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Bhp Billiton and the Financial Crisis

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BHP BILLITON
Petroleum Sector

BHP Billiton is one of Australia’s greatest corporate success stories; having grown from humble beginnings in Melbourne, BHP is now a multinational commodities powerhouse and claims to be the world’s largest national resources company. (Annual Report, 2009 pp. B)

The BHP Billiton Petroleum sector has been the focus of big BHP investment dollars of late as the company looks to expand their operations. BHP-B Petroleum produced over 376,000 barrels of oil per day in 2009 and has maintained an impressive 9% annual growth rate since 2007. (Petroleum Annual Review, 2009 pp 5)
BHP Petroleum operates in many countries across the world and is currently undertaking oil and gas projects in Australia, The Gulf of Mexico, Algeria, the UK, Pakistan and Trinidad and Tobago with the intention to expand into Malaysia, the Fawklands and Canada in the near future. (PAR, 2009 pp 5)

The market for petroleum and indeed the mining industry as a whole was unsure what effect the global financial crisis would have and what action affected parties would take during the period. Regardless of the changes, such a large and important company as BHP would have to study the potential changes and start, if necessary, reformatting their financial planning/strategies and other control processes. These would have to be looked at on a whole organisational level; ranging from the BHP hierarchy all the way down to the smaller subsidiaries in order to accurately gauge the potential effects of the changes in the market. BHP put itself in a really good position early in the piece with its sensible investment strategy. BHP management identify, as they did in previous year reports, the need for caution whilst guiding such a large company through the current global recession. This recession equated to a slowing of activity in the commodities market which would have been a major concern to BHP management. The group investment strategy of investing primarily in ‘long-life, low-cost, expandable, export-oriented, tier one assets’ (BHP Annual Report, 2009 pp 6) was a major factor in the company being able to weather the adverse financial conditions. Tier one assets/capital were established by the Basel committee to set a standard for banks (and other entities) of their minimum capital adequacy requirements (Viney, 2009. pp 66). BHP management have obviously identified this as a precedent that would be valuable to follow in their company and have used it to good effect. Tier one assets include ordinary shares, general reserves, retained earnings, foreign currency translation reserve etc and are considered the highest quality capital. Tier 1 assets have many beneficial characteristics, including: • They provide a permanent and unrestricted commitment of funds • They are freely available to absorb losses • They do not impose any unavoidable servicing charge against earnings • They rank behind claims of depositors and other creditors in the event of winding-up. (Viney, 2009. pp 66)
In addition to the security of their flexible Tier 1 assets, BHP – through their financial planning and management controls – have also sought to maintain a solid ‘A’ credit rating as an added degree of collateral. The better the credit rating of a company, the more attractive a loan prospect the company becomes and the more likely it is to have loan applications approved. (Viney, 2009 pp 67)

Both these measures allowed BHP to maintain a relatively sound balance sheet in the face of a downturn in the demand for commodities, and will allow the company to take full advantage of the recovery of the industry and indeed the economy.

One of the main reasons BHP was able to emerge from the global financial crisis relatively unscathed was the growth of countries that have a high commodity demand; namely China. The economist credited with initially predicting the financial crisis, Nouriel Roubini, stated recently that the main factor in the recovery of the Australian economy – particularly the mining sector – is the continued growth of China, Australia’s largest commodities customer. (Hayes, 2009) In 2009 alone, while the world economy is still in recession, China’s GDP grew by 8.7% - the 4th highest growth of any country. This during a period where the so-called powerhouse economies – Japan (-5.3%) , The UK (-4.8% ) and the US (-2.4%) – struggled to operate efficiently. (Australia recorded a 1% growth over this period)
(World Factbook, 2010)

In doing business with China or indeed any foreign economy, BHP management would have to employ foreign exchange risk management processes in order to realise fully the risks associated with trading in foreign currency. The assets, earnings and cash flows of BHP are all influenced by the wide range of currencies in which they are traded. Movements in the exchange rates in these countries have the potential to impact BHP’s financial results. For example, even though the organisations’ performance in a transaction remains the same, its dollar value may change significantly due to changes in the relevant exchange rates. BHP, documented in their annual report, have explored their currency options and recognised the risks posed by foreign exchange risk. BHP conduct operations in many different cultures and frequently conduct trades using, among others, the Australian dollar, South African rand, Chilean peso, Brazilian real and the US Dollar. In order to try and reduce their exchange rate risk, BHP primarily use the US dollar (due to its frequency of use) in their financial transactions, borrowing arrangements, holding of surplus cash and even the way their financial figures are presented in their reports. For BHP Petroleum, the US dollar would be an easy alternative as it is widely recognised as the currency of choice when measuring the price of oil. Eg. ## US Dollars a barrel. (BHP Annual Report, 2009. pp 9)
BHP management note that hedging was a tactic considered to reduce risk but decided that the long-term benefits to shareholders were insufficient. (BHP Annual Report, 2009. pp 9)

As the stimulus article from ‘The Australian’ highlighted, the mining sector and indeed the petroleum industry suffered during the financial crisis. Treasurer, Wayne Swan, warned mining companies in 2008 that their industry would not be immune to the effects of the crisis; a warning which rang true with fellow Australian BHP competitor, Rio Tinto, forced to cut 14,000 jobs worldwide in an attempt to cut costs associated with the financial crisis (The Australian, 2008). This was just one of many worldwide cost saving practices being employed by company managers from all industries in order to survive the crisis. BHP itself cut around 6000 jobs worldwide in response to the slowing of demand and cash flow through the company. This figure didn’t spare BHP’s Australian operations, with over 2000 Australians laid off by the company last year. CFO Alex Vanselow assured shareholders that even though job cuts had to be made, BHP was still in a strong financial position due to the healthy state of their balance sheet – as mentioned earlier.
``The balance sheet allows us to continue investing like we're doing in iron ore, in petroleum, in other commodities, and we are prepared for, on an opportunistic basis, to look at acquisitions,'' (Vanselow, 2009 – As Cited in Hayes, 2009)
Even in the middle of the crisis, BHP’s strong financial base allowed them to continue investing where other companies were merely trying to stay afloat. During 2009, BHP invested a whopping US$1.9 billion towards capital projects with a further US$548 million towards buying land and embarking on new worldwide exploration programs (Petroleum Annual Report, 2009 pp 5). This is no mean feat considering the economic climate; with mining companies finding it difficult to secure funds. Cash flow is critical to a mining organization and the sources of capital usually obtained under more stable economic periods are in scarcity during the crisis. Low commodity prices have hurt the mining sector’s ability to generate revenue, banks are afraid to lend and lower stock prices reduce the attractiveness of offering additional shares to the public.
(Duncan, 2009 pp 2) This highlights BHP managements foresight in having enough cash and tier 1 capital in reserve to make such investments possible in less than hospitable economic times.

Comparative International Management Accounting processes are used by management to provide information for internal decision-makers to plan, evaluate and control an organisation. CIMA should provide management with information for routine internal reporting (cost management strategies, planning of new operations) and non routine/special reporting (investing in capital assets and establishing long range plans). CIMA has no set structure and is useful when looking to the future of a company. The above example of BHP’s investment in its Petroleum customer sector group is a perfect example of where BHP management have gathered information internally and used this information to plan strategic and tactical decisions. For such a massive investment (the $2.48bn invested capital assets and exploration projects) to be made during an extended period of financial uncertainty is a decision that could have a huge impact on BHP. However projections show that BHP may have times their run to perfection. According to Coffey Mining CEO, Dan O’Toole, the current economic environment is ideal for new developments.
“Logically the time to begin exploring and starting on a development is now because costs are down and resources are more readily available. This is actually a really good time to do exploration work in preparation for when people’s confidence returns and they are ready to put money into operations.” (Hayes, 2009)
It could be assumed that Comparative International Management Accounting and BHP’s strong financial stability have given company management the ability to lay low and internally report throughout the worst of the crisis, manage their costs (job cuts) and plan for future operations. The use of special/non-routing reporting would enable the company to fully realise its financial position and allow it to plan strategic and tactical decisions; resulting in 2009’s investment of US$1.9 billion in capital assets; effectively shoring up the long-term future of BHP’s petroleum arm of operations. BHP’s strong financial base and responsible/conservative approach to their finances have allowed them to continue investing and expanding during the crisis, where other companies may still be trying to consolidate their internal finances as opposed to contemplating further investment. Comparative Internal Management Accounting’s purpose is to give the company decision-makers the information they require to make decisions for the future of the company. With this apparently well timed investment in the petroleum industry – an industry that is expected to boom with strong demand coming from growing cultures such as China and India – BHP, through the use of CIRM have further stamped their authority in the petroleum sector.

Along with the planning aspect of management comes the performance evaluation phase. In order to have total control, companies must begin with their strategic objective and include all elements of planning and monitoring. Sufficient planning must be undertaken at management level in order to justify a major investment as mentioned above. It is especially important for multinational organisations to plan sufficiently as they will be subject to different cultures, laws and regulations, political agendas and economic climates. BHP for example would have to understand how to do business with Chinese and respect their different cultural traits and values in order to facilitate agreements. Another example is BHP’s operations in Pakistan and the well documented troubles in the country. Political agendas may come into action here and BHP would have to be wary of the ways in which they manage the Zamzama Gas Plant in Pakistan. (Petroleum Report, 2009 pp 18)
An interesting point to note and one that highlights the importance of the evaluation processes implemented by management, is the time it takes to convert a mine/oil deposit from exploration to production. Duncan (2009, pp 2) found that, on average, it takes from 7 to 9 years to bring a mine into production. Drilling for oil will probably not take that long but it would still require a substantial period of time to set up the oil drilling rigs and surrounding structures. Especially in an offshore location, like BHP has found in the Gulf of Mexico. During this assumed 7-9 year set up process, BHP would have to constantly re-evaluate the laws and regulations, political movements and economic changes in the host country.

In conclusion, BHP has encountered – among others - a drop in revenue and share price as a result of the financial crisis. However BHP management have given themselves the tools so the company can only remain a viable entity during this time, but also to excel in the face of adversity – particularly in the Petroleum Customer Sector Group. BHP’s financial planning and control of their company is second to none and they have shown foresight in bolstering their capital holdings and tier 1 assets to strengthen their balance sheet considerably.

3 years ago at the beginning of the financial crisis BHP Petroleum committed to, among other things, achieve world-class production performance and position the company for material growth. Through their internal mechanisms, in 2009/2010 – BHP delivered! (Petroleum Annual Report, 2009 pp A)

References

Annual Report 2009, BHP Billiton, Melbourne, Victoria.
Retrieved 20/5/2010 from http://www.bhpbilliton.com/bbContentRepository/docs/annualReport2009.pdf

Annual Review 2009, BHP Billiton Petroleum, Melbourne, Victoria
Retrieved 20/5/2010 from http://www.bhpbilliton.com/bbContentRepository/docs/2009PetroleumAnnualReview.pdf CIA World Factbook 2010, Country Comparison: GDP.
Retrieved 20/5/2010 from https://www.cia.gov/library/publications/the-world-factbook/rankorder/2003rank.html?countryName=Australia&countryCode=as®ionCode=au&rank=96#as Duncan, J 2009, The Global Economic Crisis – Worldwide Impact on Mining
Companies. Macleod Dixon LLP, Toronto, Canada
Retrieved 21/5/2010

Hayes, P 2009, Commodoties Set to Rise, Economist & From Crisis Comes Opportunity, Australian Mining.
Retrieved 21/5/2010 from http://www.miningaustralia.com.au/news/commodities-set-to-rise-economist and http://www.miningaustralia.com.au/news/from-crisis-comes-opportunity The Australian 2008, Global Financial Crisis Hits Mining Companies, Wall Street Journal. Retrieved 21/5/2010 from http://www.theaustralian.com.au/business/news/miners-slash-500-jobs-as-crisis-bites/story-e6frg90f-1111118333761 Viney, C 2009, Financial Institutions, Instruments and Markets, 6th Edition, McGraw-Hill, North Ryde, NSW

WAToday 2009, BHP to Cut 6000 Jobs Worldwide Amid Downturn, Business Day. Retrieved 23/5/2010 from
http://www.watoday.com.au/business/bhp-to-cut-6000-jobs-worldwide-amid-downturn-20090121-7m2j.html…...

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