What is uranium worth to BHP Billiton?

In today’s Big Question, Paul Harris of Mosman, Sydney, asks about uranium’s effect on BHP Billiton’s share price: "There has been an awful lot of talk about the value of BHP lately, and most of it revolves around the value derived from various estimates of changes in cash flow arising from resource prices staying higher for longer. However, I don't think I have seen any value per share ascribed to BHP's uranium assets. Why is this? Are they not significant in the scheme of things? One would have thought that, taking the valuations on current listed Australian uranium companies, most of which don't have any uranium, if the BHP share price doesn't contain any significant value for uranium, a spin off might be worth a great deal to BHP shareholders. Am I missing something? "

Rob Clifford, ABN-Amro’s senior mining analyst, responds:

Spinning off assets vs staying diversified is one those chestnuts that is often debated in the mining sector. As you point out, uranium, or uranium oxide – U3O8 in the case of the miners, is very topical at the moment due to the price and the premiums being paid for uranium plays. BHP Billiton is the fourth-largest producer of mined uranium and has its foot on a large resource; it quotes an orebody containing about 1.77 million tonnes of U3O8, which is about 30% of the generally quoted global resource base.

Note that this changes with price, but is also probably rapidly increasing as the juniors continue exploring. Despite the big holding, uranium in relation to BHP has a number of complexities that make its impact on the overall value of BHP difficult to discern.

1: Uranium is only a small part of BHP’s earnings. BHP has one uranium asset; Olympic Dam (ODO), which produced about 4000 tonnes of U3O8 in fiscal year 2006 and generated about 0.4% of BHP’s revenue. Olympic Dam has legacy contracts that were struck when the U3O8 prices were low, and roll-off around 2010. Until then it has little exposure to the high spot prices; once that happens the uranium contribution to revenue could increase to about 3% (depending on the other commodity price movements). As a quick aside, Olympic Dam has been having throughput issues and has had to go into the market and buy uranium to honour its contracts!

2: The upside is potentially in the expansion. BHP (and WMC before it) is investigating an expansion at Olympic Dam, moving from an underground mine to a massive open pit operation. The early proposed figures put first ore production from the open pit in the middle of next decade and uranium production more than triple to 15,000 tonnes a year.

It would certainly be a prodigious expansion, but the challenge it brings is that the increased U3O8 production could represent about 20% of the world’s mined production and in that case is likely to impact the pricing received. (Hence, I suspect, some of the urgency of smaller plays to get contracted tonnages into the market before the potential expansion arrives).

3: Deep pockets will be needed to unlock the expansion upside. The rough proposed cost of the expansion that WMC talked about (before all the recent capital increases) was in the $4–6 billion range (let’s just say very large) and first ore from the expansion would not be available until four or five years after digging begins. If Olympic Dam was spun off it’s difficult to see a small, stand-alone operator with the balance sheet to undertake this project alone; that is, there would be massive capital expense with no returns for a number of years.

4: Uranium is a byproduct in the BHP portfolio. Although the stated resource base at Olympic Dam is very large, it is still only a byproduct (the resource uranium grade is about a fifth to a sixth of the grade being mined at the Ranger uranium mine in the Northern Territory). The mine produces copper with uranium, gold and silver as byproducts. Even if we assume that the company achieved spot prices on all its commodities, copper would still be the biggest revenue producer. A spin-off of Olympic Dam is unlikely to obtain a “clean” uranium premium in this instance.

It can be argued that BHP could extract more value ultimately from the uranium production than a stand alone producer because uranium would be part of its energy portfolio, of coal, oil, gas and uranium, and enable marketing to energy producers with multiple energy inputs.

In summary, not much value is seen in BHP for uranium at the moment because it is a small contributor (although the expansion could increase that). Olympic Dam would be difficult to spin off with “uranium-play” multiples because it is primarily a copper asset. BHP is also unlikely to want to spin it out because it can extract value from it because of the company’s size and the synergies available from its other energy products. This is at the heart of another debate, that splitting up a company and selling off the parts could unlock additional value in the near term but destroy longer-term options and hence value (but that's a discussion for another time).