FTSE 350 Metals & Mining: Divestments and diversions

For Rio, the equation is simple. Although short-term supply constraints have led to bumper earnings in the past two years – and could do so again – the miner's coal operations are now surplus to requirements. Following last year’s disposal of its Coal & Allied division to Yancoal for $2.7bn, and the $617m sale of its stake in Bengalla in 2016, Rio is happy to exit Kestrel and Hail Creek – the Australian tenements that produce both coking and thermal coal.

There are good reasons for Rio to end 2018 with zero exposure to coal, particularly the thermal variety. First, the group’s market share of the commodity is neither dominant nor likely to be as reliably cash-generative as Rio’s larger positions in aluminium, iron ore and copper. Second, the group is keen to keep up 2017’s steady stream of shareholder returns, which should continue with a further $1.9bn in buybacks in 2018, returning almost all of the proceeds of the Coal & Allied sale.

Third, Rio and coal have a checkered history. To wit, the group’s 2011 acquisition of several coking coal assets in Mozambique for $3.7bn, sold off three years later for $50m and now the subject of fraud charges brought by US prosecutors, ranks among the industry’s worst investments of the past decade. Fourth, and most importantly, a sale could open the door to the growing pools of institutional and private capital that eschews investments in fossil fuel exploitation. And with several major insurers pulling out of coal mine underwriting, Rio is clearly in step with a significant market shift.

So why does Glencore take a different stance? Put simply, it sees value in the mining and trading of an important industrial commodity for which there remains a global market. How this fits with the group’s self-certified status as the mining share to own for the electric vehicle age is anybody’s guess, although Glencore has always proved reliably contrarian.

This may be the year when BHP Billiton (BLT) also reconsiders its position. The Anglo-Australian outfit recently said it may leave the World Coal Association and the US Chamber of Commerce, citing differences between its positions on climate and energy policy. It is a peculiar stance for one of the world’s largest coal miners to take, although possibly reflective of a retrenchment towards fewer commodities and divisions. Lowering its exposure to thermal coal would also chime with BHP’s sale of its US shale portfolio, originally slated for 2019 following the encouragement of activist Elliott but which we think will be expedited amid buoyant valuations and sentiment in oil markets.

Whether such considerations factor into the thinking of Anglo American (AAL) – which sold its South African thermal coal business last year – or possible suitor Vedanta Resources (VED) – one of India’s largest coal-based power generators – remains to be seen. What is more likely to dominate sentiment at both companies is the copper market, which has entered 2018 with a host of factors driving up prices.

Even before supply disruptions and labour issues started to hover over Chile, the world’s largest supplier of the red metal, the fundamentals were pointing toward a tightening market. Indeed, the net ‘long’ positions in copper futures which mounted in 2017 suggested speculators had seen through the short-term spikes in inventory levels, and tied together two dynamics: bullish projections for global demand growth (especially in China) and limited expansion capacity at existing mines. As prices rise, so does the potential for a stand-off with mining unions in both Chile and Peru.

This backdrop helps to explain why copper pure-play KAZ Minerals (KAZ) is doubling down on production. After a seamless ramp-up of its two development projects, in late December the Kazakh miner gave the green light to a $1.2bn expansion of its Aktogay plant, which will double sulphide ore processing capacity from 2021. Net cash costs will be capped at an impressive $1.20 per pound of copper, and will be funded by strong cash flows from Bozshakol and existing production at Aktogay.