Rio Tinto’s announcement of a reduction of 10 million tonnes in its forecast shipments of iron ore to 340 million tonnes in 2015 is largely inconsequential.
The small, weather-related drop in the forecast won’t make much difference to a global seaborne market that is still vastly oversupplied, however, it does provide an opportunity to review just how Rio Tinto’s strategy is working out.
The key sentence for iron ore in the quarterly output report released Thursday was that the “focus is now on generating maximum value from the assets, including debottlenecking and productivity improvements”.
This shows that Rio Tinto is sticking to its guns in taking the approach of getting the capacity of its mines in Western Australia state to 360 million tonnes, and then running them as hard and as efficiently as possible.
In doing so Rio Tinto is trying to convince its investors, and the market at large, that a long-term strategy of being the lowest cost producer will eventually pay dividends as higher-cost producers leave the market.
Again, there’s nothing new in this strategy, it’s been Rio Tinto’s stated position for some time now.
Problem is that it’s also the stated position of Brazil’s Vale, the top-ranked iron ore exporter at risk of losing the title to Rio Tinto, as well as BHP Billiton, the number three producer.
Throw the commitment to being a low-cost producer from number four Fortescue Metals Group, new kid on the block Roy Hill with its 56-million tonne a year mine due to start up later this year, and other producers such as Anglo American and one gets the sense that everybody is playing the same game.
Of course, Rio Tinto will argue that it can play the game better than the others given the scale and quality of its mines, and that may well be the case.
But is it going to be enough to satisfy shareholders, who by now must be coming to the realisation that iron ore prices are set to remain near the current low level for an extended period.
Rio Tinto’s share price has had a strong correlation to the spot price of iron ore in Asia, which is unsurprising given that the steel-making ingredient accounts for some 90 percent of the company’s revenue.
But the correlation has broken down somewhat in the past 18 months, with iron ore falling by a far greater percentage than Rio Tinto’s shares.
Since the end of 2013, iron ore has dropped 62 percent, while Rio Tinto’s Sydney-listed shares falling 22 percent in Australian dollars and by 34 percent in US dollars by the close on Wednesday.
The major plunge in iron ore has come in the first half of this year, with the spot price hitting a record low of $44.10 a tonne on July 8, and even with a modest recovery to $50.10 on Wednesday, it’s still down 29.6 percent this year.
But Rio Tinto’s stock is down just 8 percent in Australian dollars and 17.7 percent in the US currency from the end of 2014 to Wednesday’s close.
Given the carnage in Rio Tinto’s main revenue earner, the share performance doesn’t look that bad, and is probably a testimony to the miner’s ability to cut costs, thereby keeping profit margins fairly healthy.
Investors obviously have choices and Rio Tinto’s share performance looks woeful when compared to the benchmark Australian stock index, the S&P ASX 200, which was up 4.2 percent from the end of last year to Wednesday’s close, despite taking a hit from the recent China stockmarket turmoil.
Rio Tinto’s competitor BHP Billiton has fared a little better, with its shares rising 1.1 percent in Australian dollars, but dropping 8.7 percent in US dollars.
It seems to be becoming clear that major miners can’t cost-cut their way to stronger share prices if the commodities they produce keep declining in price.
To some extent, most iron ore miners of significance have been able to cut costs far enough to keep heads above water, while jointly they continue to oversupply the market.
Vale’s move to get more of its giant Valemax ships supplying China will knock a few dollars per tonne of its landed costs, the latest example in what has become a seemingly relentless cycle of cost-cutting.
It’s becoming increasingly hard to see an end game that doesn’t end in tears for even the major miners.
Eventually the price can fall low enough to drive the likes of Fortescue, Roy Hill and Anglo American out of the market, but even then there is probably still too much iron ore capacity available.
If the plan of miners like Rio Tinto was to weather the storm of low prices until enough supply had exited the market, it doesn’t appear to be working.