Rio Tinto Operations Review: Sharp Rise In Iron Ore And Copper Volumes

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Rio Tinto (NYSE:RIO) has released its operations review for the third quarter and the first nine months of the year. Iron ore production and shipments rose sharply in the first nine months of the year, as compared to the corresponding period last year. This is consistent with the company’s strategy to expand iron ore production, despite a subdued iron ore pricing environment. The company is banking upon economies of scale to drive its results, capitalizing on its low-cost iron ore deposits.

Besides iron ore, the production of copper rose sharply in the first nine months of the year, as compared to the corresponding period last year. Aluminum production remained flat, while bauxite production declined during the first nine months.

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Operational Performance

Iron ore production in the first nine months of the year at Rio’s facilities stood at 216.2 million tons, of which Rio’s share was 170.3 million tons. Production was 11% higher year-over-year. The sharp increase in volumes was primarily due to the ramp up of production to a run rate of 290 million tons per year (Mt/a) at Rio’s Pilbara operations in May. The Pilbara iron ore mines represent nearly 95% of Rio’s global iron ore production. Global iron ore shipments stood at 220.4 million tons in the first nine months of the year, up 18% year-over-year. Shipments exceeded production, as inventory built up ahead of the expansion of port and rail infrastructure at the Pilbara system of mines, was drawn down. [1]

Copper production rose to 474,700 tons in the first nine months of the year, which was 15% higher as compared to the corresponding period last year. This was driven by higher grades and concentrator recoveries at Rio’s Kennecott Utah Copper operations and the ramp up of production at the Oyu Tolgoi mines. Rio has raised its production guidance for mined copper in 2014 to 615,000 tons from the previous estimate of 585,000 tons, in view of the higher production figures. [1]

Bauxite production was 2% lower in the first nine months of the year, compared to the corresponding period last year, as the Gove mine lowered production in response to the planned curtailment of the Gove alumina refinery in the first half of the year. Aluminum production in the first nine months remained flat on a year-over-year basis, with production from the new AP60 smelter and productivity gains across the rest of the smelter portfolio offsetting the impact of the closure of the Shawinigan smelter in November 2013 and the partial closure of the Kitimat smelter. [1]

Thermal coal production fell 1%, with higher production from the Hunter Valley and Hail Creek mines offsetting some of the loss in volumes from the completion of the divestment of Rio’s 50.1% interest in the Clermont mine in Q2 2014. [1]

Strategy

Rio Tinto is expanding capacity at its iron ore mines, despite a subdued iron ore pricing environment. The company is banking upon robust Chinese demand for iron ore in the long term, driven by rapid urbanization. ((Rio Tinto’s 2013 20-F, SEC))

Global iron ore prices have plummeted over the last year or so, due to expansion in production by major mining companies. Supply has outpaced demand resulting in an oversupply situation. However, Rio Tinto with its low-cost iron ore deposits can continue to operate profitably in the prevailing subdued iron ore pricing environment. Rio’s cost of production stands at around $50 per ton.((BHP, Rio Gamble With A Stacked Iron Ore Deck, Mineweb)) Iron ore spot prices stood at $82.38 per dry metric ton (dmt) at the end of September 2014, about 38.6% lower than the corresponding point of time a year ago. ((Iron Ore Spot Price Chart, YCharts)) The outlook on iron ore prices remains bleak in the near term, in view of the oversupply situation. Falling iron ore prices in an oversupplied market will put pressure on the margins of domestic Chinese iron ore producers, which have higher costs of production as compared to Rio, as well as high-cost seaborne iron ore suppliers.  A further reduction in prices may see a curtailment in operations by high-cost iron ore producers. [2] This will constrain supply and benefit low cost producers such as Rio.

Rio Tinto is planning to further expand the production capacity of its Pilbara iron ore operations. Plans to increase mine production capacity to 360 Mt/a by 2017 from the current 290Mt/a capacity have already been approved. ((Rio Tinto’s 2013 20-F, SEC)) Infrastructure for the 360 million tons per annum (Mt/a) expansion is 75% complete, with all rail, marine and wharf works in place. [1]

The success of Rio’s high iron ore volumes strategy will depend upon the strength of Chinese iron ore demand in the long term. With the country consciously reorienting its economy from an investment led model to a consumption led model, it remains to be seen whether Rio’s expectations of sustained Chinese demand are well-founded.

In addition to expanding iron ore production capacity, the company is also targeting cost savings with $3 billion in operating cash cost reductions planned for 2014, as compared to 2012 levels. [3] The company also intends to reduce capital expenditure, through a combination of lower sustaining capital expenditure and focusing expansion capital expenditure on projects that offer the best returns. The company intends to lower capital expenditure from $12.9 billion in 2013 to $11 billion in 2014, and further to $8 billion in 2015. These efforts are aimed at operating competitively in a subdued iron ore pricing environment. ((Rio Tinto’s 2013 20-F, SEC))

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Notes:
  1. Third Quarter 2014 Operations Review, Rio Tinto Media Release [] [] [] [] []
  2. Iron Ore Prices Sink, Driven by Market Worries, Wall Street Journal []
  3. Rio Tinto’s 2013 20-F, SEC []