Is BHP calling the peak of the China boom?

BHP’s review may be a sign that growth in China is starting to cool

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The seemingly endless growth of China – which has largely been plain sailing for decades – may be starting to cool.

BHP Billiton chairman Jacques Nasser has reportedly told investors that BHP is reassessing its capital expenditure plans in light of the company’s uncertainty about our largest resources market, according to an article in the Australian Financial Review this morning.

BHP had planned to spend over US$20 billion developing its Pilbara mine and associated infrastructure. According to the AFR report, that intent is now being reviewed, with BHP looking at where Chinese demand for iron ore ‘is likely to peak’.

Taking a deep breath

BHP’s review is an eminently sensible move. The company is looking to spend very large chunks of cash on a mine that will operate for many years. Not only do Chinese volumes matter greatly, but once Chinese demand starts to moderate (and more production capacity comes on stream), pricing will come under pressure.

If you have a fixed asset that costs tens of billions of dollars to put in place, the last thing you want is idle workers and machinery, or pricing which doesn’t allow you to make enough profit to adequately cover costs (and make a profit for shareholders).

BHP may well decide, on balance, to proceed with its planned investment, or may scale back the size of the project.

Can the boom continue?

BHP’s review openly asks the question that many have been considering – how sustainable is this boom? Remember, volume of resources purchased is only one part of the equation. The far more important issue is the price paid for these resources.

BHP traditionally has some very low cost mines – a reassuring back-stop for investors should resource prices drop. It feels like ancient history with the gold price so high these days, but it wasn’t that long ago that some miners were mothballing gold mines simply because they couldn’t make money selling at the prevailing price.

While some analysts and investors may be concerned, or indeed disappointed, BHP shareholders should be thankful for the cool heads at the top of the corporate table. Many a fortune has been squandered chasing a never-ending boom.

Foolish take-away

BHP is showing that they are not going to be pushed into high-cost mining operations if they can’t be sure the mine will be economical throughout its life. BHP shareholders should hope the company sticks to its guns – and shareholders of other resource companies (Rio Tinto Limited (ASX: RIO), and Fortescue Metals Group Limited (ASX: FMG), for example) should be asking whether their directors and management are asking the same questions and exercising the same caution.

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Scott Phillips is a Motley Fool investment analyst. You can follow him on Twitter @TMFGilla. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691)

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