Rio Tinto 2014 Operations Review: Sharp Rise In Iron Ore Production Volumes

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Rio Tinto (NYSE:RIO) has released its operations review for the fourth quarter and the full year 2014. Iron ore production rose sharply in 2014, as compared to the previous 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 company’s copper production in 2014 was higher as compared to the previous year. Alumina production increased sharply, whereas aluminum production remained flat. Excluding production from the Clermont mine, which was sold earlier in the year, thermal coal production rose sharply.

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Operational Performance

Consolidated iron ore production at Rio’s facilities stood at 295.4 million tons, of which the company’s share was 239.9 million tons. [1] Production attributable to Rio Tinto was 12% higher year-over-year. [1] The sharp increase in volumes was primarily due to the ramp-up of production to a rate of 290 million tons per year (Mt/a) at Rio’s Pilbara operations in May 2014. [2] Located in Western Australia, the Pilbara iron ore mines represent nearly 95% of Rio’s global iron ore production. [3]

Copper production rose to 603,100 tons in 2014, which was around 4% higher as compared to the corresponding period last year. [1] This was primarily due to the ramp-up of production at the Oyu Tolgoi copper mine, which commenced production in 2013. Production from the Kennecott Utah Copper and the Escondida  mines was largely in line with their 2013 figures. [1]

Excluding production from the Gove refinery, which was idled earlier on in the year, alumina production was 6% higher in 2014, as compared to the previous year. [1] This was due to stronger production across all refineries, particularly Yarwun, which ramped-up production post the completion of expansion in its production capacity in 2012. [1] Aluminum production stood at 3.36 million tons in 2014, largely in line with production levels in 2013. [1]

Rio Tinto divested the Clermont coal mine in the middle of 2014. [4]  Excluding production from the Clermont mine, thermal coal production rose 15% as a result of productivity improvements instituted by the company. [1] Including production from the Clermont mine, thermal coal production fell around 5% to 21.5 million tons in 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. [3]

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. [5] Iron ore spot prices stood at $68 per dry metric ton (dmt) at the end of December 2014, about 50% lower than at the corresponding point of time a year ago. [6] The outlook for 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 margins of high-cost seaborne iron ore suppliers.  A further reduction in prices may see a curtailment in operations by high-cost iron ore producers. [7] 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 290 Mt/a capacity have already been approved. [3] Logistics infrastructure for the 360 million tons per annum (Mt/a) expansion is 80% 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 $5.4 billion in operating, exploration, and evaluation cost reductions planned for 2015, as compared to 2012 levels. [8] 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 lowered its capital expenditure from $12.9 billion in 2013 to $8.5 billion in 2014, and intends to further reduce it to $8 billion in 2015. [8]  These efforts are aimed at operating competitively in a subdued iron ore pricing environment.

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Notes:
  1. Fourth Quarter 2014 Operations Review, Rio Tinto Media Release [] [] [] [] [] [] [] [] [] []
  2. Rio Tinto announces landmark Pilbara iron ore operational performance ahead of schedule, Rio Tinto Media Release []
  3. Rio Tinto’s 2013 20-F, SEC [] [] []
  4. Sale of interest in Clermont Mine completed, Rio Tinto Media Release []
  5. BHP, Rio Gamble With A Stacked Iron Ore Deck, Mineweb []
  6. Iron Ore Spot Price Chart, Y Charts []
  7. Iron Ore Prices Sink, Driven by Market Worries, Wall Street Journal []
  8. Rio Tinto Investor Presentation, Rio Tinto Website [] []