How Rio’s Access to High Grade Iron Ore Would Remain Advantageous to the Company in Q4
China’s regulatory authorities have initiated a series of industrial production cuts in its winter months, starting in November, to control its alarming level of pollution. Rio Tinto (NYSE:RIO), being one of the largest iron ore producers globally, is expected to be significantly impacted by these curtailments as steel production cuts would, in turn, reduce the demand for iron ore. Despite this setback, Rio’s competitive position of having access to high grade iron ore at low cost is expected to remain beneficial for the company even in an unfavorable environment for steel production.
Amid an environment of capacity cuts, Chinese steel producers have cut their production for substandard steel and have increased their demand for iron ore with Fe content greater than 60% to produce steel. Steel produced through the Basic Oxygen Furnace (BOF) method uses coke to transform iron ore to steel and thus emits a large quantity of carbon into the atmosphere. However, usage of high grade iron ore produces more steel per ounce of iron ore and consequently emits less coke into the environment.
This has led to a widening price gap between the prices of high grade and low grade iron ore. Low grade ore (58% Fe content) has experienced a price discount of an average of 40% (approx) on 62% premium grade for the quarter ending December 2017 as illustrated by the graph below. In such a scenario, Rio’s access to high grade iron mines is expected to remain beneficial for the company as it would entitle it to charge a premium for its products. Rio has an average iron ore grade of Fe content of 62% or higher. Additionally, the company breaks-even at a price level of $28/ ton, the lowest among the sea-borne players. Higher iron ore prices would provide a greater profit margin for Rio in its fourth quarter.
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(Source: Metal Bulletin)
Although the price difference between premium grade and lower grade ores are expected to decrease post March, once the Chinese winter curtailments are lifted, we expect high and medium grade producers to continue to be in a beneficial position in comparison to producers of low grade ore, given the rising environmental concerns around the globe.
We have a $47 price estimate for Rio Tinto, which is below the market price.
Have more questions about Rio Tinto? See the links below.
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