BHP Billiton Company’s International Business

Introduction

Background of the Company

BHP Billiton is a mineral resources firm extracting and processing iron, oil, copper, and potash. The corporation, which is headquartered in Melbourne, Australia, is a product of a 2001 extension merger of BHP Ltd and Billiton Plc (MarketLine 2018). It maintains a dual listed company structure with its two parent firms operating as independent legal entities but under one venture. Before the merger, BHP Ltd was a leading Australian mining company established in 1885. The key drivers of its early growth were the exploration and discovery of domestic iron ore, coal, and oil before expanding to the Americas in the 1990s (MarketLine 2018). On the other hand, Billiton Plc was a Dutch firm established in 1860 and later incorporated in the UK.

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BHP Billiton’s financial statements show a steady performance over the past few years. The firm’s total revenue from its four segments was US$43.6bn for the FY2018, a 17.2% increase from the FY2017 performance (BHP 2019a). Its pre-tax profit rose from US$11.3bn to US$14.7bn between 2017 and 2018. However, BHP’s total assets dropped from US$117 to $111.9bn over the same period (BHP 2019b). It has a staff population of over 27,161.

On international positioning, BHP is a global leader based on market capitalization. The firm’s corporate strategy centers on portfolio growth and diversification to strengthen its competitive position. BHP’s foreign investments include mining operations in Chile (copper), Brazil (iron ore), Colombia and the US (coal), and the Gulf of Mexico, UK, and Algeria (off-shore petroleum) (BHP 2019a). Its competitive advantages lie in diversified revenue streams, a strong global presence (operates in over 25 countries), and low-cost resource assets.

Theories and Arguments

Capital flows to a country constitute foreign direct investment (FDI). Multinational corporations can utilize metrics of political risk to inform their investment decisions. The Butler-Joaquin model is one such measure that illustrates how host-country policies impact capital investment cost (CIC). In this framework, a shift in CIC is dependent on the effect of political risk change on future “return of the investment and its covariance” on the asset and market (Moffett, Stonehill & Eiteman 2016, p. 152). Thus, a political risk would raise the CIC.

Changes resulting from elections, wars, and higher taxes or import tariffs can increase production costs. According to Moffett, Stonehill, and Eiteman (2016), macro-economic mismanagement can lead to runaway inflation and interest rates and frequent labor unrests create uncertainty that adds to the cost of capital investment. Therefore, multinationals, such as BHP, use country risk information in their internationalization decisions. The four variables considered include political, economic, and currency risk as well as an economy’s credit rating (Kruja & Dragusha 2014). BHP has operations in many locations and is affected by volatility in foreign exchange rates. The firm reports its financial statements in dollars. Fluctuations in the value of the US$ against major currencies such as the Euro, AUD, and the Pound increase its expenses.

Aims and Rationale of the Case Study

The purpose of this case study is to find out current corporate and strategic actions adopted by BHP to compete in its industry. The specific aims are to identify and analyze currency and political risk that BHP is exposed to in its international operations to recommend appropriate risk management techniques.

Corporate and Strategic Actions

Corporate Strategy

BHP’s operating model focuses on acquiring and developing a diverse portfolio in various destinations to drive its growth. The company’s corporate strategy is to “own and operate large, long-life, low-cost and expandable upstream assets diversified by commodity, geography, and market” (BHP 2019b, p. 2). Consistent with this plan, BHP has taken specific strategic actions. The firm is poised to realize cost efficiencies and productivity gains of $1bn this year due to active portfolio management and enhanced workforce connectivity (BHP 2019b). Its automated value chain has resulted in reduced mining costs, increased output, and enhanced safety. For instance, BHP’s integrated remote operations have been adapted for Australian Iron Ore mining (BHP 2019b). Other strategic actions include precision exploration of copper and oil in the Gulf of Mexico given their high demand prospects and expansion of coal processing capacity in Queensland.

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International Position

BHP is among the biggest mineral resources companies globally. With a market capitalization and annual revenue of US$44.07bn and 43.6bn, respectively, in FY2018, the company occupies the top position globally in the mining sector ahead of Rio Tinto and Glenscore Plc (Ahmed 2018). BHP is a leading supplier of copper, iron ore, metallurgical coal, and nickel, contributing to its strong market position.

Recent Announcements Regarding FDI or Other Major Projects

BHP plans to expand its operations through capital and exploration expenditure in petroleum, copper, and potash projects in different countries. The firm announced the continuation of phase 2 of the Mad Dog facility in the Gulf of Mexico that would process 140,000 barrels of oil a day at a budget of $2.2bn (Statista 2019). BHP has also invested $2.7bn in infrastructure in its Canadian potash exploration project expected to be completed by 2022.

Key Strength and Weakness

SWOT analysis of BHP (Appendix) reveals macro- and micro-environmental factors affecting the company. The corporation’s strong business performance in the copper segment is its main strength. Sales from this division accounted for 30.5% of BHP’s 2018 earnings (BHP 2019b). A rise in the price of copper cathode and a scrap metal ban point to robust growth prospects for this segment. BHP’s main weakness lies in safety issues related to tragic mining incidents that attract costly penalties from the authorities. Despite measures to curb injuries, accidents rose by 5% in 2018, resulting in two fatalities (MarketLine 2018). Such adverse reports imply that its safety procedures are weak.

Geographical Locations

BHP operates in 35 mining facilities and offices located in over 25 countries. In its home country, the company mines copper, coal, and iron ore in six sites and has four administrative centers, including its global headquarters in Melbourne (BHP 2019a). Outside Australia, BHP has mining assets in the Americas (Chile, Peru, Brazil, Colombia, Canada, and the US). Its other investments are in the UK, Trinidad and Tobago, and Algeria. Its principal marketing office is in Singapore.

Competition

BHP is a leading global player in the extraction and processing of different minerals. Among its top competitors are Rio Tinto, Vale SA, and Glenscore Plc. It faces stiff competition from these three players that together control 30% of the global market compared to BHP’s 16% (MarketLine 2018). Nevertheless, the company remains a global leader in the mining sector.

Partnership

BHP consolidates its domestic and foreign markets through acquisitions, contracts, and alliances. In 2016, the firm signed a 10-year agreement with Eni and Sonatrach to expand its Western Australian blocks (BHP 2019a). BHP also completed the acquisition of a 54% stake in a rich oil field from Repsol S.A. In 2015, the firm partnered with GE to develop green solutions for the rising demand for oil and minerals.

Identification and Analysis of Currency Risk

Identification of Different Types of Exchange Rate Risks

Transaction exposure. Currency volatility stemming from exchange rate fluctuations has a significant impact on the profitability of multinationals. BHP is prone to market price risks related to sales and purchases. Transaction exposure results from exchange rate fluctuations that impact a firm’s “obligation to make or receive payments denominated in foreign currency” (Brink 2017, p. 56). BHP’s financial performance is given in US dollars ($). In 2017, the firm’s had 67% of its sales earnings denominated in $ (Statista 2019). Thus, BHP’s Australian-based operations are prone to a significant exchange rate transaction risk if the dollar value drops.

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Translation exposure. This type of risk results from the impact of currency volatility on “a company’s consolidated financial statements”, especially the performance of its overseas subsidiaries (Brink 2017, p. 56). BHP is exposed to US dollar-denominated debt. Translation of the foreign currency results in variations in asset and liability reports, and thus, requires specific protections.

Operating (or economic) exposure. This exchange rate risk can also affect a firm’s operations. It results from the impact of sudden currency fluctuations on a firm’s “future cash flows and market value” (Brink 2017, p. 57). This long-term risk can have a severe effect on the global competitiveness of domestic operations. Sudden exchange rate fluctuations can result in cheaper copper or oil imports to Australia if the US dollar strengthens significantly against the AUD.

Effects of the Identified Risks

Exchange rate fluctuations. Transaction exposure affects the rights and obligations of a multinational. This international factor is reflected in the profits reported by the corporation. BHP’s revenue by geographic segment dropped for the non-US denominated Asian segment from $3.2bn to $2.6bn, indicating that transaction exposure affected the profiting capability of the company. Translation exposure affects firm value. Differences in this accounting action result in indirect cash flows when included in consolidated financial statements (Papacostas & Tonin 2018). Thus, translation has taxation implications for the firm. Additionally, investors may rely on income statements to forecast an entity’s sales revenue and FDI opportunities (Perdomo & Marroni 2014). Thus, the financial reports affected by translation exposure may be reflected in a firm’s stock price. Exchange rate volatility is also likely to impact predicted dividends payable to investors based on translation-exposed financial reports. Economic/operating exposure is difficult to predict and hedge (Perdomo & Marroni 2014). BHP operates in competitive markets, which means that its economic risk is high.

Existing or potential effects. Transaction exposure has an impact on BHP’s sales revenue by its Australian-based entities. Its critical protections include denomination of 67% of its operational costs in US dollars and hedging. Foreign exchange risks will affect shareholder value in the long term. For instance, spot (backward) prices for BHP’s copper and petroleum segments are often greater than forwarding ones, reflecting a high cost of translation exposure. Since the US dollar is the currency for taking credit and maintaining surplus cash, potential effects of exchange risks are expensive loans, losses due to AUD depreciation, and diminished shareholder value.

Corporate Strategy

Techniques adopted to manage the identified risks. BHP uses a range of risk management strategies for currency fluctuations. It employs foreign exchange hedges to handle the impact of transactional exposure. Specific hedging strategies included in the board-level policy are forward exchange contracts and collar options (Perdomo & Marroni 2014). These techniques enable BHP to manage price risks. While the forward swap contracts fix an anticipated rate, collar options set a price range (Brink 2017). BHP also uses currency hedging to manage transaction costs. Up to 67% of its sales earnings are denominated US$, while costs are valued in AUD (Statista 2019). It utilizes forward swap contracts for currency hedging for US dollar-denominated overseas transactions. BHP manages its translational risk using a host of techniques, such as offshore currency assets as hedges and cross-currency swaps.

Identification and Analysis of Political Risk

Identification of Country/Political Risks

Firm-specific. Safety and environmental policies regulate the mining industry. Despite BHP’s in-house measures to achieve zero fatalities, injuries rose by 5% in 2018 and resulted in two deaths (BHP 2019b). Thus, lawsuits, environmental compliance costs, and rehabilitation budgets are key threats BHP faces. It also grapples with project/technical risks related to feasibility studies, mine establishment, and processing.

Country-specific. Political risks affecting BHP may include uncertainties related to elections, wars, new policies, and taxation. It needs government approvals before beginning exploration. Hefty fines for noncompliance and bad transactions, such as the failed acquisition of Potash Corp of Canada, can affect its profitability.

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Global specific. Falling demand for BHP’s products will impact its growth. Fluctuating prices of seaborne iron, copper, and petroleum will affect its results. The demand for minerals and oil in China (accounted for 30% of BHP’s revenue in 2012) due to a slowing economic growth will reduce BHP’s global sales.

Effects of the Identified Risks

FDI inflow. Country risks result in reduced FDI incentives for BHP to invest in an economy. Political difficulties increase operational costs impacting FDI inflow. Economic mismanagement by governments slows down GDP growth, increases interest rates, and causes inflation that introduces exchange rate risks (Kruja & Dragusha 2014). Reduced FDI inflow causes unemployment and a drop in a country’s sovereign credit. BHP’s recent public announcement that its US onshore oil fields are on leased land and certain restrictions may limit its ability to sell extracted petroleum products.

Existing or potential effects. Country/political risks impact the demand and supply of BHP’s products as well as growth opportunities. Oligopolistic practices by oil-producing countries to control global oil prices have affected BHP’s petroleum business. In Australia, the Petroleum Resource Rent Tax has increased operational costs of the firm, impacting its financial performance (BHP 2019b). Slowing economic growth in China would potentially affect BHP’s copper segment.

Corporate Strategy

BHP has a risk management policy that includes portfolio diversification to manage political/country risks. Its sales and purchases are denominated in US dollar and AUD as a protection against financial crises. Diversified assets in politically stable locations is another strategy. Regular risk monitoring and reviews are used to inform foreign investment decisions.

Conclusions and Recommendations

Findings

BHP’s most significant risk arises from transaction, translation, and operating exposure since purchases and sales by Australian-based operations are denominated in US$. Therefore, exchange rate fluctuation impacts BHP to a high degree since currency hedging may not offer adequate protection. Another threat is country/political risk related to mining regulations, safety standards, and taxation. Compliance costs and litigations impact BHP’s operational costs to a moderate extent. Another risk impacting BHP to some degree is the declining global demand for copper. However, this trend is likely to affect its Indian and Chinese markets.

Recommendations

BHP is exposed to various political and foreign exchange risks. Appropriate exposure management policies are required to manage these threats. First, investment agreements with local mining players are recommended to help manage political risks arising from ownership and leases. Second, BHP should use investment insurance and guarantees to cushion itself from environmental liabilities related to exploration, mine rehabilitation, and injuries. Third, the company’s operating strategies – exploration and processing – should focus on creating value as opposed to product diversification, which is sensitive to currency risk. To manage the foreign exchange risk, active hedging of product exposures, passive methods (3-year modeling and scenario analysis), and strategic approaches such as decreasing cash flow volatility are recommended.

Reference List

Ahmed, SK 2018, Top 25 mining companies by market capitalization, Web.

BHP 2019a, Our business, Web.

BHP 2019b, Annual report 2018, Web.

Brink, CH 2017, Measuring political risk: Risks to foreign investment, Routledge, Abingdon.

Kruja, A & Dragusha, B 2014, The impact of political risk on foreign direct investment, Iliria International Review, vol. 4, no. 1, pp. 73-92.

MarketLine 2018, Company profile: BHP, MarketLine, London.

Moffett, MH, Stonehill, MI, and Eiteman, DK 2016, Fundamentals of multinational finance, 6th edn, Pearson, New York, NY.

Papacostas, D & Tonin, F 2018, Foreign exchange options and risk management, Risk Books, London.

Perdomo, I & Marroni, L 2014, Pricing and hedging financial derivatives, John Wiley & Sons, New York, NY.

Statista 2019, BHP Billiton – statistics and facts, Web.

Appendix

Strengths
  • Strong business performance – copper
  • Market position – global leader
  • Marketing & supply chain capacity
Weaknesses
  • Safety concerns
  • A slump in oil production
Opportunities
  • Rising demand for copper & steel
  • Mergers & acquisitions
Threats
  • Strict environmental laws
  • Foreign exchange risks
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