A Conversation with Andrew Mackenzie, CEO of BHP Billiton

Thank you, Frank. As Frank said, I gave a speech earlier in the week covering similar themes in more detail with energy specialists in Houston. Washington plays a key role in shaping global policy and influencing economic development, so I'm delighted to launch this US Australia speaker series with CSIS. We are the world's largest diversified resources company, supplying steel-making materials, metals, energy, and potash. We are the only company that supplies all of oil, gas, coal, and uranium, as well as metals critical for energy infrastructure and renewables. This makes us semi-objective in our choices about how the energy portfolio evolves. Our portfolio delivers an all-of-the-above approach, giving us a powerful perspective on geology, technology, trade, and how demand changes as countries develop. A prime example is China. Since Deng Xiaoping's market reforms over 30 years ago, China has industrialized and urbanized, lifting over 650 million people out of poverty—more than the population of Latin America and double the US population. Globally, more than a billion people have been lifted out of poverty, two-thirds in China alone. BHP Billiton has been privileged to support this progress because the commodities we supply are critical building blocks for modern societies. Energy is crucial at all stages of development. While developed economies are becoming more efficient, the real growth in energy demand is in emerging economies, where people gain access to electricity and improve living standards. Over a century after Edison built the first power station, a fifth of the world's population still lacks access to modern reliable energy. Over 700 million people burn wood or charcoal to heat their homes. In the next 20 years, 1.7 billion people will gain access to electricity for the first time. The growth of the resources industry is tied to alleviating poverty and the successful development of emerging economies. Demand for energy is likely to increase by 30% in the next 20 years, with two-thirds of new demand coming from Asia, half from China and India, and fastest growth in Africa. Every nation will choose a different mix, balancing affordability, security of supply, and public preferences. In the next few decades, fossil fuels will remain central due to their affordability and existing infrastructure. Renewables are growing rapidly, and we encourage that, but we need large-scale cost-effective storage to rely on them. Nuclear provides low-carbon baseload power, but post-Fukushima it faces public resistance. By 2030, we anticipate that 70% of the world's energy will come from oil, gas, and coal, down from 80%. Gas will see the strongest growth, but the shale gas revolution is unlikely to go global quickly. Coal will remain the primary source of affordable energy in Asia. Every form of energy relies on resources we extract from the Earth. A renewables future is good for our copper business, which uses seven times more copper than traditional fossil fuel industries. Innovation in geology and technology has helped us meet challenges. The era of easy oil ended in the 1970s, but plate tectonics and advances in drilling and 3D seismic technology improved exploration. Horizontal drilling combined with hydraulic fracturing enabled the shale gas revolution. Continuous innovation has kept oil reserves growing by 30 billion barrels a year. Similarly, copper production has increased 16-fold despite falling grades. Energy security is a matter of governance, not geology—what's above ground matters more than what's below. About 90% of investment in resources still goes to more developed countries with better governance. BHP Billiton believes open markets, free trade, and competition create the right conditions for development. Asia's continued development depends on access to affordable energy and resources. The US debate on energy exports is important; we believe exporting gas is the right thing to do. An open market has enabled Australia to become a leading gas exporter. Exports benefit both the US and its partners. US customers will continue to enjoy lower gas prices. Transportation costs and competition will limit US exports, but they will help allies diversify supply and signal the importance of open markets. Successful transition of populous nations into consumer economies relies on geopolitical stability. US leadership can encourage global markets that support this process, improve supply resilience, and advance free trade. Open markets will also help countries reduce emissions and adapt to climate change. As a producer of large amounts of fossil fuels, we must control emissions. I am 100% convinced from the geological record that variation in CO2 and other greenhouse gases results in temperature changes with negative implications for life on Earth. Warming is real, this episode is due to human influence, and physical impacts are unavoidable. Solutions must address both energy poverty and climate change; you can't solve one without the other. We need to work with governments on long-term solutions to reduce emissions. Revenue transparency is important; BHP Billiton was a founding member of the Extractive Industries Transparency Initiative and ranked third globally in transparency. Transparency is good for business, shareholders, and communities. With innovation, good governance, and open markets, we can supply resources, deliver returns, address energy poverty, and improve the world's ability to solve complex issues like climate change. Resource security compatible with environmental responsibility is achievable. Thank you.

You talk about the four pillars. Our knitting is petroleum engineering, mining engineering, and geology. We need to find things where those skills give maximum return to shareholders. The patterns of demand are shifting. The bulk of our profitability has come from materials turned into steel, but that's shifting as China slows its infrastructure building and moves toward consumption. That's why I talked more about energy—the bulk of our investments will likely be concentrated on increasing our ability to supply energy to Asia. Long-term, a stabilizing world population will want better agriculture, leading to opportunities in fertilizers like potash. But we select projects based on returns and net present value to create the highest-level portfolio. The focus on four pillars has led to big cost savings. We announced unit cost cuts of $5 billion over two years and a big increase in capital efficiency. Even though we are cutting capital by about 25%, we can add as much value from $15-16 billion of capital that previously took over $20 billion.

Part of it is that they are moving toward a consumption-driven economy. There is strong alignment from top to bottom in the country to do that. I serve on a group of 13 foreign CEOs advising Premier Li Keqiang of China. The way he lays things out and how things happen is inspiring. When we talk to CEOs of state-owned enterprises, major customers in steel mills and copper mills, we find strong alignment on this message. They are using credit controls to increase efficiency and are concerned about the environment. It's going to be tough, but we must be mindful of history. I remember flying into LA in 1979 for a job interview, and it was no different than being in Beijing today.

Companies need to both make a profit and help the next generation. On coal, it is the lowest cost source of power and electricity, whether in China or West Virginia, where 95% of generation is from coal. Local resources are critical. The energy industry has not been well served by demonizing one fossil fuel over another. While the trend will move toward gas long term, it will require a lot of coal. The good news is that with so much electricity dependent on fossil fuels, there is an even greater obligation on the industry to do something directly about emissions. We have reduced our intensity by 16% and invested $430 million in that process over the last five years, with 100% accountability, non-negotiable. Then we move into the 90% of emissions we affect by providing fossil fuels. It is a shared responsibility, but where we have the skills, we should land them more clearly. The big challenge is bulk storage of carbon to make carbon capture and storage work. There are good ideas based in geology. I was a chief research engineer at BP. If we can create large-scale opportunities to capture carbon under major power stations, fossil fuels can alleviate poverty in an environmentally responsible way. Resources are there for another 100 to 200 years. We should work as one industry. Even though coal produces more carbon per unit of energy than gas, if we get a solution, it makes gas even better. That draws us into the policy debate. In Washington, the notion of using multiple fuels and not picking the flavor of the day is important. My first thought was that seeing Secretary Mon or Senator Manchin would be high on the list when talking about coal and poverty. The role of coal needs to stay but be improved. How do you sell that policy message to policymakers? Don't move away from nuclear and neglect it. Start from the basis that we accept mainstream science and want to make energy less negative toward the environment. There is no one wonder solution; you need a raft of measures. It's great to have choices of fuels. In addition, you need a range of technologies. The resources industry can make the best contribution to some, but other industries have to contribute. You need a range of policy measures. It's hard to think of one solution when we are not going to get a global solution quickly. Part can be government funding for R&D, part regulation, but it's hard to avoid some form of appropriate carbon pricing to drive incentives for the right choices of fuels and technology. Wrap all that in free trade in goods, services, and ideas to create flow of possibility and move forward more quickly.

The super cycle was a one-off caused by the massive acceleration of China as a result of Deng Xiaoping's reforms. It didn't really take off in demand until the late '90s and accelerated through the 2000s. The resources industry was not well prepared. The mining industry was a bit better because it saw steel demand coming. But right until about 2003-2004, all companies were still forecasting $20 oil. That's how caught out they were. On the mining side, steel growth in China was at some points more than 20% per annum. China didn't have enough domestic production, so everyone ran around trying to build things quickly, often inefficiently. Money was wasted. Not all companies performed well for shareholders. Now we are in a different phase. China is moving to more stable growth, more consumption-based, growing at 6-8%. The metals intensity of that growth is much lower; it's more energy based. Infrastructure is built, so supply can be adjusted in small increments. We can look with reasonable optimism that supply will be able to adjust to demand without dislocations. We are looking at a period of flat to falling prices. Companies like us have to become more efficient to hold on to margins. We have been successful so far; our return on capital is rising. That agenda will be shared across the industry. I don't think there is another China waiting to happen. I'm a bit more optimistic about other Asia, but India is still a long way behind. It's lower prices, more efficiency. People will become more sanguine about the resources picture. High prices and their falloff created a stigma. Investors were worried about super abundance and not making enough money, while others worried about running out. Now we are more in the middle, with enough resources to go around. It's about timing and deliverability.

Those of you who know about the G20, there is a B20, and there is an alphabet soup of 20s. I know about B20. They have chosen four themes to run global task forces of business leaders, chaired by Australian CEOs. I have been given the privilege of looking after trade. The other three are finance, infrastructure, and human capital. You've seen the announcement from finance ministers about trying to get an additional 2% annual growth above forecast. Everyone is worried about zero job growth. The progress in productivity in our company shows it's possible to get growth without adding much employment. To get employment, you have to add a lot more. Part of it is upscaling jobs and compensating for digitization and automation of lower-skill jobs. We think trade can make a big difference. Its track record is strong. There has been good progress since 2008; the moratorium on tariff restrictions and protectionism seems to have held, but the volume and growth in world trade has slowed, especially in developed economies. I'm a bit more optimistic. If we have a few measures, there is a possibility of adding another Germany to the world: another 100 million to 150 million jobs and possibly as much as $5 trillion of aggregate GDP. We have picked three things to work on: attacking non-tariff barriers to trade, spending more time on creating more trade in services (which is more than 50% of world GDP but only 10-20% of global trade), and while we like multilateral or bilateral agreements like TPP and TTIP, we need to ensure they ultimately coalesce and raise standards. G20 is not WTO; it has no executive powers. We have to break things down into individual actions that each country can commit to, even just one in a matrix of 3x20, so we can see measurable progress before Turkey.

I think it's a great way of proving it because you get the oil credits to pay for some of the development costs of storage. But there is no way you're going to get the volume of storage through using EOR. I don't think you'll find a practical way of storing if you depend on conventional oil and gas reservoirs, even if they're only filled with water. You have to find a way that any old rock underneath a power station can be a significant sink for CO2. There are a lot of ideas. CO2 is very corrosive, which is a problem for pumping, but it also etches the rock and can create additional space and precipitate as carbonate. That's where we think we've pledged quite a bit of money to get that research going. Ultimately, it's great to prove things through EOR, but the long-run solution has to work under a Chinese power station.

The shared values are the things I talked about: everything that goes with a modern Western economy, respect for the law, transparent processes, and a real spirit of entrepreneurism. The oil and gas part of BHP Billiton got started because of joint ventures between us and ExxonMobil in the Bass Strait. So we've been strongly linked. There are obviously important differences. The resource endowment of Australia is comparable, perhaps even better than the United States, but the US has great resources and more than 10 times the population. The bulk of US resources will be used in the US, even if you agree to export everything, which I think you should because I'm a free trader. Australia handles things that way. With a small population, the vast bulk of its resources are exported. That export flow, whether gas to Japan or steel-making materials to China and Korea, is absolutely critical for geopolitical stability in the circum-Pacific. Many allies of Australia and the US are dependent on those flows of commodities out of Australia. That will build manufacturing in those places. I think we have a lot to do together. Australia is a small nation, sometimes talked about but not being a member of G20 because of its relatively small economy, but as a resource economy it absolutely needs to be in G20 and a fundamental player in APEC, which was kicked off by an Australian, Paul Keating. We should continue to build on that. In so many walks of life, Australia and the US have been shoulder to shoulder, both in peace and in war.

I would sign a big note of caution, as I said in my speech about the shale gas revolution going global quickly. I make that point on a number of levels. This is new technology; the geological habitat of those hydrocarbons is not well understood. Until people have decent well tests and can show me the decline curves and likely recovery from individual wells, I remain skeptical of just looking at an in-place estimate and applying an average recovery. First, we need to go and drill and do proper tests. Then we can have a proper debate. The reason it's gone so well in the US is not just endowment and access to technology. For a very brief period at the back end of the last decade, there was a question mark about whether the US would be self-sufficient in low-cost gas. It has an enormous industry based on gas: distribution, chemical industry, power generation. As gas comes up, you can quickly back out coal. Most countries don't have that; their history is using coal, they don't have a distribution system or lots of gas-fired power stations waiting to be filled. They haven't evolved the regulatory way of doing things. When you talk about shale gas in terms of geopolitics, I would aim off quite a bit, even in China, for quite a few years. You also have to think about the remaining power balance within conventional gas. The availability of conventional gas is quite restricted in the world, more restricted than oil. If gas existed absent shale gas, it would be a much more concentrated set of countries, like OPEC.

I do. I wouldn't give up. I am optimistic. When you drop organic matter into the Earth, it's thermodynamic that it wants to exist in two forms: carbon and methane, coal and gas. So there's bags of it around, and we know there's lots of coal that we can get after. Extracting that more difficult tight gas requires a lot of things to happen, and it won't always be low cost. In which case, people will have to turn to coal. I'm very optimistic about supply. I just think the sense that the US change will happen quickly, in a matter of 20 or 30 years, is on the optimistic side.

I can. We have actually supported the repeal of the carbon tax as it's called in Australia because it was ultimately a tax that was designed in a way that was very injurious to Australia's competitiveness. You have to balance how that price works with your own competitiveness and not simply penalize local industry without removing one molecule of CO2 from the atmosphere. The chances are that what would have happened is the coal industry would have invested less, and more coal would be developed elsewhere, possibly less efficient. You've got to understand the impact on competitiveness and what other nations are doing. For a resources-rich nation to prejudice some of its most successful industries is a tough call. We have to keep talking as much as possible to get global, but realistically we're not going to get there easily. Carbon price on its own is not going to get there; you need a raft of measures. Each country will probably have to do different things: regulations, subsidies for R&D, ensuring the energy mix, developing technology. I do think it's something we have to keep working on. Ultimately, an appropriate carbon pricing mechanism applied in many countries will speed the progress to finding a solution that squares the circle between poverty alleviation and environmental responsibility.

I'm probably not going to answer your questions directly. I think the case for US gas exports is already well made without adding additional cases for it. In terms of the US, we are a very large investor in US shale and a big investor in the Gulf of Mexico. Outside of Australia, it's our biggest set of businesses. Number three is Chile. It seems appropriate that because of that, people like myself spend a bit of time here and in other places to be part of the debates we're having today.

I look, he was very convinced that it was a wrong move. An economy like Australia has to balance what's good for the whole economy rather than select individual industries for what I might call selective favoritism. I leave that to politicians. You can't look at one industry in isolation from the vibrancy of the whole economy. Australia earns enormous amounts from exporting resources; it is a fundamental industry. I'm not saying it's enough to be diversified, but if it violates the principles of free trade and goes down the route of protectionism, it goes against everything Australia has stood for in terms of resources. The issue in Australia with gas prices is that you need to stimulate supply. There's plenty of gas around. If we stimulate supply, some of the concerns being voiced may be easier to deal with. Ultimately, people are paying the market price for gas, and I don't think you should interfere with that.

I don't have the detailed figures in my head. Africa has a lot of things happening, a lot of growth, but the bulk of the growth is already in the consumer base rather than in construction and infrastructure. I think it will become slightly more important, but it will be completely overshadowed by what we supply to Asia.

Thank you.