BHP Billiton Cuts Iron Ore Production Costs, Market Takes a Hit

Monday October 6, 2014, 3:30pm PDT
By Nick Wells - Exclusive to Iron Investing News

BHP Billiton (NYSE:BHP) is joining the race to the bottom as it looks to become the lowest cost producer of iron ore in Australia. News that the miner would cut production costs hits a market that has already been battered with low prices this year as surpluses continue to eat away at the profitability of the base metal.

According to a statement6 put out by BHP on Monday, the plan is to cut unit costs by 25 percent at its Western Australia iron ore operations and to increase capacity to 65 million tonnes per year. The company is trying to compete with Rio Tinto (NYSE:RIO), which has traditionally been the lowest cost producer of iron ore in Australia.
 
"We will continue to squeeze the lemon because at the end of the day it's just so value accretive," Jimmy Wilson, the head of BHP's iron ore department, said in a video conference with journalists.

The news brought small relief to the company's share price, with its shares rising just under one percent on the New York stock exchange. Certainly, while BHP hopes the cuts will bring it success, the decision could also be a blow to the currently oversupplied iron ore market. Prices no doubt have a lot of ground to make up.

No rest for the juniors

Unfortunately, the overstocked iron ore market is going to keep getting larger. Goldman Sachs has forecasted the world surplus to more than triple from 52 million metric tonnes to 163 million in 2015, and the news has already been poorly received by Glencore PLC (LSE:GLEN).

Ivan Glasenberg, Glencore's CEO, told a panel discussion in London that BHP's announcement has already had an effect on the market. "If you look at the statement put out today by BHP Billiton, one of the world's biggest iron-ore producers, saying they're going to expand production — it has already had an impact on prices," he said.

In particular, BHP's decision spells bad news for junior mining companies. Falling prices have already made profitability hard to come by for smaller iron miners, and the news from BHP will not bring any relief. An oversupplied market market will lower prices and further decrease the profit margins for juniors.

Hope comes from Asia

The iron ore market has seen prices tumble over the last four years, with prices falling from $190 a tonne to less than $80. This year alone has seen a roughly 40 percent drop in price, with prices hitting their lowest since 2009.

Hope for relief rests on the shoulders of China and India and their respective construction markets. Chinese demand has slowed this year, as the economy is estimated to grow only 7.3 percent, down from an estimate of 7.4 percent in August, but India could still provide brief respite.

Iron ore output has dropped in that country as a result of action taken to end illegal mining. The move has forced JSW Steel Ltd (NSE:JSWSTEEL), India's third-largest steelmaker, into looking to buy London Mining as a solution to iron ore demand in its home country. Overall, India is said to be looking to ship up to 45 million tonnes of iron ore over the next three years. While the demand won't end the global surplus, it could help ease some strain on the market by lessening the surplus and providing a stimulus.

Prices still down

Standard and Poor's initial estimate of a return to prices in the $95 range per tonne of iron ore was revised at the start of October, with an 11 percent drop. The financial services company now estimates16 that iron prices will stay weak until about 2016, with 2015 and 2016 seeing prices of $85 per tonne.

Today's news certainly didn't help the outlook for iron ore, but investors with faith in the base metal will no doubt want to keep an eye on key developments to see which companies weather the storm.