Miners hit wall and just keep digging
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.
mmaiden@fairfaxmedia.com.au
Frequently Asked Questions about this Article…
Rio reported iron ore production of 66 million tonnes in the June quarter, 7% higher than a year earlier. The company said it is on track to reach an annual capacity of 290 million tonnes this year and that its "phase two" expansion toward 360 million tonnes a year is progressing, with options including new mines and incremental productivity improvements.
BHP delivered its 13th consecutive production record in the Pilbara for the year to June. Iron ore production was up 7% to just under 170,000 tonnes (per the report) and June‑quarter output was 17% higher than a year earlier. BHP is aiming for capacity of 220 million tonnes a year by 2016 and last year sidelined a US$20 billion Port Hedland outer harbour expansion.
Both groups are cutting costs, trimming their development pipelines and selling surplus assets. They are also driving down cash production costs and examining a mix of outright expansion plus squeezing more productivity from existing operations.
Critics in the market worry that expanding iron ore supplies from Rio and BHP could put downward pressure on prices, especially as China's growth becomes more moderate. The article notes any resulting price pressure would generally be a bigger problem for smaller competitors than for low‑cost giants like Rio and BHP, which are better positioned to absorb weaker prices.
Sam Walsh said Rio was producing iron ore at a cash cost of US$24.50 a tonne, with an all‑in cost to deliver to China (including royalties, shipping and underlying capital) of about US$47 a tonne. BHP pays roughly US$5 a tonne more than Rio to extract ore. These low cost positions help both companies remain profitable even if prices fall materially.
The article notes the iron ore price was US$129 a tonne on the referenced Wednesday, had fallen as low as US$86.70 a tonne early in September of the prior year, and averaged about US$125 a tonne over the year. It also points out smaller Australian producers generally need the price to stay above about US$100 a tonne to be viable.
Fitch observed that projects still expanding tend to share common features: 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 said.
The key takeaways are that large, low‑cost producers like BHP and Rio are increasing production and cutting costs to protect profitability, which gives them resilience if iron ore prices soften. For investors, this means the majors may weather weaker prices better than smaller peers, but expanding supply can add market price pressure — a factor to watch when assessing mining stocks.
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