Expansion Plans Lead to Gains for Australian Mining Shares

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The list of factors contributing to share price gains in BHP (ASX:BHP) and Rio Tinto (ASX:RIO) keeps getting longer. Earlier this week we mentioned the possibility of a 25% gain in iron ore prices next year. In today’s Australian, Scott Murdoch reckons a 25% gain in iron ore prices would deliver a 10% boost to BHP’s earnings and a boost of 25% to Rio.

The government is keen to get its share. Based on the current corporate tax rate, the Australian Treasury would book AU$480 million in iron-ore relates tax revenues on a 10% gain in ore prices, and a tidy AU$1.2 billion on a 25% increase. That could come in handy in an election year, no?

Earnings increases driven by rising commodity prices are drawing the attention of the world’s pirate equiteers, according to a report published yesterday by Ernst and Young. “Cashed-up private equity raiders could soon add resource giants like BHP Billiton Ltd and Rio Tinto Ltd to their shopping lists, with widespread belief in the longevity of the commodities boom,” reports Financialnews.com

“According to a report by Ernst & Young’s Global Mining & Metals Centre, the traditional barriers to investment in the mining sector by private equity are changing. Ernst & Young Global Mining & Metals Sector leader Mike Elliott said private equity had historically taken little interest in the sector because of its cyclical nature, a perceived need for specialist knowledge and possible lack of exit options.”

This is part of the “revaluation” argument which explains the recent surge in BHP’s share price. It’s a belief that the third phase of global industrialisation is much stronger and long-lived than the first two. “With the demand from China and India to secure resources and the constraints on supply globally, it is generally agreed that mining is now in a new super cycle that is generating higher and more predictable cash flows” Elliott said.

Uh oh. Whenever something is “generally agreed” upon, it’s time to get nervous. Are the big Aussie miners fully, or even over-valued at today’s prices?

Not quite yet. One reason the shares are being re-valued is that the miners have big expansion plans in places where huge mineral ore bodies are already known to exist. Consider just one of BHP’s projects, the AU$6 billion expansion of its prized asset, Olympic Dam in South Australia.

Last year the asset produced AU$634 million in earnings. The new plan – which requires a new airport, a desalination plant, a new railway, and a town of 5,000 construction workers – would expand copper production to 500,000 tonnes per year and triple uranium production to 15,000 tonnes per year. It would also include a new ore processing facility with four times the capacity of the current facility.

Marius Kloppers is ambitious.

But is he over-reaching, betting on commodity prices staying higher, or declining at a slower rate, than previous cycles? Olympic Dam is home to 30% of the world’s known recoverable uranium reserves. BHP is so bullish on uranium’s future as fuel for the world’s nuclear plants that it’s reassessing its uranium assets in Western Australia, even though the current state government under Alan Carpenter supports the existing ban on new uranium mines.

The area where BHP has begun reassessing its assets is Yeelirrie, 500km north of Kalgoorlie, according to Nigel Wilson in today’s Australian. The company reckons the site contains 55,000 tonnes of uranium oxide. Rio’s on board too, exploring the prospects at its 36,000 tonne U308 deposit at Kintyre. No wonder the pirates are interested. Look for the share prices to keep on keepin’ on.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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