Rio Pulling in the Horns

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At its recent investor seminar Rio Tinto warned of an uncertain and volatile short-term outlook, nothing new there, though with an expected fourth-quarter pick-up in Chinese fixed-asset investment. Longer term, Rio remains bullish on global commodity consumption with China remaining the key driver until at least the mid-2020s.

The company expects an additional 2 billion humans to urbanise globally by 2030. All commodities will benefit, though the rate of growth will slow, particularly for iron ore and coking coal, these being early-cycle beneficiaries in developing economies. With iron ore for example, analysts forecast long-term delivered China price in 2013 real terms is USD 90 per tonne, 50% below first-quarter 2011 highs of USD 180 per tonne, but ahead of the 10-year average of USD 80 per tonne.

Annual global demand for iron ore and coking coal is expected to grow by a compound 2.2% per year, or 25% in total over the next 10 years. For iron ore this equates to a 450 million tonne increase, or around half the 800 million tonnes that was added in the prior 10 years. Half yes, but still a very substantial increase, especially from the seaborne producers’ perspective.

Seaborne is a two-third and faster-growing subset of total supply, and the market that matters for Rio and BHP. The seaborne iron ore market could grow by 40% in total in the next 10 years, more if high-cost, price-sensitive Chinese domestic supply falls away. That’s around 60% of the 750 million tonnes in seaborne that was added in the last 10 years, equivalent to nearly two new Rio Tintos.

Also, the bulks of course are likely to be the worst performing commodities from a volume growth perspective. Growth rates in copper, thermal coal, aluminium and titanium dioxide are expected to be far greater. These are not earlycycle commodities and in many cases the industry supply response is increasingly challenged. Just look to recent high profile project deferrals like BHP’s Olympic Dam copper/ uranium expansion.

With weaker prices in mind it makes less sense to chase volume for volume’s sake, particularly while labour and other input costs remain elevated. This was the correct strategy last decade, now a focus on costs is required. By 2015, Rio expects its capital expenditure to be half the 2012 peak of USD 16 billion.

Sustaining capital expenditure will decline by USD 1 billion in 2013, and no new major project approvals are planned in the near term. Rio also targets over USD 2 billion in cash cost savings in 2013, increasing to USD 3.3 billion in 2014 versus 2012. Rio’s Pilbara cash costs will decline as it expands with all key infrastructure in place. And it targets significant Australian thermal coal cost compression in 2013, not dissimilar to recent statements from BHP. The company targets accelerating and increasing cost reduction in aluminium via selling, general and administration cut-backs, and further productivity improvements.

 

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