Tough Year for Miners and Commodities Firms: BHP Bilton, Glencore, Lonmin Battered

Miners and commodities firms' profits have taken a massive hit this year as economic crises destabilise prices, drag down production and slow demand while natural disasters, geopolitical conflict and delayed projects weigh heavily on groups' balance sheets.

With countries struggling to manage the eurozone sovereign debt crisis, the knock-on effect has left companies battling against dampened demand and production, as well as higher costs to keep afloat. In turn, commodity prices have been volatile as supply and demand fundamentals shifted rapidly over the last year.

In the latest set of company earnings data, mining giant BHP Billiton and commodities trading behemoth Glencore both revealed a substantial profit plunge.

Natural disasters are also weighing heavily on miners and commodities firms as the US drought has hit the agricultural sector.

Geopolitical tensions have infringed on projects and production, with London-listed Lonmin desperately seeking a cash injection after violent unrest and the killing of 44 mineworkers in South Africa led to the closure of the Marikana.

Delays to projects and production have also had an impact.

BHP Billiton, Anglo American and Rio Tinto are trading down 2-3 percent as of 12.41 GMT.

Supply and Demand Fundamentals

Mining companies have all faced weak prices for iron ore, copper, coal, nickel and aluminum as demand from one of the world's largest consumers of the commodities China slowed this year. Previously a double-digit power house for GDP growth, China is expected to grow at the weakest pace for more than a decade over the next 12 months.

BHP Billiton's profits collapsed by 35 percent across the year as commodities prices dropped across some sectors and softening demand from its largest iron ore customer, China weighed particularly heavily on the mining giant.

Along the same lines, only last month Brazil mining group Vale also reported its worst quarterly earnings results in two years.

Glencore, the Swiss commodity trading behemoth, blamed its 26 percent fall in profits for the first half of the year on the slump in commodity prices, as well as weakened demand.

"Financial markets were relatively optimistic entering 2012, following the sovereign debt-related challenges experienced during H2 2011," said Ivan Glasenberg, CEO at Glencore.

"This optimism generally faded as the half progressed and with it expectations for economic growth and commodity prices. Concerns over how precisely the European situation would and could be resolved have continued to erode global risk appetite.

"For the world's two most important economies, the US and China, 2012 is essentially a year of political transition. Each of these factors extends into H2 2012 and is likely to continue to hinder the gradual process of underlying economic recovery following the 2008 financial crisis."

Glencore's net profit, excluding one-off items, fell by 26 percent compared with the first half of 2012, to $1.8bn.

Elsewhere, Swedish steel maker SSAB blamed waning US demand for adding extra pressure on its business, already weighed on by economic issues elsewhere across the globe.

At the end of July, SSAB reported that its operating profit for the third quarter sunk to 775m Swedish krona (£74m) from 1.3bn Swedish krona in the same period a year before.

"In the medium term, beyond 2012, we see a clear risk of weakness in demand as our economists now forecast a relatively weak growth outlook for 2013, that is, notably weaker than that of the IMF," said a commodities outlook report from Danske Bank.

Natural Disasters: US Drought

In addition to the problems in the energy and commodities sector, agriculture is also feeling the strain.

HSBC published a report warning that the rising price of grain off the back of America's worst drought for 25 years threatens to throw parts of the world into social unrest.

"The drought in the Midwestern corn belt is having a devastating effect on corn production, and may ultimately have a significant impact on the global price of all foods," said Richard Bernstein, manager of the Brown Advisory US Equity Value Fund.

The knock-on effects of grains and soft commodities price rises can directly affect the cost other commodities in the sector.

For example, grains are used in animal feed for livestock, so the price of this commodity goes up or down in correlation.

The increasing use of biofuel in vehicles, which grains also help make, will mean the energy market will be hit by what is happening the corn fields of America, which is the world's largest producer.

Since the start of the year HSBC found that corn is up 25 percent, wheat 30 percent, and soybeans 42 percent.

The worst US drought in a quarter of a century has damaged crops and fresh data has shown that soybeans increased to a record price on the back of falling yields.

Soybeans futures have surged the most on the Standard & Poor's GSCI index of 24 commodities - by 43 percent.

"But much depends on government behaviour. With memories of Haiti's 2008 food riots and the Arab Spring (where high food prices played a part) still fresh, panic buying by governments and/or export bans would only exacerbate the problem and may cause social unrest," added Ward.

Delayed Projects and M&A

Mining and commodities companies' dwindling profits from the change in commodities prices has also meant that groups have had to delay crucial new projects.

When BHP Billiton announced its drop in profits, it added that it has been forced to delay the approval of any new projects until the middle of 2013 at the earliest and defer the expansion of another.

"With 20 major projects in execution with a combined budget of $22.8bn, BHP Billiton is largely committed for the 2013 financial year. No major project approvals are expected over this timeframe," said BHP.

The project in question was a major one. The Olympic Dam is the world's fourth-largest known copper deposit and largest uranium source and is one of the three massive projects that were due to go to the BHP board for final approval by December 2012.

Meanwhile, Glencore is still waiting for approval and one of the most significant M&A deals in recent history, worth $90bn.

The plans are still subject to regulatory and shareholder approval and the firm neglected to divulge details on this in its group statement.

However Xstrata's recent profit lapse and tough negotiating from shareholders make this merger look less appealing than before, leading to the Glencore boss saying it is "not a must do deal".

Glencore is already the largest shareholder in Xstrata with a stock holding of around 34 percent.

However, Qatar Holding owns a 12 percent stake in Xstrata and put up a hurdle to the deal in June, saying it wants a ratio of 3.25 shares in any newly formed entity from the merger for every share it currently holds. This is above the 2.8 ratio Glencore offered to Xstrata shareholders in its merger negotiations.

Glencore chief executive Ivan Glasenberg stood firm against the Qataris after his firm's first half results were revealed, hinting that he would drop the deal unless they agreed to his terms.

"We cannot understand the position of the Qataris, asking for more than the 2.8 ratio. We have seen nothing coming out of recent results that supports this, in fact we have seen quite the opposite," said Glasenberg. "It is not a must-do deal. It is a deal that we believe makes sense ... but if shareholders have another opinion...it is their choice."

Geopolitical risks

Meanwhile, geopolitical risk factors have taken a dramatic turn for some mining companies.

For the world's third largest platinum producer, Lonmin, miners were striking and staging protests, which led to police having reportedly killed 30 workers in the clashes in South Africa.

"Over the past couple of years, South Africa has witnessed a number of extremely violent strikes and protests partly due to worsening poverty, increasing social inequality, low wages, and poor social service delivery," the NGO Human Rights Watch said in reaction to the strikes.

However, the repercussions are huge.

According to the group's annual report, Lonmin has debt facilities of $945m, including $700m of five-year loans provided by seven banks in May 2011.

As with all similar project financing loans, the loans are subject to covenants "including a maximum ratio of net debt to earnings before interest, tax, depreciation and amortization of 4 times, and a minimum Ebitda to net interest ratio of 3.5 times."

The strike has threatened to breach these debt covenants.

To make matters worse, Lonmin loses around 2,500 ounces of platinum, at an estimated $3m, with each day of strike action.

"The balance of probabilities is that the impact on production of the current events will result in covenants being breached at the next test date on 30 September," said Lonmin, which has a net debt of $356m.