Improved market conditions, but uncertainty remains

By comparison with recent periods, the mining sector enjoyed a relatively buoyant year in 2016, with equity valuations improving considerably across large parts of the sector. Prices for a number of commodities improved during 2016, aided by a combination of fiscal stimulus in China, policy-driven capacity reductions and new supply entering the market at a slower rate.

This supportive environment allowed us to generate strong cash flow and further strengthen our financial position. We continued to focus on productivity, cost reductions and capital discipline in 2016, in order to maximise our cash generation and the return on every dollar we invest. Similar strategic approaches played out across large parts of the mining sector – allowing many companies facing financial distress at the beginning of 2016 to pay down debt and regain some financial stability. However, our early and consistent action in these areas has positioned us favourably, and allowed us to continue investing in our most attractive organic growth opportunities where others have not been able to do so. We enter 2017 in good shape.

Despite some renewed optimism for the sector during 2016, we remain cautious. Recent commodity price rises have been helped by discrete fiscal policy decisions that could quickly be unwound. In addition, the geopolitical landscape remains uncertain, and major political transitions could impact our markets and operating environments during 2017. Elsewhere, we are seeing an increased threat of rent-seeking, resource nationalism and the adverse application of regulatory laws to previously settled practices. These include Indonesia’s proposed revision to its mining legislation, a mooted production tax increase in Western Australia and the application of EU tax regulations on competitiveness. Accordingly, we will continue to adopt a conservative approach to our financial management and capital spending.

A clear strategy to deliver value through the cycle

A clear and effective strategy is critical for us to perform strongly under a range of industry conditions. Our goal is to deliver superior value for our shareholders through the cycle, and we believe the best way to do this is to focus on the “four Ps”: portfolio, performance, people and partners. We couple this with our disciplined approach to capital allocation. This ensures that every dollar we generate is applied to the highest-returning opportunity – whether that be for maintaining our balance sheet strength, investing in compelling growth opportunities or delivering superior shareholder returns.

+ Superior cash generation

1. Portfolio

 At the heart of our approach is a portfolio of world-class assets – from our Pilbara iron ore business, to our Queensland bauxite ore reserves, our Canadian aluminium smelters and our global suite of copper mines. These are multi-decade assets that deliver attractive returns throughout the cycle, while providing material opportunities for growth over the long term.We use a clear strategic framework to assess our existing assets and new opportunities – taking into account the industry attractiveness and the competitive advantage of each asset, and its capacity to deliver strong and stable returns.

In 2016, we:

  • Invested US$1.3 billion in compelling growth opportunities.
  • Announced an increase to our Pilbara iron ore reserves in Western Australia.
  • Agreed the sale of our aluminium smelter and hydroelectric facilities at Lochaber in Scotland.
  • Signed a non-binding agreement to sell our interest in the Simandou project in Guinea.
  • Completed the sales of our Mount Pleasant thermal coal assets and of our interest in the Bengalla coal joint venture.

2. Performance

Safety is our number one priority and is core to everything we do. A well-run operation is a safe operation.

We seek to generate value at all stages of the value chain – from mine through tomarket. We prioritise value over volume in all of our operating and investment decisions. We have delivered substantial cost savings over recent years and this remains a key focus area.

Beyond this, we continue to increase the productivity of our existing assets, as a substantial and low-risk source of incremental returns.

We have established a leading position in the development and use of technology and innovation – allowing us to deliver more tonnes more cheaply and with less risk. As the industry faces increasingly complex geological, environmental and cost pressures, our technology advantage will be an increasingly important value driver.

Our commercial activities ensure we reap the maximum value from each of our businesses. Our marketing teams work hand-in-hand with our operations, so that our resource management is fully aligned to the market.

Over the years we have leveraged our understanding of customer needs to create new markets for our products, including high-temperature Weipa bauxite, and champagne and pink diamonds.We deploy industry-leading capabilities in supply chain optimisation and a variety of logistics solutions across the Group – and have in-house centres of excellence for value-in-use analysis, pricing and contracting strategies. Together, these activities allow us to manage risk and capture value in all market conditions.

In 2016, we:

  • Completed more than 1.3 million safety critical control verifications in our critical risk management programme.
  • Committed to generating US$5.0 billion of additional free cash flow over the next five years from mine-to-market productivity improvements.
  • Achieved a further US$1.6 billion of operating cash cost reductions, as part of our target of US$2.0 billion over 2016 and 2017.
  • Strengthened our organisational structure, by adjusting our product groups to better align our assets with the business strategy, help drive further efficiencies and optimise performance.
  • Appointed executives responsible for Health, Safety & Environment and Growth & Innovation to our Executive Committee.

3. People

As our industry evolves, new capabilities will be required and we must attract, develop and retain the right people to meet this challenge. We are strengthening our technical and commercial capabilities in particular, and establishing centres of excellence around these areas. Beyond this, we are committed to building a diverse and inclusive workforce at all levels of the organisation.

In 2016, we:

  • Appointed a Human Resources Group executive to our Executive Committee.
  • Announced we would be doubling our annual graduate intake.

4. Partners

As a global company, the environment in which we operate is becoming more complex. In order to secure access to new resources, while managing the unique risk profiles of our businesses across the globe, we must partner with a range of external stakeholders. These include our customers, suppliers, investors, governments and local communities.

Partnerships are relevant at all stages of the value chain andmining life cycle – from exploration, through to operations, marketing and mine closure. Successful partnerships enable us to secure and maintain our licence to operate and are a key long-term success factor for our industry.

In 2016, we:

  • Extended our Channar Mining joint venture in Australia’s Pilbara region and agreed to supply up to 70 million tonnes of iron ore to Sinosteel Corporation over the next five years.
  • Marked 50 years since our first contracted iron ore shipment left the Pilbara, destined for a customer in Japan.
  • Appointed a Corporate Relations Group executive to our Executive Committee, strengthening our focus on external & internal stakeholder engagement.

+ Capital allocation discipline

We adopt a consistent and disciplined approach to capital allocation. Our first allocation is to sustaining capital. Secondly we fund dividends for our shareholders. Finally, we assess the best use of the remaining capital between compelling growth, debt reduction and further cash returns to shareholders. At each stage, we apply stringent governance and assessment criteria to ensure that every dollar is spent in the right way.

In 2016, we adhered to our disciplined capital allocation framework, resulting in: sustaining capital of US$1.7 billion, dividends of US$2.7 billion, reduced net debt by US$4.2 billion and compelling growth capital of US$1.3 billion.

+ Balance sheet strength

In a cyclical and capital-intensive industry such as mining, a strong balance sheet is essential in order to preserve optionality and generate shareholder value at all points in the cycle. We have a guidance range for net gearing of between 20 and 30 per cent. At 31 December 2016, we were below the guidance range at 17 per cent and intend to retain a conservative stance given the uncertain macroeconomic outlook.

In 2016, we:

  • Reduced our net debt from US$13.8 billion to US$9.6 billion.
  • Reduced our gearing ratio from 24 per cent to 17 per cent.
  • Reduced our gross debt by US$5.4 billion.

+ Quality growth

We have a high-quality pipeline of near-term and longer dated projects across the portfolio. By reinforcing capital discipline and reshaping our projects, we have retained significant, high-quality growth despite further reducing our capital expenditure. Our project pipeline has a compelling internal rate of return.

In 2016, we:

  • Reduced capital expenditure from US$4.7 billion in 2015 to US$3.0 billion.
  • Approved US$338 million to complete the development of the Silvergrass iron ore mine in Western Australia.
  • Approved US$5.3 billion capital expenditure to develop the underground copper and gold mine at Oyu Tolgoi.

+ Superior shareholder returns

We are committed to delivering superior returns to shareholders over the long term, and the cash returns we pay out to shareholders are a vital component of this. In a cyclical industry such as mining, we believe the most prudent way to deliver strong returns is to allow the overall level of returns to varywith the cycle. Accordingly, we aimto deliver shareholders total cash returns of 40 to 60 per cent of underlying earnings through the cycle. This policy is sustainable during cyclical lows, and allows shareholders to participatemore fully in the upside during high points in the cycle.

In 2016, we:

  • Adopted a new shareholder returns policy, designed to deliver superior cash returns to shareholders over the long term.
  • Paid US$2.7 billion in dividends to shareholders. In February 2017 we announced shareholder returns of US$3.6 billion with respect to 2016.

Our 2017 strategic priorities

Throughout 2017, we will continue to focus on the four Ps and our value over volume approach, to generate superior cash flow and maintain our balance sheet strength today and into the future.

We will maintain our focus on safety as our number one priority – as measured both by the elimination of fatalities and minimising our all injury frequency rate and lost time injuries. Our strong focus on costs and performance will continue in 2017, as we work towards delivering operating cash cost savings of US$2.0 billion over 2016 and 2017. Beyond this, we will seek to extract productivity gains across our entire value chain, as part of our commitment to deliver US$5.0 billion of incremental cash flow from mine-to-market productivity improvements by 2021.

We will continue to shape our world-class portfolio of assets, ensuring that we focus only on the highest returning assets in our preferred industry sectors and seeking to exit assets that do not fit these criteria.We will progress our high returning growth projects, including the Amrun bauxite project, the underground expansion at Oyu Tolgoi and our Silvergrass iron ore mine. We expect to invest around US$5.0 billion in capital expenditure during 2017.

Investing in our people and our partnerships with external stakeholders will be a key focus during 2017. We are investing more in developing employees at all levels of the organisation – from our graduate intake to our top leaders. This is fundamental as we seek to build the technical and commercial capabilities that will enable us to unlock maximum value from our assets. In addition, we will continue building and maintaining strong partnerships across all stages of the value chain, founded on trusted relationships and our reputation for doing things the right way. Strong partnerships allow us to access and execute new opportunities, maximise value from our existing assets and manage licence-to-operate risks.

We enter 2017 with a sense of cautious optimism. The long-term outlook for our key commodities remains strong and our world-class assets, operating excellence and commercial capabilities place us in a strong position relative to peers. However, the near-term environment is marked by uncertainty – with geopolitical risk at both a macro level and a local level, and government policies impacting supply and demand in a number of key commodities. In this context, a conservative approach remains prudent and we will maintain our balance sheet strength and resilience to downside risks as core priorities.