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How Is BHP Battling the Current Depressed Coal Price Environment?

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BHP’s coal operations

BHP Billiton’s (BHP) (BBL) coal business is the world’s largest supplier of seaborne metallurgical coal. Seaborne coal trade has been on a structural decline since it reached its peak in 2014. This has led many coal companies to file for bankruptcies.

Low coal prices are severely affecting other coal producers (KOL) such as Peabody Energy (BTU), Alliance Resource Partners (ARLP), Arch Coal (ACI), and Cloud Peak Energy (CLD). The SPDR S&P Metals and Mining ETF (XME) invests in the metals and mining space.

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Cost-cutting initiatives

BHP’s coal president Mike Henry said in September 2015, “Prices for metallurgical coal have fallen by a further 25-30 per cent since the start of this calendar year and thermal coal by 10-15 per cent. There are no signs of things getting better in the immediate term.”

This is the main reason BHP has been focusing on volume and cost-cutting initiatives for coal operations during the current challenging market conditions.

The company is doing this to keep all its operations cash-positive. BHP has significantly lowered its energy coal and metallurgical coal unit costs over the last three years. BHP’s Queensland Coal unit costs fell 23% year-over-year in fiscal 2015, to $65 per ton. This is 50% below the peak.

BHP further expects its costs to fall to $61 per ton in fiscal 2016. This is despite lower volumes as the Crinum mine is exhausted. This reduction will represent a nearly 60% reduction in four years.

Focus on productivity

BHP is also focusing on benchmarking productivity, renegotiating supply agreements, and increasing equipment and wash-plant utilization.

During fiscal 2015, BHP saved ~$400 million on controllable cash costs and another ~$200 million on fuel and energy in its coal segment, which drove positive EBIT (earnings before interest and tax) despite a huge drop in prices.

However, going forward, the outlook for metallurgical coal and thermal coal remains bleak due to weaker demand from China and environmental issues. Lower prices would necessitate that BHP either further lower its costs or face severe margin pressure.

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