Rio Tinto occupies a privileged position in the iron ore market. It is the lowest-cost producer in Australia’s Pilbara, the world’s most attractive region for mining the key raw material for steel. That explains why Rio’s new chief executive, Sam Walsh, announced a speeding up of a big Pilbara expansion during his maiden results on February 14. But he was also the latest mining boss to highlight the need for spending restraint and capital discipline.
Low-cost miners such as Rio face a dilemma. They have a limited window of opportunity to take advantage of a booming Chinese need for iron ore before the country’s steel demand peaks, probably sometime soon after 2025. But they don’t want to add too much to production.
Many shareholders, irritated by soaring project costs and huge writedowns on bad deals struck during the boom years, want more focus on shareholder value - hence this year’s lower capex target and higher dividend at Rio. But efficient producers are certainly tempted to invest. Today’s iron ore price is about $155 a tonne and Rio’s all-in cost of shipping ore to China is $47 a tonne.
While expanding in the Pilbara makes sense for Rio and rival BHP Billiton, the broader industry has a collective action problem. If inefficient Chinese iron ore producers, whose high costs help support today’s high prices, are displaced by too much low-cost production, then prices - and profit - could fall sharply.
Iron ore production is oligopolistic, but not a cartel. It’s too early to tell whether the producers will replicate the effect, if not the reality, of a collusive agreement to limit production increases. BHP scaled back its own Pilbara expansion last year as part of a capital spending cull. But the big question mark is over undeveloped low cost big basins, such as Rio’s giant Simandou development in Guinea, West Africa. Tom Albanese, Walsh’s predecessor at Rio, was a big proponent of Simandou. So far, Walsh, who previously headed Rio’s iron ore unit, is making the right noises about shareholder value. But he has yet to signal a willingness to quit digging while he is ahead.
Low-cost miners such as Rio face a dilemma. They have a limited window of opportunity to take advantage of a booming Chinese need for iron ore before the country’s steel demand peaks, probably sometime soon after 2025. But they don’t want to add too much to production.
Many shareholders, irritated by soaring project costs and huge writedowns on bad deals struck during the boom years, want more focus on shareholder value - hence this year’s lower capex target and higher dividend at Rio. But efficient producers are certainly tempted to invest. Today’s iron ore price is about $155 a tonne and Rio’s all-in cost of shipping ore to China is $47 a tonne.
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Iron ore production is oligopolistic, but not a cartel. It’s too early to tell whether the producers will replicate the effect, if not the reality, of a collusive agreement to limit production increases. BHP scaled back its own Pilbara expansion last year as part of a capital spending cull. But the big question mark is over undeveloped low cost big basins, such as Rio’s giant Simandou development in Guinea, West Africa. Tom Albanese, Walsh’s predecessor at Rio, was a big proponent of Simandou. So far, Walsh, who previously headed Rio’s iron ore unit, is making the right noises about shareholder value. But he has yet to signal a willingness to quit digging while he is ahead.