy coal: Global energy coal consumption has increased at an average rate of 7.4 per cent per annum since 2002. FY2008 witnessed strong growth in the energy sector on the back of significant rises in oil prices and this saw coal, despite the near record prices across all energy coal indices, remain the cheapest fossil fuel for electricity generation in most seaborne markets, ahead of gas and oil, even when emissions costs (credits) are accounted for. Energy coal prices continued to strengthen as global seaborne supply struggled to match strong growth in demand, particularly in the Pacific. Other factors contributing to high energy coal prices include a surge in freight rates, a weaker US dollar relative to some of the key coal exporting country currencies and equally large increases in global oil and gas prices.
The following table indicates the estimated impact on FY2008 profit after taxation of changes in the prices of our commodities. With the exception of price-linked costs, the sensitivities below assume that all other variables, such as exchange rate, costs, volumes and taxation, remain constant. There is an inter-relationship between changes in commodity prices and changes in currencies that is not reflected in the sensitivities below. Volumes are based on FY2008 actual results and sales prices of our commodities under a mix of short-, medium- and long-term contracts. Movements in commodities prices can cause movements in exchange rates and vice versa. These sensitivities should therefore be used with care.
| Estimated impact on FY2008 profit after taxation of changes of: | US$M |
|---|---|
| US$1/bbl on oil price | 32 |
| US¢1/lb on aluminium price | 24 |
| US¢1/lb on copper price | 26 |
| US¢1/lb on nickel price | 2 |
| US$1/t on iron ore price | 62 |
| US$1/t on metallurgical coal price | 27 |
| US$1/t on energy coal price | 24 |
The impact of the commodity price movements in FY2008 is discussed in section 3.6 ‘Operating results’.
3.4.2 Exchange rates
We are exposed to exchange rate transaction risk on foreign currency sales and purchases as we believe that active currency hedging does not provide long-term benefits to our shareholders. Because a majority of our sales are denominated in US dollars, and the US dollar otherwise plays a dominant role in our business, we borrow and hold surplus cash predominantly in US dollars to provide a natural hedge. Operating costs and costs of local equipment are influenced by the fluctuations in the Australian dollar, South African rand, Chilean peso and Brazilian real. Foreign exchange gains and losses reflected in operating costs owing to fluctuations in the above-mentioned currencies relative to the US dollar may potentially offset one another. The Australian dollar, Chilean peso and Brazilian real generally strengthened against the US dollar throughout FY2008, while the South African rand generally weakened.
We are also exposed to exchange rate translation risk in relation to net monetary liabilities, being our foreign currency denominated monetary assets and liabilities, including debt and other long-term liabilities (other than closure and rehabilitation provisions at operating sites where foreign currency gains and losses are capitalised in property, plant and equipment).
The following table indicates the estimated impact on FY2008 profit before taxation of a weakening of the US dollar against the Australian dollar or South African rand, which are the two principal currencies outside of the US dollar to which we are exposed in terms of our net monetary liabilities. The sensitivities give the estimated impact on profit before taxation based on the exchange rate movement in isolation. The sensitivities assume all variables except for exchange rate remain constant. As outlined above, there is an inter-relationship between currencies and commodity prices that is not reflected in the sensitivities below. Movements in commodities prices can cause movements in exchange rates and vice versa. These sensitivities should therefore be used with care.
| Estimated impact on FY2008 profit before taxation of a weakening US dollar against local currency: | US$M |
|---|---|
| Australian dollar (US¢1/A$) | |
| Net monetary liabilities (1) | (18) |
| South African rand (0.2 rand/US$) | |
| Net monetary liabilities (1) | (13) |
| Rand debt (1) | (4) |
- Impact based on difference in opening and closing exchange rates for the period.
The impact of exchange rate movements in the current year is discussed in section 3.6 ‘Operating results’.
3.4.3 Interest rates
We are exposed to interest rate risk on our outstanding borrowings and investments. Our policy on interest rate exposure is for interest on our borrowings to be on a US dollar floating interest rate basis. Deviation from our policy requires the prior approval of our Financial Risk Management Committee, and is managed within our Cash Flow at Risk (CFaR) limit, which is described in note 26 ‘Financial risk management’ in the financial statements. When required under this strategy, we use interest rate swaps, including cross currency interest rate swaps, to convert a fixed rate exposure to a floating rate exposure. As at 30 June 2008, we had US$1.6 billion of fixed interest borrowings that had not been swapped to floating rates, arising principally from legacy positions that were in existence prior to the merger that created the DLC structure.
3.4.4 Growth in product demand
The demand for our products is directly related to the strength of the global economy. However, the diversification of our portfolio of assets and commodities we extract limits the impact of a particular industry or region.
The global economy has remained resilient in the face of significant structural weaknesses in developed economies. The continuing massive industrialisation in China is providing solid support to the global economy.
Over the past financial year there has been considerable weakening in most major developed economies. The deflation of asset values within these economies has led to a reduction in wealth effect for consumers. This appears to have ended the past decade’s unsustainable consumer debt driven economic growth, particularly in the US.
However, a direct spill over into emerging market economies has remained largely contained. Emerging market economies have contributed more than their industrial counterparts to global growth since the year 2000. Led by China and India, economic growth in these economies has been strong with solid support from growth in domestic demand and strong trading activity with other emerging market economies.
We expect short-term global economic growth to slow as developed economies experience further weakening in the coming quarters. Liquidity is likely to remain low, and risk premiums high for some time into the future. Rising inflation, particularly in food and energy, alongside weakening economic growth has restricted the flexibility of central banks to inject liquidity and stimulate their economies.
Higher inflation will also have a likely negative impact on emerging market economies through their adoption of tighter monetary policies. However, we believe that emerging market economies should remain relatively strong on the back of continued domestic infrastructure investment and regional trade. While short-term disruptions may occur, we expect that their long-term economic growth will remain robust as they continue on the path to industrialisation.
3.4.5 Operating costs and capital expenditures
Strong global demand for resources continues to provide cost challenges for the whole industry. Rising prices for inputs such as diesel, coke and explosives, labour and contractor charges, shipping and freight costs added to already tight market conditions. Severe weather disruptions in Queensland also had an adverse cost impact. However, our world-class orebodies, strong supplier relationships, internal systems, the capabilities of our people and our continuing focus on our ‘Business Excellence’ improvement program have provided some relief against significant cost pressures.
3.4.6 Exploration and development of resources
Because most of our revenues and profits are related to our oil and gas and minerals operations, our results and financial condition are directly related to the success of our exploration efforts and our ability to replace existing reserves. However, there are no guarantees that our exploration program will be successful. When we identify an economic deposit, there are often significant challenges and hurdles entailed in its development, such as negotiating rights to extract ore with governments and landowners, design and construction of required infrastructure, utilisation of new technologies in processing, and building customer support.
3.4.7 Health, safety, environment and community
We aspire to Zero Harm to people, our host communities and the environment and strive to achieve leading industry practice. Sound principles to govern safety, business conduct, social, environmental and economic activities are integral to the way we do business. Our Charter highlights that we care as much about how results are obtained as we do about delivering good results. Our Health, Safety, Environment and Community Management Standards provide the basis for developing and applying management systems at all levels of our Company and are a driver of our contribution to sustainable development.
As a global company, operating in many different countries, we are subject to extensive regulation surrounding health and safety of our people and the environment. We make every effort to comply with the regulations and, where less stringent than our standards, exceed applicable legal and other requirements. However, regulatory standards and community expectations are constantly evolving, and as a result, we may be exposed to increased litigation, compliance costs and unforeseen environmental remediation expenses, despite our best efforts to work with governments, community groups and scientists to keep pace with regulations, law and public expectation.