Diversification: A Perspective on Recent Trends

Saturday, 21 August 2010 17:59

Recently, the PotashCorp takeover bid by BHP Billiton has attracted a lot of attention across the
globe. Underpinning this move, at the heart of BHP’s global strategy, is the diversification
mindset; a strategy that has not failed the mining giant so far. But neither is BHP alone in this
arena nor has diversification been a new phenomenon to this industry. In essence,
diversification has witnessed gradual transition from theory to practice, with the underlying
proposed hypothesis that relative strength of one set of commodities will compensate for
weakness in other commodities. It is a known fact that different commodities not only have
different market growth profiles but also different curve of prices over the economic cycle. 

 
BHP’s strategy has paid rich dividends, especially in the last couple of difficult years for the
industry. In other words, fluctuations across BHP’s nine commodity divisions roughly balanced
out in financial terms over an extremely volatile two years for commodities markets. Revenues
were stable, rising only marginally from $50.2bn to $52.8bn. Measured by earnings before
interest and tax and excluding one-off items, profits rose 8 per cent from $18.2bn to $19.7bn.
During the downturn BHP’s profitability was bolstered by its major presence in oil and gas,
commodities that no other mining peer produces. BHP’s sometimes-forgotten oil division
contributed $4.6bn to group earnings before interest and tax in the year, almost tying with base
metals as an earnings contributor.

Taking a closer look, one can broadly divide metals commodities into two categories – one that
are largely interdependent in trade and the other that are interdependent to a lesser extent. Zinc
trade is highly dependent on the trade of steel, both the trades are highly dependent on the oil
prices, but zinc’s prices are not expected to be highly correlated with potash prices, an
agricultural commodity. Essentially, though commodities on a whole move together over an
economic cycle, the different application industries of these commodities ensure that there is a
distinct element of uniqueness in trade of each commodity; the outcome luring trades into
diversification and offset troughs in cycles. Agricultural fertilizers and oil, which are tied to food
and energy demand respectively, track different economic cycles to iron ore or copper or
aluminum, which track manufacturing demand.

From evolutionary perspective, the big enterprises that have conventionally controlled the
manufacture of one specific mineral are increasingly investing in the production of other
minerals. These other minerals are either complementary such as chromium or manganese in
relation to iron, or substitute such as bauxite versus copper. Interestingly, investment
diversification often also applies to minerals that have neither a commercial nor a technical link

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Diversification: A Perspective on Recent Trends
Saturday, 21 August 2010 17:59

with that produced by the investor. For e.g., enterprises investing in the energy-producing
sector, and especially in coal and uranium industries fall into these categories. We could
perhaps call this a form of inter-sectoral and international oligopoly.

However, one also needs to see that till very recently, different geographies have had different
approaches. For Europe, its domestic basis is much narrower and its diversification investments
are in foreign countries. To elaborate on this, each mining country usually specializes in the
production of one particular mineral, while the Western groups tend to share their activities
between different minerals and different countries. The novel investment strategies of the
capitalist countries' industrial, mining and oil enterprises have created a new paradigm, one that
relinquishes the national and sectoral barriers that earlier bordered clogged competition spaces.
A new and larger competition space is developing which includes a great diversity of minerals
and where foreign investors of different nationalities and industries are involved.

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