BHP investing for the long term

Last week, mining heavyweight BHP Billiton (ASX: BHP) surprised many in the market when it opened its new Daunia coking coal mine in Queensland, which is the seventh mine to run under the BHP Mitsubishi partnership.

Like most other commodities, coal has diminished in value significantly over the last two years as conditions for the sector have fallen to what the Queensland Resources Council believe to be the ‘worst in more than a decade’. With demand from countries such as China, India and Japan having tapered off, the price tag on coal has fallen to a four-year low of just US$145 per tonne, which compares to the US$330 recognised in 2011.

However, the partnership has decided to push forward with the Daunia project with BHP’s new coal chief Dean Dalla Valle insisting that the commodity has good long-term prospects. He said “I still see a good long-term demand trend for metallurgical coal albeit with the near term challenges.”

A similar view was expressed by BHP’s chief executive Andrew Mackenzie last month in regards to the prospects of fertilizer ingredient potash. When the company released its full-year results, it also announced that it would continue investing in its Jansen project in Canada despite near-term price challenges, instead taking the view that demand for potash would push its price up in the long term.

The company’s decisions to push forward with risky projects have not exactly fared well with many investors, who instead want to see significant cost cutting and increased shareholder returns. However, BHP has reduced its costs per tonne of production for coal to under US$100. According to The Sydney Morning Herald, the miner has cut coal costs by US$800 million to around US$3 billion.

To highlight how poor the conditions for the coal mining sector have been, Whitehaven Coal (ASX: WHC) has seen its shares plummet 71% since early 2011, whereby its shares fall from over $7.30 to just $2.15 today.

Foolish takeaway

Should BHP’s predictions be correct in that conditions will pick up over time, shareholders will be well rewarded. However, the sector still faces significant volatility and share prices will likely fall further before they start delivering consistent returns.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned in this article.

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