Welcome everyone to our 2018 interim results. I'm here in London, and Peter Beaven, our Chief Financial Officer, joins us from Melbourne. As usual, please note the disclaimer and its importance to today's presentation. Over the past 6 months, we have lowered debt, we've increased return on capital, and distributed more cash to shareholders. Yet there is still much that we can and will do to increase cash flow, capital discipline, value, and returns. Our agenda for safety and productivity will increase latent capacity across the portfolio. It'll grow volumes this year by 6% and get the most out of our investment dollars so that we can thrive at low levels of capital. If spot prices persist, free cash flow is on track to exceed $12 billion for the current 2018 financial year.
In the December 2017 half year, higher commodity prices and a solid operating performance combined to secure increases in underlying EBITDA to over $11 billion. Return on capital employed rose to 13%. Through disciplined investment in high return, low risk opportunities, we delivered free cash flow of almost $5 billion. We reduced net debt, and we increased returns to shareholders through dividends of $3 billion. That's almost $1 billion over the minimum 50% payout ratio. The health and safety of our employees and contractors and of our communities are core to all that we do. While Total Recordable Injury Frequency, or TRIF, this period fell to 4.1 per million hours worked, tragically, two of our colleagues died. One at Goonyella Riverside, that's in Queensland, in August, and another in the Permian in the Texas part of our shale business in November.
These fatalities have had a profound and permanent impact on families, friends, and colleagues, everyone at BHP. We are more committed than ever to learn from these events, to make sure all our people go home safe every day. We're committed to bring this about by how we design, plan, and execute every part of our work, and by how we make sure that the effective controls we require to eliminate fatality risks are firmly in place. Part of this involves our field leadership program. That's where leaders spend more of their time in the field on safety. That includes me. That's now recorded over half a million interactions in the first half. This is one way, an important way, that we create the culture that will eliminate fatalities and reduce injury rates.
We're also determined to make use of technology for a step change, not just in productivity, but also in safety. At Samarco, BHP's, our commitment to do the right thing for the people and the environment affected by the dam failure is strong. In Brazil, the Renova Foundation's compensation and environmental programs are making good progress. However, regulatory and licensing challenges have delayed the resettlement of some of the most impacted communities. On the other hand, the state prosecutors have now joined in the discussions with the federal prosecutor's office to settle the major outstanding civil claims. This is a positive development. Restart of Samarco is also important. However, as we've always said, it has to make economic sense and the effective approvals have to be in place. I'll now hand over to Peter. Welcome, Peter.
Thanks, Andrew. Higher commodity prices and a solid operating performance supported our results over the last half. We generated EBITDA of over $11 billion, up 14%, with a margin of 53%. Our underlying profit of $4.1 billion was 25% higher. Our attributable profit of $2 billion includes two exceptional items: $210 million related to Samarco, and a $1.8 billion charge as a result of the recent U.S. tax reform. The reduction in the income tax rate will clearly have a positive impact in the years ahead. Each of our commodities made a significant contribution to our operating results. Iron Ore generated EBITDA of $4.3 billion with high margins. While the unit costs were impacted by the Mount Whaleback fire and port maintenance, these will come down as improved supply chain performance underpins expected record volumes in the second half.
Higher oil and gas prices supported petroleum EBITDA of $2 billion. Our conventional business continues to generate strong margins, and higher than expected recoveries in our shale fields are pushing volumes to the upper end of guidance. In Queensland Coal, we had record production at 4 mines, but geotech issues at Blackwater and Broadmeadow meant that production fell. We've increased this year's cost guidance to $66 per ton due to these issues, although we remain confident of reaching our medium-term target of $54 as we continue to drive productivity and release latent capacity at Caval Ridge. Finally, in copper, Escondida's Los Colorados concentrator has now ramped up to full capacity, and Spence is currently beating its nameplate capacity of 200,000 tons per annum. As a result, total copper production was up 17%, and EBITDA nearly doubled.
The EBITDA waterfall chart highlights the gains from higher commodity prices, which more than offset the productivity challenges faced during the period. While underlying productivity momentum remains strong, this period it was masked by several one-off events. We've consistently said that productivity gains will be lumpy, and this is increasingly true now that the low-hanging fruit has been picked. The negative productivity of $500 million this period was largely attributable to Olympic Dam and BMA. At Olympic Dam, we've just completed a planned smelter maintenance campaign. It's key to the asset's integrity, which in turn is the foundation for our future expansion plans. At BMA, the geotech issues at Broadmeadow and Blackwater proved more significant than first anticipated. In other parts of the business, things are going well. Escondida positively contributed more than $200 million of productivity with the ramp-up of the third concentrator.
Western Australia Iron Ore delivered over $100 million of gains as we reached a record annualized production run rate of 284 million tons in the December quarter. As we move into the second half, Olympic Dam operations have restarted. The geotech issues at Blackwater have largely been resolved. We'll continue to creep production at WAIO, and our 3 concentrator strategy at Escondida is seeing record material processed. With this momentum, we're confident with our guidance of $2 billion of further productivity gains by the end of the 2019 financial year, notwithstanding some rising inflationary pressures. Operating cash flow was $7.3 billion. Underlying cash flow increased by $2 billion. As you can see on the graph on the right, this robust operating performance was offset by higher tax and other payments, including a $1.3 billion cash tax payment related to the jump in profit last financial year.
We generated free cash flow of $4.9 billion. It's a solid result, albeit down on the strong performance in the prior period due to the higher tax payments and CapEx, in line with our expectations. If current spot prices persist, we could generate free cash flow of more than $7 billion in the second half. To do this, we'll need to produce more and at lower cost than in the first half. This will no doubt have its challenges, but given our current performance, we think we can achieve this. Our capital allocation framework continues to be firmly embedded in every investment choice we make. During the half, we invested $1 billion in asset integrity. We preserved our balance sheet strength, and under the 50% dividend payout ratio, we paid out $1.8 billion.
With a $3.6 billion excess cash, we invested $2 billion in our high-returning development projects, we returned $500 million to our shareholders as additional dividends, we paid down debt. Our net debt was $20 billion a year ago, now we're at $15.4 billion. Significant reduction. This half, net debt reduced by $900 million. With $4.9 billion of free cash flow generated, $2.3 billion went to shareholders, $900 million went to non-controlling interests, predominantly Escondida. In addition, there was a $700 million non-cash mark-to-market movement as the U.S. dollar weakened. This was offset by the increase in value of the hedges included within other financial assets in the balance sheet. Our commitment to a strong balance sheet through the cycle is unwavering. As we've previously said, in the medium term, this translates to a net debt level of between $10 billion-$15 billion.
In keeping with our capital allocation framework and with some of our commodities trading above our long-term forecasts, we look to take net debt to the lower half of this target range in the near term. We also continue to make significant progress in capital productivity, our commitment to capital discipline means that we only invest in the best of our broad suite of quality projects. Our guidance for capital and explorations expenditure is unchanged, with a total spend of $6.9 billion this financial year. $2 billion of this will go into maintenance, which includes around $900 million of deferred stripping. $1.9 billion will go towards capital-efficient latent capacity and improvement projects. This includes infill well drilling in conventional petroleum and sustaining CapEx in Queensland Coal and Western Australia Iron Ore. We'll invest $1 billion in major projects, including Mad Dog 2 and the Spence growth option.
$1.1 billion will go to onshore U.S., where we continue to carefully assess our CapEx program rig by rig and completion by completion to secure the best value for shareholders ahead of the planned exit. Finally, $900 million to exploration. In the 2019 and 2020 financial years, annual capital and exploration expenditure is expected to remain below $8 billion. This includes the South Flank iron ore project, for which we'll seek board sanction in the middle of this calendar year. The capital cost for South Flank is now expected to be around $45 per ton. This reflects the stronger Australian dollar and updated estimates as feasibility studies have progressed. This spend will fit within existing guidance for sustaining CapEx in iron ore of $4 per ton.
In addition to investing in high return development for options, we've been steadily increasing the share of free cash flow distributed to shareholders. As a result, shareholders are receiving a higher proportion of the cash generated by our business, as illustrated here. Notably, this has been achieved at a time when we have also significantly reduced debt. As always, all future capital decisions will be determined by our capital allocation framework. The optimal balance between shareholder returns, investments, and the balance sheet will naturally evolve through the cycle. We think the balance is about right at this point in time. Once again, we present return on capital by asset. Over the first half, ROCE was almost 13%. Higher prices helped to offset one-off events. We're confident that our detailed asset level plans will drive continued improvements. Escondida reported a step up in returns.
With the ramp-up of the Los Colorados concentrator and no major capital investment required, you can expect further increases. Western Australia Iron Ore once again generated returns of over 25%. In the medium term, continued capacity creep, coupled with unit cost below $13, will support stronger returns. Smelter maintenance clearly weighed on returns at Olympic Dam this year. With the operations ramping up to full production and with access to higher grade ore in the southern mining area, the increase in copper production will continue to lift returns. In the onshore U.S., our focus is on maximizing the value of this acreage as we move forward with our exit plans. We announced in August that we classified our onshore assets as non-core. We're pleased with the progress that we are making and remain on track to complete the exit within the two-year timeframe we've previously mentioned.
On the trade sale, extensive work has been performed on each field to prepare for sale. The Fayetteville data room is now open, and the data rooms for the remaining fields will be opened in coming weeks. Assuming two to three months for due diligence, we expect bids will be received mid-year. Negotiation and completion of transactions would follow, and we would expect that this could take place in the second half of this calendar year. In parallel, we are evaluating the demerger and IPO options. There's been encouraging interest from potential buyers. The environment for sale is supportive, and we remain confident our exit process will deliver value. In conclusion, we remain absolutely focused on maximizing cash flow, maintaining capital discipline, and improving value and returns.
I'm confident we will continue to make strong progress in each of these areas in the second half of this year and well into the future. Back to you, Andrew.
Thank you, Peter. As normal now, our detailed insights on economic and commodity markets are available in the Prospects blog, which has been released today onto our website. Briefly, despite recent volatility, we are still optimistic on the short-term outlook. Global growth is healthy and sentiment remains positive. Our long-term view is also unchanged. Population growth, higher living standards, and a recommitment to free trade will increase demand for all our commodities. With our simplified portfolio, with the removal of close to a decade of cost inflation, and with lower debt, we are very well-placed for this future. Our commodities are geologically difficult to find and extract, and this concentrates rent in those value chains close to the mine gate or wellhead, and that's where our capabilities are at their most competitive.
Our large-scale assets are also biased to the production of high-quality products, and these are becoming even more valuable in an ever more environment-focused world. That production is low cost and hence benefits from steeper cost curves. It's our portfolio's blend of quality, scale, and geographical concentration that is the key differentiator. That's what provides us with a strong and long-lived foundation to enable high value, continuous improvement, and growth. At the same time, we lead and develop our people and our culture so as to create those distinctive capabilities which accelerate us towards those goals. Over recent years, we, I, have described our strategy to increase the value of BHP in six parts. Part one, first, relentless pursuit of safety and productivity. As you've seen from Peter's presentation, with $12 billion of annualized gains and much more yet to come.
Second, small, low risk, high return investments that release latent capacity. Third, the development of our strong pipeline of major projects, always in line with the discipline of our capital allocation framework. Fourth, counter-cyclical investment in exploration, which has delivered results. Fifth, a drive for industry leadership in technologies which unlock more resources through high-return investments, reduce costs even further, and as I said earlier, keep our people safe and healthy. Sixth, which you just heard from Peter, the realization of maximum value for the exit from our onshore U.S. acreage. We've made considerable progress in all six of those areas. In our Australian minerals assets, our Maintenance Center of Excellence has used leading-edge data and analytical techniques to drive significant savings in unit costs.
Despite some one-off setbacks in this half that Peter covered, we anticipate to add a further reduction in unit costs of 10% across our Australian minerals operations over the medium term, and that adds to the 50% reduction that's been secured over the past five years. For example, in iron ore, we expect costs below $13 a ton, chiefly through efficiency gains at the port. Autonomy matters, too, and our Jimblebar truck fleet is now fully autonomous. Technology continues to work its magic as well. It's improved the scheduling and throughput of the rail system. Just of yesterday, we have the approval to increase production to 290 million tons of iron ore per annum, and we expect to reach this by the end of the next financial year.
In coal, as planned, the Caval Ridge Southern Circuit project will come online early in the 2019 financial year. At Olympic Dam, after the completion of its maintenance campaign in the last half, it will unlock its potential as it moves further into the high grades of the southern mine area. Escondida's Los Colorados extension project reached full capacity in December, and its three concentrators achieved record throughput of 365,000 tons per day just last month. We plan to go beyond this. Our investment in desalinated water has put Escondida on track to average 1.2 million tons per annum of copper throughout the next decade, with minimal further capital. At Spence, we approved in the half the development of the 2 billion-ton Hypogene resource in August, and this adds almost 200,000 tons of copper concentrate production to Spence.
We want to create more options to grow in copper outside our current footprint, and we're mainly choosing to do this through greenfield exploration, and so we're pleased that we've just been awarded several prospective leases in Ecuador. In petroleum, we have a program of work in the U.S. and Mexican Gulf of Mexico and the Caribbean to grow our conventional business. In the near term, our rich pipeline of brownfield projects will partly offset the natural decline of existing fields, and these are projects which offer an average return of over 50%. The Northwest Shelf Greater Western Flank B and Mad Dog Phase 2 projects are on track. Similar opportunities are emerging beyond these. For example, a new tieback to Atlantis.
Because our Gulf of Mexico exploration prospects are near existing infrastructure, if they are successful, like our exciting discovery earlier this year at Wildling-2, capital costs and production lead time for those will be on the low side. Over the past six months, our long-term plans delivered solid results. We generated free cash flow of close to $5 billion. We increased return on capital to 13%, and we declared dividends of almost $3 billion. These are strong foundations from which to deliver our plans for the 2018 financial year. Copper equivalent volume growth of 6%, free cash flow at spot prices of more than $12 billion, and further debt reduction and shareholder returns. There is still much we can and will do. We are committed to maximize cash flow, committed to maintain investment discipline, and committed to substantially increase shareholder value.
We have everything in place to deliver significant further improvements in safety, productivity, return on capital, and ultimately, in returns to shareholders. Thank you. I think we're now ready for questions. Who would like to ask the first question? I think I've got Paul Young from Deutsche Bank on the line. Paul, go ahead.
Yeah. Hi, Andrew, and hi, Peter. A few questions on Escondida. First of all, on the labor negotiations, Andrew, how will your strategy differ this time to avoid a prolonged strike? Just on the plant throughput, the theoretical throughput of all three plants is around 380,000 tons a day. Just interested in the early stages of ramp up, what are you running at the moment? Any insights-
Paul, can I stop you a minute? We have a sound problem here in London. I got the question about the Escondida labor, but I didn't get the question on the ramp-up. Could I ask the technical people to see if you could fix this? I'm sorry about this, Paul. Look, while we're waiting, let me just talk to the first part of your question, hopefully we'll get it fixed so we can ask it again. Sorry, just a minute. No, I can't hear him, and obviously this wasn't checked earlier. Paul, look on the industrial relations side, it's very hard for me to give you a firm answer to that question.
Clearly, as you know, from July, the workforce has a legal right to go back on strike as we start, I think, or restart the negotiations that we broke off 18 months ago. I can tell you that since that, the return to work has been very positive. You've heard some of the results from Escondida. Morale is strong and relationships at the moment are very positive, I think, on that site. We fully intend to talk to the union and talk to them about the possibility of getting a settlement ahead of when it's possible for a legal strike. I can't say more than that, clearly our intentions are not to undertake a disruption to our production.
We also have the long-term aim of making sure that when we get through to the latter part of the next decade and we're producing at a much lower grade, we have a cost structure that still makes it competitive to invest at Escondida.
Hey, Andrew, can you hear me?
I can hear you now. They put a speaker next to me, which is much better. If you ask the second question.
Okay, great. Yeah, it was actually on the upside of Escondida. With running your three plants, the theoretical throughput is 380,000 tons a day or thereabout. I'm just wondering what rates have you been running at recently with running all three, and do you think you can actually achieve the 380,000 tons a day sustainably? Thanks.
Well, we've been running just in December at 365,000 tons a day. I would certainly hope that the team there can get to 380,000 and beyond sustainably. I'm very optimistic, a bit like you've seen in iron ore and coal, that having created this investment platform over the last few years, which we don't really need to add to in the near term, that some of the best new latent capacity projects are going to come out of Escondida in the years to come that will mirror some of the success we've had in some of the iron ore and coal assets in the preceding years. Yeah, I'm sure we will get to 380,000 and more sustainably.
Okay, great.
Thanks.
Lastly, Andrew, just on oil exploration. You reset the exploration strategy two years ago. Just wondering how would you mark yourself so far on the conventional exploration?
Seven out of 10. Obviously, pleased with the discovery at Wildling and at Le Clerc, and we're looking at how best to commercialize these right now. I include in that strategy, Paul, the very successful bid that we had in Mexico, where we won the opportunity to be the operator of the development of Trion. I think with hindsight, looking at the more recent licensing round in Mexico, where we were significantly outbid, I think there's a lot more interest come back into that market. We timed our bid in Trion, I think, very well at, if you like, at the low point in the cycle. I think everything we know about Trion, and as we continue the process to get on with appraisal, leads us to believe that this is a very effective catch.
There's a lot of exciting prospectivity now in the Western Gulf of Mexico. Again, during some of the fallow years for the oil price, we've been extremely good at picking up some very attractive acreage. Seven out of 10, but I'd like a 10.
Okay. Thanks, Andrew.
You're welcome, Paul. The next question's from Clarke Wilkins.
Hi. Just, first question is probably for Peter. Just in terms of the unification, like, the Elliott proposal, the big difference still seems to be in terms of the tax losses and whether they can be maintained or not. Is it as simple as that sort of top-hat structure that they propose? Or is there something else that they're not aware of, or we're not aware of, that just drives the higher cost that just doesn't justify the collapse of the deal fee at the moment? The other question, just in terms of the increase in the payout ratio versus buyback. What consideration was given there, given obviously to get the cash for the U.K. to pay the increased dividend, again, you're sort of diluting the franking credits down.
Any considerations, is there a better way to return those franking credits through off-market buybacks rather than upping the payout ratio?
Clarke, can I suggest that Peter answers the whole of the second part of your question and deals with the detail of some of the costs related to the loss of tax cover on PLC revenue from unification. If I might just answer a bit more broadly aspects of your question. If I broadly aspects of your question, what I'd like to say is Sorry, I'm being a bit distracted by the sound and the technical problems that are still not been quite ironed out here. Let me just collect my thoughts a bit. What I wanted to say is that there's a huge difference in the valuation that we would put on unification, depending on the assumptions that you make around the mix of the shareholding in the unified company and how many of those shareholders are resident in Australia.
That difference drives how many of the franking credits will be wasted and how many of them can be used by Australian resident shareholders. That range creates a wide range in valuation. From something that can be quite positive, but something that can be quite negative from unification. As I've said in several media interviews this morning, we have to understand that. We have to reduce that risk considerably, and we're working on that. We're very open to the ideas around that, before we might rush to move towards unification. Then we have to consider the cost that Peter will now describe. Go ahead, Peter.
Clarke, just on tax losses, just a quick recap. Probably around about $1 billion worth. Two material sources. There are three sources, two of those are material loss. Losses in what was Worsley and so on. That is offsettable against the profitability of New South Wales Energy Coal, which as you know, is a highly profitable asset. Now we have, how to say, more or less over $2 billion worth of assessed losses in that grouping. You can see that is worth a lot of money to us, to utilize that against a very profitable asset. It's probably NPV in the order of $600 million associated with that. In the other part, the other material part, of course, is the Singapore, the BMAG profitability. You know that is again, a profitable entity. You know that our tax rate is zero, essentially, in Singapore.
You also know that only 58% of that gets taxed in Australia, therefore 42% is really the benefit, I think, to shareholders. There is some more stamp duty. In the event that we collapsed, the issue is that in fact those costs, we would in fact not be able to take advantage of those tax losses. The issue for the Australian tax group in PLC is that it would essentially dissolve. The only thing you could maybe restructure ahead of any reunification, but you'd have to have a good business purpose. The ATO is somebody They look very closely. They're smart folks. We'd have to work our way through that. The second part is really around Singapore. Again, we have this ongoing conversation with the ATO. It's a matter of a difference of opinion on the price that we are charged.
It isn't going to go away from with the collapse. They're very different, independent issues. That's really the issue. The costs are there, and they're not going to go away as a result of the unification. In fact, we'll lose the benefits that we have. That's really a basis of that. On the payout ratio versus buyback, every time we go, we have a think about buybacks versus cash returns. One thing, though, there's a couple of things, two things basically, around buybacks. One is that you're buying something, so you need to be sure that you're actually buying something for value. You know what you have to pay for it. You have a pretty decent idea of what it's worth, because it's our company. We got to tick that box. The other box you got to tick is it's got to be material.
In this half, we declared a dividend of 17% above the payout ratio. Of course, the payout ratio has to go in cash. That's $900 million, that's just not material in a company of our size.
Okay. Look, Clarke, if I could just add to the first part of the question. We are going to be spending a lot of time on the road, Peter and myself, and with some of our colleagues. We will be talking to a wide range of shareholders, including, by the way, Elliott, about their most recent proposal, but also about what we understand around the unification of the DLC based on five years of work. I personally have been studying this since I became CEO in trying to find a way through, because we are attracted to the simplification that comes from unification. I think what you've heard from myself and Peter, at the moment, there are enormous risks in assessing what the value might be, from pretty decent to ones which are actually value-destroying.
Until we can reduce that level of risk and increase the level of expected return from this type of transaction, we'll handle it exactly the same way we'd handle capital projects. We have to get the risk return right. We are open to ways in which we can do this. Things can change externally. We can bring about changes internally. We see this a lot with these sorts of things, and just last week, we saw RELX choosing to unify after many years, I think, in their case, of studying it, through external changes and things like Dutch taxation and internal changes that they did. In the same way, we are working towards and waiting for the stars to align. We are always open to ideas as to how we might unify and make our company more simple, if that's the right thing to do.
I have no doubt we'll hear a lot more this week, and we'll probably talk to you again as shareholders. Who'd like to-
Thank you very much.
You're welcome, Clarke. Next question's from Sylvain Brunet, who's from Exane. Sylvain?
Hi. Good afternoon, Andrew. First question maybe on the supply chain and potential implication on cost. Have you experienced in any part of your business any tightness already in consumable or spare parts which were made in China, and impacted by the supply reforms? We heard that on electrodes, for instance. My second question is on Escondida again. If you could tell us a bit more beyond the moral and the results at Escondida, what would you say is different from last year, obviously other than the copper price, which is 20% higher? Lastly, if I may, on strategy. You talked positively in recent times about electrification. One metal that comes to mind is obviously lithium, where there are probably more opportunities than in cobalt, for instance. Conceptually, is that an avenue BHP could consider? Thank you.
Okay. Let me try and remember all three. I'll try and do them in this order. I don't have anything specific to add about, if you like, supply chain inflation. We're seeing pockets where prices are up a little bit. We have a new and globalized supply organization. There are obvious things, of course, the flow-through of higher oil prices. Some of the, if you like, margin resets that we've seen in the steel business. I think we feel with our productivity agenda and the way that we buy the goods and services to do our businesses, that we are able to quench the small amounts of inflation we're seeing, and continue to drive our unit costs down through our productivity agenda. I didn't quite understand your question on Escondida. I think what's changed from last year to this year is we now have three concentrators.
We now have our new desalinated water supply working. We have relatively unconstrained sources of electricity. We are able to substantially ramp up the amount of ore that we can process. While grade has remained reasonably constant, this is resulting in a much higher production of copper, and that's likely to continue. Of course, now with more of the ore going to the concentrators, the tank house is no longer full, and we'll be looking at ways in which we can fill that to possibly increase even more of the production of copper from our Escondida. As I said on the talk, we've invested majorly, and we don't really have to invest again now in a significant way to ramp up production and hold it at around 1.2 million tons per annum for about 10 years.
Sorry, Andrew, to be clearer, my question was really on the parameters of the wage negotiations. Should I be clearer?
Okay. These are things that we still have to talk about with our union, and I'm not really wanting to negotiate at that level of detail in public. I think in my answer to Paul's question, you heard roughly where we're heading to maintain, in the long run, a competitiveness at Escondida that makes it investable in 10 years' time when it's more of a 0.7%-0.8% operation. Your supplementary question, what was your third question again? I had it in the-
Lithium.
lithium. I've been very clear. We do believe in the trend towards electrification, but our best way of benefiting from that, we feel, is growing our copper business. The copper market, even when you look for all the increases that are likely to happen, and certainly compared to lithium, is at least 10 times the scale. For a company like BHP, that is our best way of participating in electrification. While we have it, we get a small kicker as well from nickel.
Thanks, Andrew.
Thanks, Sylvain.
Our next question comes from the line of Jason Fairclough of Bank of America Merrill Lynch. Jason, please go ahead.
Hi, Jason.
Peter, thanks for the call. Two quick ones for me. First, just on the productivity gains. You talked about $2 billion. Just to clarify that this is going to be before uncontrollable factors such as oil and currency. I guess, given what's happening with oil, with the AUD, to what extent do we actually see anything drop through to the bottom line here? Just secondly, there were some passing references to potash in today's presentation. Could you please remind us of the sunk capital in Jansen and maybe frame your current thoughts about that market and the project?
Let me give the first question to Peter, because he'll tell you the detail of the productivity calculations.
Jason, as you say, the productivity gains, how we calculate them is before prices for inputs, and that's no change, foreign exchange and so on. To the extent that those things come through, that obviously has an impact. As we said a few times before, in the event that we have a high oil price, of course that is net a very good thing for us. FX will do what it does, but it tends to, as we know, flow through everybody's results, and of course that then has an impact on price. More or less, I think the most important thing, I think correctly, we call out what is controllable. As we said earlier, I think we're on track for an additional $2 billion through the course of the next financial year.
I think as we have done in the past, and you can touch it and you can feel it with the $12 billion, I think we would expect that we would be able to touch and feel it in the form of cash.
Okay. Peter will give you the detail on the potash capital. Let me just remind you that we're not going to make a decision on potash for at least another year. While we are continuing to sink the shafts, that work is going well. It's about 85% complete, and we're through all the technical difficult areas now. We're well below the freeze level where the ground is frozen, and our excavating technology is working well. We're on track Probably quite shortly into this year to actually get into the ore body, and then we have to think about permanently lining the shafts so they're ready to be developed when we choose to do so. That's a decision that is at least a year, probably more away. We signaled that recently.
In terms of the actual capital, we've spent most of the capital that was sanctioned for building the shafts. Peter, I'll give you the detail of the numbers as the CFO.
We have $3.5 billion sitting on our balance sheet, that's what you see in the ROCE chart. Obviously, happy to take any questions offline on that.
just to be clear, though, Peter, as a statement of the obvious, maybe, if we start looking at decisions on whether to invest more into this project, we take that $3.5 billion as sunk, it's an NPV from here calculation?
That's how the corporate finance theory will tell you, that is probably absolutely the right thing, unfortunately, in many ways. It is what it is. I think this will be, in the fullness of time, I think it's a good option. It's conceptually a good business industry to be in. We have to work really hard to make this thing make sense. There's no doubt about that. It'll have to go through the capital allocation framework. We've said this many times. We'll continue to say it. We've demonstrated it on many other types of projects in other commodities. It's not going to be any exception to this one. We've got our work cut out. We've got good teams. We've got options. If it doesn't make it doesn't make it.
$3.5 billion on the balance sheet today. To get it to the point where you even think about the next investment, what do you think the sunk capital is going to be? Is it going to have a five in front of it?
I think we continue to work the project, Jason. At the moment, we're looking at something relatively modest, but which will deliver a project on a cash basis which will operate at the bottom of the cost curve, and it will use very much the ore body very close to the shafts we're sinking. This is something we work all the time while we wait to think about our decision, as we do with many projects, to see what is the right thing for this company. If I refer to your own conference when we presented a while back, or I think it was in August results, we laid out in some detail the optionality we are considering. I think when we make some choices around that, we'll obviously be completely transparent with the market about the costs involved.
Okay. Thank you very much.
Thanks.
Thanks both.
The next question today comes from Myles Allsop of UBS. Myles, please go ahead.
Great. Yeah. Three quick questions, please. First of all, with the Iron Ore business in the Pilbara, do you think you can creep it beyond 290 million tons, or are you going to be constrained by the licenses now? Secondly, can you just give a quick update on Samarco? What needs to fall into place before we can see a restart? Is a restart possible during calendar year 2018? Is it likely? Thirdly, just going onto sort of the onshore process. Clearly, it's been a bit of a slow start, but it looks like we've got good momentum. If you get $10, $12 billion coming in, will you consider out-of-cycle capital returns, or will you wait until this time next year before deciding what to do with the cash? Thank you.
Okay. Gosh, I should write these things down. Just give me the three headlines again, because I had answers to them all, quick ones.
290 Iron Ore.
Oh, yeah. Okay. Yeah. 290 Samarco, obviously the cash from shale. We've just got the 290 approved, we are confident that by the end of the next financial year, we can produce at that level. I think that's all I would want to comment on at the moment. This is a system that we continue to work, the way we can creep its productivity by, we've done a great job on rail. We're now very much applying ourselves to the port operations, trying to do that with a minimum amount of capital. Once we get closer to 290 in a year's time, we'll talk some more then. I'd rather not go beyond that at the moment. The restart of Samarco, there's a number of things that we have to get right.
I think if I might just back up a little bit where we are right now. I kind of talked about it very briefly on my presentation. We now have all the parties sitting together working on something that we call Framework 1.1. Framework Agreement 1.1 is an agreement which we hope to reach, the target is April, certainly by the middle of this year, with all the parties on progress towards settling all the outstanding civil claims, the data that will be sought from that, the consultations that will be required in order to get what we call Framework 2.0.
That is very important that we iron that out first, so that we understand what everybody wants and what we agree to provide in terms of the restitution of the damage, and in many cases, the social disruption that was caused by the failure of the dam. Certainly once we get to Framework 1.1, we can start thinking then beyond and to what is the likely fate, if you like, of the Samarco operation. We want restart to happen, as I mentioned in the talk, but there's several things that we need to get right. We need to get the economics right. We need to understand the best way to run that business. We, for sure, are not likely to go back to the sort of independent non-operated joint venture that we had before. I think Vale and I, and Vale and BHP are very much agreed on that.
The exact look of that is something that we still have to discuss as restart becomes more likely. We haven't yet got all the approvals that we'd be required to restart, and we also need to get an appropriate settlement with the bond holders, who have yet to come to some sort of compromise with us as the equity holders on what part of the, if you like, the costs of cleaning up Samarco, that they should bear. There's quite a few things that need to come together, and they need to come together in a way that makes economic sense for restart to occur. Of course, we would like that to happen, and we'll be working with that intent. Also we will be, as all things, looking at it through the capital allocation framework.
Peter might want to add to this, but as to the proceeds from shale, again, I would say one thing at a time, Myles. The important thing is that we need to get these transactions done. We'll need to then, as usual, do our long-term plans, look at our cash flows, and when we come back in August, of course, we'll have a little bit more certainty around that. Possibly not then on the sale. I take slight issue with your comment that it's off to a slow start. We always said we'd give ourselves two years to maximize value. I think against that timetable, we're doing very well. All the data rooms will be open in a matter of months. The flyers are already out. We expect to receive bids by the middle of the year.
There's a lot of things that need to come together before we would want to give you the more firm guidance that you seek, and we need to put it in the context of how the world's markets look in six months to a year's time as we normally do in a more fundamental way around August. Though by then, we probably won't have exact certainty on how the shale sales are going, but much more than we have today. I don't know if there's anything you want to add to that, Peter? No.
It's a matter of weeks, not months, Andrew, on opening of the data rooms.
Sorry, I misspoke. Yeah. It'll be open by March for sure.
Out of cycle returns on what are the options you have?
We'll talk to you about that when we have more certainty around what our cash flows are.
Okay.
Our next question today comes from the line of Menno Sanderse of Morgan Stanley. Menno, please go ahead.
Yeah, morning, gents.
Hi, Menno.
Just two questions around the targets. The company remains exceptionally confident in the $2 billion efficiency savings despite what most people would argue is a two out of 10 in the first half of financial year. Could you just give us a bit more detail why you are so confident? Especially in met coal, you're still targeting $54 cost, for instance, which is far away from where you are today. Are these ambitions now more aspirational, or do you still think you can really genuinely get there? Secondly, on free cash flow, clearly a very good number for the full year, over $12 billion. Are there any big swing factors in the second half versus the first half, for instance, working capital or taxes, that inflate that number a little bit for the full year? Thank you.
Okay, I don't believe so to the second part of your question, Menno, but I'll double-check with Peter after I answer your question. I think two out of 10 is a little harsh. I always said that as we find to get into the, if you like, the harder territory on productivity, that delivery was not going to be monotonic. It was going to be a bit lumpy. We were very clear that we were going to face a one-off hit from the Olympic Dam shutdown, and that some of the other things were going to be a little bit slower in coming to compensate for that. Obviously, we've added to that some of the difficulties that we faced in coal. They're partly geotechnical, but they're partly down to the impact or the long impact of Cyclone Debbie. Four out of the six BMA mines are actually beating their targets.
They're just held back by geotechnical problems at Broadmeadow and at Blackwater, which we're more or less through right now. I think it's a bit better than aspirational. If you look at some of the other businesses, there's a lot of things going in the right direction. We did 284 million tons at iron ore in the second quarter. Quarter-on-quarter, we took about $1 out of unit costs at iron ore. The $54 a ton for coal, that's in the future. We've guided to 66 for the full year, and of course, we had the difficult first year, which was at 71. You've heard a lot of the answers to the questions on Escondida.
The ramp-up of OGP1, and obviously joined by the desalinated water, has gone well, and that is unquestionably creating the potential for further increases in both recoveries and throughput to maximize the capacity of that system. That's something we'll see later on into FY 2019, but in time, I would say, to secure a strong delivery of those productivity targets I could go on. Obviously, Olympic Dam now into the Southern Main area gives us an opportunity to chase productivity in that area as well. We've had good results, even though we're selling the business from our trials in the shale business on different wells. They're being more productive than we had expected. We continue to work at pushing availability, reducing the number of shuts we have to take.
There's not many in the back half of the year, that partly answers the second part of the question. We're extending the time between shuts, which means we have more producing time, and it means that we're spending less money on shuts. A lot of things. I could probably go on, but the list is very long in order to give us the security that we really are still very much driven to derive further productivity benefits, including reaching the 2 billion target. I'll just double-check with Peter that I haven't missed anyone else, but I don't think I have. I think the second half is much cleaner than the first half. Peter?
I think, Andrew, there isn't anything unusual coming in the second half that we know of at this point in time. We've got our work cut out. There's no doubt about that. The second half has to be better than the first half. We always expected that. We have the operations running where they are today, we're thoughtful about maintaining that guidance. Of course, if we make $7 billion in the second half, well, it's price. Price will be important whichever way. We're not making that as a guidance. It's just the way it is with spot prices today.
Certainly. Thank you.
Thanks, Menno.
The next question comes from Glyn Lawcock of UBS. Glyn, please go ahead.
Hi, Glyn.
Good morning, Andrew. Hey. Just going back to WA iron ore and the 290. You've answered a lot of questions on it, just a couple of things. Firstly, you're not far off 290. You're within sight of it, but how do you think about that with respect to the market? Is there anything you have to do to get the 290 material? My other question is just on slide 17, which I found quite interesting. You're obviously balancing cash and returns, and on top of that, there's an extra bit that's missing, which is you're paying down debt. Once you're at the sort of bottom end of your debt range, which is where you say you want to get to, given the current environment, how should that chart look?
Is that the new BHP where you're going to be balancing or will we see that swing the other way where that net line actually moves more into the return? Just thinking how you think that chart looks a couple of years out once your balance sheet's where you want it to be. Thanks.
Okay. Look, I'll come back on the iron ore question in a moment, we make these decisions on the basis of our capital allocation framework. This is not some kind of new metric around balancing, it has become more balanced because we've got our debt, as of the 31st of January, into the $10 billion-$15 billion range. We don't want to go outside that range, we do want to drive to the bottom part of the range. It does mean the majority of the free cash is either going to be invested in the business or it's going to be returned to shareholders. We've been very clear that we're not going to allow capital to go above $8 billion out to 2027 or $6.9 billion for this year. It's not really targeting a balance.
It's just illustrating that it is more balanced, if I could put it that way, and that was the purpose of that chart. Is there anything you want to add to that, Peter? No.
No. Glyn, when we get there, guess what I'm going to say? We'll run it through the capital allocation framework, we'll come up with the right balance between the balance sheet, the returns to shareholders, and investment. Clearly as we get our balance sheet to where it needs to be, we're there inside of the, in fact, our medium-term range today, the guidance on CapEx is unchanged. We want to give, we need to give more cash back to shareholders. No doubt about that. That line will take care of itself.
Can I just ask then?
Go ahead
If an opportunity comes along, would you move outside the debt range?
You mean back up again?
Well, yeah.
Peter?
Is that now a very hard ceiling for you?
Glyn, again, sorry to say that you probably predict what I'm going to say. It would depend on the opportunity. We do think about our balance sheet on a stress-tested basis. We do two things on our balance sheet when we think about what's strong. First of all, we need to make sure it buffers the downside. We, of course, stress-test it for prices and so on that we have seen in the recent past, which would, in our modeling, persist for an extended period of time. In addition to that, we also model a countercyclical investment, and we want to make sure that we can both buffer as well as be offensive, if you like, countercyclical in acquiring something, some unknown asset that may just come to the market in the event that everybody else became distressed. We think we're good on both parts.
This is really the basis of the $10 billion-$15 billion range that we've provided. We would be able to make an acquisition and retain a strong balance sheet. That is a balance sheet that would, for convenience sake only, always have an A in front of it.
Yep.
On iron ore, I can't add much to what I've already said, Glyn. Clearly, some of the discussions I had about extending shutdowns, that applies to iron ore. We have used a lot of work in tightening the way we run our rail system, improving its maintenance, shortening turnaround times, increasing throughput. We're doing all the same work on the port to creep towards 290. It's lots of little small things as we orientate so much of our workforce to make themselves and the equipment that they operate more productive, more available, higher utilization. We get there with minimal amounts of capital.
Sorry. Maybe, Andrew, I'll rephrase my question then. Apologies. What is the first priority for iron ore? Is it 290? Is it return on capital? Is it margin? I'm just trying to understand how is the 290 a must achieve.
Well, the first priority is obviously return on capital or, if you like, shareholder value. In the case of iron ore, through the ability to add tons at almost no additional capital and no additional cost, then that correlates perfectly with boosting the return on capital employed.
All right. Thank you.
Thanks.
The next question today comes from Lyndon Fagan of J.P. Morgan. Lyndon, please go ahead.
Hi, Lyndon.
Thanks very much. Look, my questions are on costs. The first one is just in relation to iron ore. I'm just trying to understand the cost increase a little more clearly half on half. You've reported about AUD 1 a ton increase in Aussie dollar costs half on half, which compares to a bit of cost out from Fortescue and Rio. I guess when you benchmark against the key peer group-wide costs went up, it'd just be good to understand that a little bit better. I guess on met coal, you've retained your $40 a ton medium-term cost target. You're sort of in the 70s now, I guess I'm struggling to work out how you get to that 40. Thanks.
There are quite a lot of numbers in there. I'm looking at Peter, but I think our medium target is $54 a ton, not 40. Am I right? Yep.
That's correct. I think maybe New South Wales Energy Coal is 40.
Yeah
in the medium term. Queensland Coal is a little higher than that.
Yeah.
I guess, anyway, I'll stop there. Andrew, you can take the rest.
Okay. On Iron Ore, there's some detail in there of one-offs on the half on half. I think on the full year to full year, we have reduced costs, I think by about 2% or 3%. If we take calendar year to calendar year, I also think, from memory, we've reduced costs from first quarter to second quarter by about $1 a ton. As I was saying, there can be one-offs, it can be a bit lumpy, but our trajectory is down and we are confident of, in the medium term, getting below $13.
Thanks. Yeah, that was my bad on the 40. Just a quick follow-up in relation to South Flank. You've talked about what happens to the weighted average Fe content and lump proportion after bringing that on. Just wondering if you could share how it influences costs. I imagine it's a higher cost asset than Yandi. Yet you've still got your $13 sort of cost out or cost going down to $13 in Iron Ore. Just wondering how that sits in there if costs potentially go up from 80 million tons of ore coming in.
Well, I think there's a lot of detail in there that I'd rather handle with you offline and possibly through the IR team. We haven't actually finally agreed the definition that will be moved into execution on South Flank. We're a few months away from that. At the point when we do that, we'll be very clear to lay all these things out for you, Lyndon.
Thanks.
Our next question comes from Grant Sporre of Macquarie. Grant, please go ahead.
Hi, Grant.
Good morning, everybody. Just a follow-up question on Samarco, if I may please. Earlier this year, Vale indicated that they would look to wanting to own 100% of the asset. I'd just like to know from your perspective what sort of milestones you would like to see in place before you contemplate, let's say, the sale of your 50% to Vale, if indeed you were to consider that. Thank you.
I think that that's a very high level of specificity. There are many ways other than running things through a non-operated joint venture that we might run Samarco, were we to achieve a restart. Of course, we are engaged. We're always engaged with Vale. We've had a good relationship since the terrible disaster happened. We go backwards and forwards on the best way to make it work. We're really not at the point of getting to the final stages. We're looking at all options. As I said earlier, the most important thing we need to do now is to complete Framework Agreement 1.1, which puts us on a trajectory to get a full settlement of all the remaining civil claims.
Once we have that, we start to see the approvals become upon in Samarco, we think a bit more about how we deal with the bondholders, then we will continue to work with Vale on what is the best way to run the operation. What is the best perspective from the perspective of BHP? What is the best way that we can retain influence over that operation? Most importantly, the influence that we have on the ongoing cleanup of the environment and the resettlement of the affected communities. Also, dealing with a lot of the compensation issues through the Renova Foundation. It's a complex set of things that we have to work together. We have to have our influence felt, and we also have to look after the return on capital employed for the BHP shareholder. That will be preeminent.
There are so many moving parts that the level of specificity you're asking me to do now is, I think, a little bit premature.
Thank you very much.
Thanks, Grant.
The next question today comes from Fraser Jamieson of JP Morgan. Fraser, please go ahead.
Hi, Fraser.
Yeah, morning, Andrew. Good evening, Peter. Thanks for taking the questions. The first one's just an extension, actually, on that question on Samarco and non-operated JVs more generally. I think you previously spoke about feeling that those were probably unsustainable in the long term. You've got a couple of other ones in the portfolio other than Samarco. Can you maybe give us your latest thoughts on that structure in general and how we might see that developing over the medium to long term? Then the second one is, if we assume a successful sale of the U.S. onshore assets, your volume growth profile will look much more limited at a group level than it currently does now. I'm just wondering, how comfortable are you with that dynamic?
Do you think this is a business that needs to grow in volume terms, or can you still drive enough earnings growth through other means? I'm thinking about that particularly in the context of cost inflation returning, adverse FX moves, et cetera. Thanks.
On the non-operated joint ventures, not a lot more to report, Fraser. We've been very clear that we're never going to enter into one of them again. We've also been clear we don't believe that the non-operated joint venture structure, independent non-operated joint venture structure, could be blamed for having caused the dam failure. There's no doubt, these are things that were set up a long time ago. I think with the modern sense of, if you like, accountability, that we would feel they're not the right things to do in the future. However, unwinding the existing ones when you don't have the impetus that I've been talking a little bit about the Samarco restart and the knowledge and the sense that we both have between ourselves and Vale is not straightforward.
Our other shareholders are perhaps less motivated to make changes to the arrangements than we might be. We obviously have to, through all of these things, protect value for the BHP shareholder. Long term, I don't think you'll ever see another one like it within the BHP portfolio. We would hope that by then we had reformed to something different and, at best, more in line with, say, a joint venture where there is a nominated operator from one of the major companies that is commonplace in petroleum. Other than Samarco, this I think, will take time for reasons that you can understand because of the different motivations of the other shareholders. One word, I'm sorry, I should write these things down. Your second question, I did have an answer.
The second question was just around volume growth for the group-
Yeah
post-
No, fine. I've got it. You've heard me on this before. We do not have volume targets either for the company or for individual commodities. We assign capital through the capital allocation framework to the projects which offer the most competitive return and compete effectively with returns to shareholders. We want to create options that can compete for that capital across our portfolio, but we're not driven to simply replace volume as a result of decline at a higher level than driven to get returns or even to increase volume. It can be, at the company level, a reasonable surrogate, if you like, for growth in free cash flow and growth in value. We'd rather measure the dollars than the tons or the barrels. That's basically the answer.
Because of that, and we've looked at that from a number of angles, including the climate change angle and how that may change the demand for our products. We always feel there are several ways in which we can grow value and cash flow, and therefore grow volume, with different mixes of commodities, depending on how the markets for those commodities evolve. That's part of the benefit of the diversification that we offer within BHP. I think in oil, we are clear that having pivoted back towards conventional, we would like to create a few more options that could compete for capital within those constraints. That's why we do have a fairly significant exploration program. Why we went for and won our bid for Trion, and are interested in a number of brownfield operations within our existing footprint. They have to compete within the capital allocation framework.
Got it. Thanks.
Okay.
Your final question, Andrew, comes from Hayden Bairstow of Macquarie. Hayden, please go ahead.
Hi, Hayden.
Hi, Andrew. How you going? Just a quick one on met coal. Just on the issues you're having at Broadmeadow, I mean, the longer term growth optionalities, most of them do appear to be sort of similar large block cave caving underground. Is it specific to the type of mining you're doing or is it just a lot of faulting in that specific mine that's causing the instability in the operational performance?
The answer to your question is the second part is right. We have had greater, if you like, geotechnical challenges in that mine than we had hoped to have. I think top coal caving, as we go deeper in there, will become more important, over time. There have been periods in the past when Broadmeadow has been probably the best top coal caving operation in the world. We have a lot of knowledge about how to run these operations well. We actually transferred some of that from the San Juan mine before we sold it. Current manager at Broadmeadow is one of the previous managers at San Juan, that's in North American Coal, which we sold. We've learned, and therefore we will get better with time.
Some of those geotechnical challenges will be easier for us to overcome, all other things being equal, as a result of that knowledge. You're right, it is an important part of the future development of coal, and we are absolutely determined to be leading exponents of top coal caving and have an ability to handle ever-increasing geotechnical problems with less disruption than we've suffered in this case. As you can see, over the past six months, our long-term plans have delivered solid results, despite some several one-off issues that Peter referred to, and they're largely behind us. This, I think, sets us up very well for a strong second half with higher volumes, lower cost expected right across the portfolio, and that's particularly at Iron Ore, Escondida, Olympic Dam and Queensland Coal.
The questions have allowed us to, I think, give a bit more color around that. This momentum in our operations, coupled with the further gains in capital productivity, maybe said a little bit less about that, will support free cash flow. If spot prices persist, that should be more than $12 billion for the 2018 financial year. With this kind of cash, which is effectively the same as we had the last full year, we'll continue to reduce debt and increase shareholder returns as we've done in this period. I hope you feel that our plans are consistent and clear. We built a solid base and we're applying them consistently, and we're building momentum. I look forward to talking you through our continued progress when we meet again in the full year results in August. I should just close on one thing.
I apologize for a little bit of the technical difficulties early on. I hope that didn't spoil your enjoyment of this call and that we recovered appropriately and see you all soon. Thanks.