Iron Ore Miners Rio Tinto, BHP Betting Against the Bank

One interpretation of rising iron ore output among Western Australia’s big boys – Rio Tinto, BHP Billiton and lesser-known Fortescue Metals – is that they are betting against the rest of the market when it comes to cost of production.

According to Reuters, BHP produced a record 187 million tons of iron ore in the fiscal year ended June and by December it plans to be running at an annual capacity of 220 million tons. Rio mined 66 million tons in the three months to June, on track to meet its 2013 guidance of 265 million tons.

Rio said last week that it would lift its annual production capacity to 290 million tons by the end of September and to 360 million by the end of 2014. Yet at the same time, Chinese steel production growth is slowing and the FT believes the seaborne iron ore market is expected to move into surplus over the course of 2013.

If that is correct – and it looks highly probable it is – the iron ore price will fall.

So: how much?

How far and whether it will hit the $86 per ton seen in August last year is debatable, but at the current $129/ton, all mines are profitable, even China’s high-cost, low-grade supplies…at $86 per ton, they will not be, or so the big boys seem to be betting.

The cost of production for both Rio Tinto and BHP Billiton is around $50 a metric ton, Reuters says, so even if iron ore does fall sharply in the second half of the year on the back of slowing demand growth in China, BHP and Rio would likely be the last profitable producers standing.

The probability of an oversupply position and falling prices explains the trouble new ventures are having in raising debt financing. Both Australian Roy Hill and Anglo American’s Minas Rio ventures are looking doubtful.

Even Rio and BHP are cutting back on new investment, preferring to spend what capex they are on improving efficiencies at existing mines, which fits well with the medium-term game plan of squeezing competitors out the market over the next couple of years.

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Read more from Stuart Burns.

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