Rio Tinto’s Q3 Production Review: Iron Ore Production Growth Slows As Oversupply In Global Markets Set To Continue

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Rio Tinto continues to ramp up its iron ore production despite a prevailing oversupply situation in global markets, though the pace of production growth has declined, as illustrated by the company’s Q3 production report released yesterday. Rio Tinto’s Pilbara iron ore operations in Western Australia (which account for around 95% of its global iron ore production) achieved a production run rate of 330 million metric tons per annum (Mt/a) in Q3, with iron ore production from the Pilbara region rising 2% year-over-year. [1] Moreover, the company’s management approved the development of the Silvergrass iron ore mine in August, which would add another 10 Mt/a of iron ore production to Rio Tinto’s overall output by Q4 2017. [1] However, given the prevailing weakness in iron ore prices, Rio Tinto’s management has become extremely selective about investment in new projects. As a result, growth in production going forward is likely to be muted. The following graph illustrates our iron ore shipments forecast for the company.

The global iron ore supply is dominated by mining giants such as Rio Tinto, Vale, and BHP Billiton. These companies have access to high-grade, low-cost iron ore deposits. Moreover, with a steady ramp up in iron ore production, these companies have reaped the benefit of economies of scale, translating into profitable operations even at subdued iron ore prices, such as those prevailing at present. In case of Rio Tinto, the company’s EBITDA margins (on an FOB basis) for its Pilbara iron ore operations declined by only 300 basis points year-over-year to 58% in H1 2016, despite a steep 14% decline in benchmark iron ore prices over the same time period. [2] Unit cash costs for the Pilbara operations stood at $14.30 per ton in H1 2016, around 12% lower year-over-year. [2] Boasting one of the lowest cost iron ore mining operations in the world, Rio Tinto can continue to operate profitably at current levels of iron ore prices.

Despite slowing production growth from the likes of Rio Tinto, weak demand for iron ore from China, which accounts for the purchase of roughly two-thirds of the world’s seaborne iron ore supply, is expected to limit the upside for iron ore prices in the near term. As per World Steel Association estimates, the decline in Chinese steel demand is expected to continue in the near term, which is likely to translate into a decline in the country’s iron ore imports, as illustrated below.

Decline in Chinese Steel Demand 1

With the weakness in demand for iron ore set to persist in the near term and global iron ore supply set to rise, the prices of the commodity are unlikely to recover significantly any time soon.  Though Rio Tinto can continue to operate profitably at current levels of iron ore prices, the company’s iron ore mining margins are set to remain under pressure in the near term.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Rio Tinto
Notes:
  1. Rio Tinto’s Q3 2016 Production Report, Rio Tinto News Release [] []
  2. Rio Tinto’s Q2 2016 Earnings Presentation, Rio Tinto Website [] []