What is the impact of stranded asset risk on mining companies?

ChatGPT: "Stranded assets" refers to assets that lose their value or become obsolete before the end of their useful life. In the context of mining companies, stranded asset risk refers to the possibility that the assets owned by these companies, such as mines, mineral reserves, or equipment, may become uneconomic or obsolete due to changes in technology, regulation, or market conditions.

In 2022, BHP announced the merger of its oil and gas portfolio with Woodside Energy was complete. In the statement, BHP CEO, Mike Henry notes “BHP’s world class portfolio is weighted towards commodities which support economic growth and have decarbonisation upside combined with our operational excellence will underpin attractive returns and long-term value growth. ” – Merger completion and in specie distribution. BHP. 1 June 2022,

In August 2022, NGS Super, a retirement investment fund that was originally set up for teachers and that has over $13 billions in funds under management, announced it was divesting $191 million from fossil fuel companies, including Woodside. NGS Super Chief Investment Officer Ben Squires said:

“Companies whose revenue relies on further oil and gas exploration and production are at risk of becoming stranded assets as the world decarbonises, especially if they are solelyfocused on upstream oil and gas production. By divesting these companies, we expect to generate higher returns from allocating capital elsewhere” .

In 2023, Woodside announced a record net profit of $US6.5 billion for 2022. The profit included seven months’ worth of contribution from the oil and gas assets bought from BHP in 2022.

Part 1

Required: Research and explain how stranded asset risk is expected to impact the share price of BHP and Woodside in the next 5 years, 10 years, and 20 years. With respect to maximising its share price, do you think it was a good decision for BHP to sell its oil and gas assets in 2022?

I begin this guidance with some observations to develop your understanding of what is implied by the term “stranded assets risk” .

“Stranded assets” need not be fossil fuel deposits.  For example: Adidas is reportedly facing a loss of around US$1.3 billion from holding a large inventory of Yeezy-branded sports shoes that it cannot sell because of racist comments made by Ye, Yeezy’s brand originator who is the rapper formerly known as Kanye West.1

The Adidas/Yeezy case also shows that changes in technology, regulation, or market conditions are not the only bases for assets becoming stranded. Assets can become stranded in consequence of adverse reputational developments.

The inclusion of risk in the term “stranded asset risk” is important.  Risks are not certainties. An asset (ie, a valuable resource owned or controlled by a company) becomes stranded only if one or more of the following factors occurs: (a) it becomes obsolete or unviable because of some technological development, (b) regulation prohibits profitable use of the asset, (c) market conditions change so the asset is no longer in demand, and (d) there are negative reputational costs attached to using the asset.

Committing to invest in an asset in the face of uncertainty about (a) the longevity of the technology required to use the asset2, (b) stability in regulations allowing profitable use of the assets3, (c) changes in market conditions,4 and (d) reputational robustness of the asset can bring significant competitive advantage if the risks don’t eventuate.  This is because all the risks reduce the attractiveness of the asset to competitors which lowers the price to acquire it and so by investing in a potentially stranded asset, a company can earn a higher expected return. The actual return will be low ifthe risk eventuates.

Here’s an example to illustrate how taking on stranded asset risk can result in large profits if the risk doesn’t eventuate. On 8 March 2023 The New York Timesreportedthat Mr Bjorn Gulden, the CEO of Adidas, said the following at a news conference to, among other things, explain the situation with its Yeezy inventory:

“Losing the Yeezy business is so hard,” he told reporters on Wednesday, praising the creativity of the collaboration on multiple levels, including the design, marketing and its use of social media and apps.

“There is no other Yeezy business in the market,” he said. “The people who think you can just replace this with something else — you can’t.”

The point here is that the very qualities that made the rapper formerly known as Kanye West a potent, effective brand influencer were also qualities that carried high risk if Mr Ye went off-script and said or did things that damaged the brand.  As it turned out, he did.

Structuring your answer:

Research and explain how stranded asset risk is expected to impact the share price of BHP and Woodside in the next 5 years, 10 years, and 20 years. (70%)

BHP and Woodside are two large, ASX-listed companies operating in the natural resources sectors. Most of their value derives from the deposits of natural resources they control and which they expect to extract and sell.

What the question requires you to do is assess and discuss the extent to which each company’s assets are subject to the risk of being a stranded asset because of (a) changes in technology (which may affect demand for their products), (b) adverse regulation, (c) market conditions, and (d) negative reputational effects.  Feel free to add other factors if you find them relevant.

The factors giving rise to stranded asset risk are not always entirely independent of each other.  For instance, adverse regulation is more likely if there is also an increase in negative reputation.  The impact of each factor on share price is also more likely to vary by time horizon.

For example, it is highly likely that technology will change significantly over 20 years and less so over five years.  Note however that the proportion of both Woodside’s and BHP’s total value today that is attributable to expected cash flows 20 years from now is likely to be low given reasonable discount rates.5    Further, both companies are likely to be able to make investments and undertake actions that reduce their vulnerability to stranded asset risk as a consequence of technological change over the longer term.

Assignments that attract higher marks are those that provide more detailed  and well-researched answers that are economically sensible and within the word limit.   It’s easier to write a longer assignment so you must be disciplined to stay within the word limit. A well-researched answer will provide citations to credible evidence, from different sources and perspectives. For example, an answer that is largely constructed on the basis of one or two sources is unlikely to attract higher marks.

With respect to maximising its share price, do you think it was a good decision for BHP to sell its oil and gas assets in 2022? (30 percent)

There are a number of potential reasons that might have motivated BHP to sell its oil and gas assets to Woodside in 2022.  For the purpose of this assignment, focus on addressing the issue from the perspective of stranded asset risk.

It seems reasonable to assume that BHP reduced its exposure to stranded asset risk by this divestiture. The question is whether you think, based on your analysis, BHP was premature in selling its oil and gas assets perhaps because the stranded asset risk was decreasing and/or the expected return from them is so high that it more than compensated for the risk and/or there were other steps that BHP could have taken to benefit from its oil and gas assets whilst reducing the adverse effects of stranded asset risk.

Marks will be awarded primarily on the reasons in support of your conclusion. Provide a balanced view. Your actual conclusion will not be given much weight in the marking . Reference to credible evidence is important here as well. One source of information that might help you understand the motivations behind BHP and Woodside’s decision is their annual reports. Your mark in this section will also depend on how well you integrate your research from the previous section. Overall, your assignment should flow well, so that the reader clearly understands how your research in the first section translates into your overall conclusion for Part A.