IT WOULD have been a bit more than sheer coincidence yesterday that Rio Tinto chief executive Tom Albanese and his top executives book-ended BHP Billiton's annual meeting with a morning media briefing and an afternoon update for analysts.
There's mutual respect of the kind superstars in any arena often have for each other, but there's intense rivalry too. They are chasing the same investors, after all - and what they had to say yesterday underlined not only their mutual strengths, but points of difference.
BHP has been both a miner and an upstream oil and gas player since 1966, when it found oil in Bass Strait. Its pitch to investors is that it offers stable growth. Rio Tinto is a pure miner, and a much heavier punt on one commodity - iron ore.
Both groups say their industry is moving from a multi-year boom where demand overwhelmed supply and pushed prices to record highs into a period in which demand is less feverish as China's growth slows, and prices are also lower, because mine production is rising in a lagged response to record prices.
They both allowed increases in development costs and operating costs during the boom that they are now saying they want to wind back, and they are both being hurt by strong currencies in the countries they operate in and higher royalties.
It's a tougher environment, one that BHP chief executive Marius Kloppers told shareholders yesterday would hit commodities that starred in the boom hardest as prices "mean revert" - that is, fall back towards long-term averages.
Kloppers however once again added (and no doubt could even if he were sleep-walking) that the new environment played into the hands of companies that "sit at the low end of the cost curve, who are able to expand production in a timely and disciplined fashion, and who can invest in the right portfolio of commodities." BHP is one of those companies, or course. Rio Tinto is another.
In its briefing yesterday Rio set out in black and white for the first time just how good its iron ore business in Western Australia's Pilbara region is.
The group's iron ore chief executive Sam Walsh said Rio's cash cost of production in the Pilbara was $US24.50 a tonne in the first half of this year. The all-in cost per tonne to deliver to China including royalties, shipping and underlying capital costs was $US47 a tonne.
That means that iron ore is still very profitable for Rio, and only slightly less profitable for BHP, which has a cost base in the Pilbara that is only a few dollars a tonne higher than Rio's, and still right at the bottom of the global iron ore cost-curve.
The iron ore price fell from a high of $US191.90 a tonne in February last year to a low of $US86.70 a tonne early in September. It hit its lows as Chinese iron ore stocks were run down, and as they have been rebuilt the price has rebounded, to $US122.80 a tonne in mid-November and $US117.90 a tonne on Thursday.
This rebound if maintained will carry more marginal Australian iron ore producers, including Fortescue, back into the game. As a rule of thumb, they need $US100 a tonne or more. Rio and BHP on the other hand were still solidly profitable at $US86.70 a tonne, and at current iron ore prices are still booking what by other industry standards are super-profits.
With almost half of its $US27.8 billion total revenue coming from iron ore in the first half of this year, Rio is the heavier punt on the commodity and its price recovery. Its profit is tied tightly to movements in both the iron ore price and the underlying cost of iron ore production.
BHP's iron ore weighting is lower. Its iron ore revenue of $US22.6 billion in the year to June was 31 per cent of total revenue. Its petroleum division is, however, unique among the heavyweight miners and almost as large, with revenue of almost $US13 billion in the June year. It's also highly profitable, retaining 49? in the dollar of revenue as earnings before interest and tax compared with 63? in the iron ore business. The gap will probably narrow this year as BHP's average iron price falls compared with 2011-2012.
The contribution both iron ore businesses make depends substantially on what sort of economic growth Beijing engineers next year. Marius Kloppers said yesterday that BHP expected China's GDP growth to range between 7 per cent and 8 per cent in coming years, down from a run rate of 10 per cent-plus during the boom. Rio's Tom Albanese was a bit more bullish, predicting growth above 8 per cent next year.
It also depends on how quickly new iron production comes on stream, (BHP's decision to delay the expansion of its Port Hedland export port in the Pilbara will keep supplies tighter and prices stronger in the medium term), the extent to which Chinese iron ore production falls in the northern hemisphere winter, and on whether or not production here is hurt by cyclones during the summer .
Rio's heavier weighting in the commodity will be a liability or an asset depending on how these issues play out - but the group also revealed some very interesting cost reduction targets yesterday.
It announced that it was boosting the existing capacity of its Pilbara operation from 230 million tonnes to 237 million tonnes, and as a result boosting its expansion target from 353 million tonnes a year to 360 million tonnes a year by 2016.
The increase is technology-driven, and Sam Walsh told investors yesterday that Rio's industry-leading mine automation technology and other advances would allow Rio to hit the 2016 production target with 16 per cent or 900 fewer people than it would otherwise need to employ.
He also said that as productivity gains are booked, Rio's all-in mining costs should fall from an already very low $US47 a tonne to around $US35.50 a tonne by 2020. Both groups have wonderful businesses in the Pilbara, but Rio does seem to have the edge.
mmaiden@fairfaxmedia.com.au
Frequently Asked Questions about this Article…
What are Rio Tinto's iron ore production costs in the Pilbara and what do those costs mean for investors?
Rio Tinto reported a cash cost of US$24.50 a tonne in the Pilbara for the first half of the year, and an all‑in cost to deliver to China of about US$47 a tonne (this includes royalties, shipping and underlying capital costs). For investors, that means Rio’s Pilbara operations are highly profitable at current prices and sit low on the global cost curve, giving the company strong margins even if prices fall.
How do BHP's iron ore costs compare with Rio Tinto and why does the mining cost curve matter?
BHP’s Pilbara cost base is only a few dollars a tonne higher than Rio’s, which still places BHP at the bottom of the global iron ore cost curve. Being low on the cost curve matters because companies with lower production costs can remain profitable at lower prices, expand production in a disciplined way and better withstand industry downturns.
How have iron ore prices moved recently and what price level do marginal Australian producers need to return to profitability?
Iron ore fell from a peak of US$191.90 a tonne in February last year to a low of US$86.70 in early September, then rebounded to about US$122.80 in mid‑November and US$117.90 on the latest Thursday quoted. The article notes marginal Australian producers such as Fortescue generally need about US$100 a tonne or more to be profitable.
How exposed are Rio Tinto and BHP to iron ore revenue and how does Chinese growth affect their outlook?
Rio is more heavily weighted to iron ore — nearly half of its US$27.8 billion first‑half revenue came from iron ore — so its profits are closely tied to iron ore prices and production costs. BHP had US$22.6 billion of iron ore revenue in the year to June, about 31% of total revenue, and also has a large petroleum division. Both companies’ prospects depend substantially on how fast China’s economy grows next year, with BHP forecasting 7–8% growth and Rio’s CEO predicting growth above 8%.
What Pilbara production and expansion targets has Rio Tinto announced?
Rio said it had increased existing Pilbara capacity from 230 million tonnes to 237 million tonnes, and raised its expansion target from 353 million tonnes a year to 360 million tonnes a year by 2016.
How is mine automation and productivity expected to affect Rio Tinto's costs and workforce?
Rio says industry‑leading mine automation and other technology gains will let it hit the 2016 production target with about 16% (roughly 900) fewer people than otherwise needed. As productivity gains are realised, Rio expects its all‑in mining costs to fall from about US$47 a tonne to around US$35.50 a tonne by 2020.
What factors could keep iron ore supplies tighter and prices stronger in the medium term?
The article highlights several supply‑side factors that could support prices: BHP’s decision to delay expansion of its Port Hedland export port, seasonal reductions in Chinese domestic iron ore production during the northern‑hemisphere winter, and the risk that Australian production could be disrupted by cyclones in summer. These factors can keep supplies tighter and support prices.
How important is BHP's petroleum division to its overall earnings compared with iron ore?
BHP’s petroleum division is large and highly profitable — nearly US$13 billion of revenue in the year to June. The article notes BHP retains about 49% of petroleum revenue as earnings before interest and tax, versus about 63% in its iron ore business. That gap could narrow if BHP’s average iron ore price falls compared with prior years.
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