Beyond those projects that are currently in execution, which represent around 20% of our company valuations, there are numerous high returning growth projects which we believe should attract capital. This next wave of projects represents 13% and 18% of our BHPB and Rio valuations respectively and generates an average return of 20% for both companies with paybacks of just 7-8 years. These “probable” growth projects include; for Rio; the Pilbara expansion to 360Mtpa, de-bottlenecking to 415Mtpa and the OT UG. For BHPB these include de-bottlenecking the Pilbara to 270Mtpa, Spence Hypogene, US$4b per annum of US Onshore spend, and Mad Dog 2 and Stampede in the GoM. We exclude all other “possible” growth options due to the lower returns, longer paybacks and large capex. These include Rio's Simandou and La Granja and BHPB's Olympic Dam, Scarborough/Thebe, and Jansen projects.

Capex reductions already underway
While we are not advocating companies defer or slow down high returning growth, doing so would significantly reduce capex. Rio's capex would drop to US$5b by 2015 and BHPB's to below US$10b by FY16. Reductions are underway anyway as projects are completed. BHPB will likely announce a FY14 capex budget of between US$17-18b (we model US$17.4b) including a further US$4b of spend on US onshore tight oil but no other approvals. Rio's capex guidance for 2014 will likely remain unchanged at US$13b when including capex for Pilbara 360 and the Oyu Tolgoi but we expect no further capex approvals until November.

Eoin Treacy's view The fall in industrial metal prices has created a number of interesting dynamics in the mining sector from both a supply and consumption perspective. Major decisions are now being made which are likely to shape the outlook for the industry over the next decade. Let us look at this from both the supply and demand perspectives.

On the supply side industrial metal miners have invested fortunes in expanding supply following a decades long decline. The emergence of China as a major demand growth driver, over the last decade in particular, prompted this move. Competition to increase supply emerged as the price of industrial metals rallied from historic lows to post new all-time highs. A great deal of new supply is now coming on line while the demand growth projections used to promote expansion are undershooting. The miners are therefore posed with the quandary of whether to continue to invest in new supply in the hope that demand growth will accelerate or to wait until the supply / demand imbalance is depleted so that prices can rise.

An additional consideration from the perspective of miners is that the record profits they posted as commodity prices surged encouraged governments to seek a bigger share. This is likely to have a material impact on the economics of investing in additional supply in future.

On the demand side of the equation, just-in-time manufacturing has become ubiquitous for major industrials. While its tenets can be applied to any number of processes let us focus on commodity pricing. Throughout the 1990s industrial commodity prices trended lower in real terms, which facilitated just-in-time inventory management. Major industrials dispensed with warehouses and lowered holding costs in an effort to drive efficiencies. However in a rising commodity price environment, the argument for holding inventory becomes much more compelling.

More than 10 years ago one can imagine that the argument for allowing banks to become active in warehousing must have been seen as attractive since the sector had been in what must have seemed like terminal decline. However, offering well capitalised traders the opportunity to withhold supply is a recipe for higher prices. This article from Bloomberg contains some interesting detail on just how much supply is now held in warehouses. Here is a section:

Almost 2.1 million metric tons of aluminum is being stored in Vlissingen, enough to supply Western Europe for about four months. The city's LME-tracked warehouses held 62,250 tons at the end of 2010, LME data show. Stockpiles in Detroit rose to 1.47 million tons from 943,625 tons over the same period, the LME data show.

Glencore's Pacorini Metals has the most storage units in Vlissingen, New Orleans and Johor, while Detroit is dominated by Goldman's Metro International Trade Services LLC. In Antwerp it is NEMS, a unit of Trafigura Beheer BV, a commodities trader operating in 56 countries, LME data show. Trafigura, based in Singapore, increased its LME-listed depots by three to 45 since the start of January, ranking it fifth.

Trafigura will adjust the size of its warehousing business in response to demand, Victoria Dix, a spokeswoman for the company, wrote in an e-mail.

The LME said July 1 it is reviewing rules to ease waiting times. Warehouses with lines exceeding 100 days would have to deliver out more metal than they take in, the bourse said in the proposal, which will be reviewed by its board in October and take effect April 1 if approved. The LME was bought by Hong Kong Exchanges & Clearing Ltd. last year for $2.2 billion.

“It doesn't really matter whether the warehouse owners are banks, or trading companies or they are standalone entities,” said Craig Pirrong, a professor of finance at the University of Houston. “The real debate should be about the warehouse rules and whether the rules are creating artificial bottlenecks.”

As David pointed out yesterday, at Fullermoney we have long argued that commodities, with the exception of the precious metals, are not appropriate buy-and-hold investment vehicles because they are integral to the smooth functioning of the global economy. Simply put, withholding supply indefinitely is counter to the capital formation role of markets. Therefore we welcome any measures introduced by regulators to facilitate curtail this practice.

From a price perspective industrial metals remain under pressure. The slowing pace of investment in new mining projects is a medium-term supply concern. On the other hand, potential changes to how metals can be stored, traded and who will be permitted to do so represent a significant potential headwind. Tin has perhaps the most compelling chart pattern from a bullish perspective. Prices found support earlier this month near $15000 and a sustained move below that level would be required to question potential for some additional upside.

BHP Billiton (Estimated P/E 11.65, DY 4.34%) is an S&P Europe 350 Dividend Aristocrat. The share has been confined to a volatile range since 2011 and is currently rallying from the lower boundary. It will need to continue to hold its progression of higher reaction lows if the benefit of the doubt is to continue to be given to higher to lateral ranging. Rio Tinto (Estimated P/E 9.11, DY 3.99%) has a similar pattern.

Glencore Xstrata Estimated P/E 13.91, DY 4.89%) dropped to test the 250p area earlier this month and has rebounded somewhat. A clear downward dynamic will be required to check potential for a further unwind of the short-term oversold condition.

Considering the potential overhang of supply in the sector, in the absence of a new demand growth driver, the majority of industrial miners are likely to remain in medium-term ranges.