American senator Everett Dirksen wasn't talking about the commodities industry when he reputedly said "a billion here, a billion there, pretty soon you're talking real money." Were he alive today, he could have. Great gobs of real money are being vaporized by mining and oil and gas companies. The slowdown in China, conveniently, is taking much of the blame. It shouldn't.
Episodes of woe are recorded almost every day. Shares of Royal Dutch Shell, one of the world's biggest oil companies, slumped again this week after it took an $8.2-billion (U.S.) hit on weak oil prices and decisions to scrap a Canadian oil sands project and retreat from Alaska. Glencore, the world's top commodities trader, has fallen by two-thirds this year alone. The Swiss company, which acquired Viterra and Falconbridge in Canada, is now busy shrinking its asset base and debt. On Friday, Chevron announced it would cut as many as 7,000 jobs – up to 11 per cent of its work force.
Research done by Citigroup for Glencore reveals astounding value destruction. The bank took Glencore's initial public offering in May, 2011, as a starting point and measured the share performance and market capitalization decline of 23 of the world's leading mining and oil companies through the end of October. The group includes BHP Billiton, Anglo American, Exxon Mobil, First Quantum, Freeport McMoRan, Petra Diamonds and Acacia.
The collective equity loss for these 23 companies alone was almost $650-billion. The figure excludes the losses of some biggies, among them Barrick Gold, Kinross Gold, Canadian Oil Sands and Teck Resources that, mysteriously, did not land on the Citigroup list. If the absentee losers and other stock market duds are added, the loss could easily rise by another $100-billion. Translated into loonies, let's say $1-trillion (Canadian) has been wiped off the resources map in the past four years, equivalent to the gross domestic product of Saudi Arabia or Switzerland.
A few of the individual losses are gruesome. While BHP Billiton shed only 51 per cent over the period, compared with Glencore's 77 per cent and Lonmin's 97 per cent, the company is so big that the price fall wiped out $118-billion (U.S.) in value. The value crunch at Vale, the Brazilian company that owns the former Inco, was even greater, at $120-billion. Rio Tinto lost $60-billion and Anglo American almost $50-billion. The big oil companies suffered the least damage. Companies such as Exxon, BP and Chevron used better refining and retailing margins to offset the profit hit from tanking oil prices.
What explains the slaughter? In simple terms, the share collapse is the result of the commodity collapse. Copper, coal, iron ore, nickel, zinc and oil are down by a third to two-thirds. Iron ore was hit the hardest, with a 69-per-cent loss; zinc, down 24 per cent, got off easiest.
Why did they fall? The weak economic recovery in North America and Europe didn't help. Nor did the decisions by most of the big companies to greatly expand capacity. The spending commitments were largely made before the 2008 financial crisis and assumed that the BRIC countries – Brazil, Russia, India and China – would defy gravity forever. They did not, of course. Brazil and Russia are in recession and the growth rate in India, while still robust, is below its recent peak of 10 per cent in 2010. If there is one culprit in the eyes of mining bosses and mining investors, it is China.
China's growth rates obsess investors. A half-a-percentage-point rise or fall in GDP forecasts can send commodities shares soaring or tumbling, taking investors' spirits up or down with them. Lately, investors have been in a sour mood because China's growth forecasts have been on the wane. According to the International Monetary Fund, Chinese GDP will land at 6.8 per cent this year and 6.3 per cent next year.
But China's slowdown is not news; the growth rates have been dropping for years – GDP was 10.6 per cent in 2010. Nor is the slowdown dire. China is still growing at rates that are the envy of Europe and North America. They're just not as strong as they used to be. And the slowdown doesn't mean that China is consuming less resources.
As economics writer Anatole Kaletsky said in a recent column in Project Syndicate, "even as the pace of growth slows, China is contributing more to the world economy than ever before." Simple arithmetic explains why. China's GDP is now more than $10-trillion, up from $2.3-trillion in 2005. Growth of, say, 7 per cent on the larger figure expands the economy a lot faster than growth of 10 per cent on the smaller figure. In other words, China needs more resources than ever and, barring a banking or debt crisis that plunges the economy into recession, should keep sucking up resources to power its rapid urbanization drive and move to a consumer economy.
So China can take only part of the blame for the equity collapse. The real blame lies with the companies themselves; they are guilty of every sin in the book. They assumed the good times would last forever, went on a merger and acquisition spree at the top of the market and, worst of all, launched ambitious and hideously costly expansion plans in iron ore, coal and other commodities on the assumption that demand would keep rising.
The good news is that the Chinese and Indian economies are still expanding and capacity is finally coming out of the market as companies such as Glencore shut mines or reduce their output. When balance returns to the market, the share prices of the beaten down companies could take off. Only the bravest investor would bet the turnaround is coming tomorrow.
Eric Reguly