Miners hit wall and just keep digging
When the going gets tough in the mining game, the toughs get going, as the production reports that BHP Billiton and Rio Tinto have just released demonstrate.
Rio overcame mechanical breakdowns and bad weather in the Pilbara to set new records for iron ore production, shipments and rail volumes. Production in the June quarter was 66 million tonnes, 7 per cent higher than a year ago.
The group was producing 100 million tonnes of iron ore a year only a decade ago, and chief executive Sam Walsh says it is on target to reach annual capacity of 290 million tonnes this year. A follow-on goal of 360 million tonnes a year by 2015 is still in place, but subject to confirmation.
BHP delivered its 13th consecutive production record in the Pilbara in the year to June. Iron ore production was up 7 per cent to just under 170,000 tonnes, and production in the June quarter was 17 per cent higher than a year earlier, beating market forecasts.
Last year the group put an ambitious outer harbour expansion at Port Hedland on ice, but is still aiming at reaching a capacity of 220 million tonnes a year by 2016. Its annual iron ore production was just 73.7 million tonnes a decade ago.
Both groups are cutting costs, trimming their development pipelines and selling surplus assets in response to softer commodity prices. Shareholders and some analysts are nevertheless still uneasy about the iron ore expansion, which comes even as China's economy settles into a period of more moderate growth that relies less on steel-hungry infrastructure construction and more on consumer demand.
There are some in the markets and some on BHP and Rio share registers who believe that they are setting the iron ore price up for a fall with their expansion, and after BHP's decision last year to lower its longer-term production growth trajectory by sidelining its $US20 billion Port Hedland outer harbour expansion, Rio has been the main focus.
In its production report on Tuesday, Rio confirmed, however, that it was on track to hit 290 million tonnes a year capacity in the third quarter, and said its "phase two" expansion to 360 million tonnes a year was progressing.
There was a hint that squeezing the existing operations harder might play a larger role alongside outright expansion. A number of options for lifting capacity were being examined, including new mines and "incremental tonnes from further productivity improvement at existing mines", Rio said. A 2015 deadline for the target to be hit may also be flexible.
Rio is headed to 290 million tonnes a year for sure, however, and BHP is still headed towards 220 million tonnes a year. And while the critics are right that expanding iron ore supplies will bear down on iron prices, asking Rio and BHP to go into their shells in the iron ore market is a bit like asking Australia's latest cricket find, Ashton Agar, to stop trying to score runs. They are doing what comes naturally, and any price pressure that follows will be a much bigger problem for their smaller competitors than for them.
Last year, before he stepped up from Rio's iron ore division to replace Tom Albanese as chief executive of Rio, Sam Walsh said the group was producing iron ore at a cash cost of $US24.50 a tonne. The all-in cost per tonne to deliver to China including royalties, shipping and underlying capital costs was $US47 a tonne. BHP is paying around $US5 a tonne more to get the iron ore out of the ground, but both are extremely low-cost producers, and both are driving their cash production costs down.
The iron ore price was $US129 a tonne on Wednesday. It got as low as $US86.70 a tonne early in September last year, but has averaged $US125 a tonne over the year. Smaller competitors and hopeful producers in Australia need it stay above $US100 a tonne to have a bright future. Rio and BHP can make money if the price halves from current levels, which is unlikely, and will be able to offset milder price declines with higher production.
As the credit ratings group Fitch observes in a new report on the balance sheet pressure lower commodity prices are causing, many projects are being cut back, but there are a select group of projects that are still expanding, and they have some features in common.
They include long mine life, low mining costs, expandability, and a stable political climate. Miners with low-cost positions are under less pressure "to make capital expenditure and other adjustments in the current environment", Fitch concludes.
That's a good description of the advantages BHP and Rio are exploiting as they push production higher in the Pilbara.
The Maiden family owns BHP shares.
InvestSMART FORUM: Come and meet the team
We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.
Want access to our latest research and new buy ideas?
Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.Sign up for free