Mexican drug cartels have been diversifying into the iron ore business, smuggling ore worth about $US1 billion a year into China. But it’s the emergence of a more legitimate cartel – one run largely by Australians – that should worry China more.
Rio’s latest result shows how powerful the big three global producers have become. The company’s results for the six months to June 30, with underlying earnings rising 21 per cent to $US5.1 billion ($5.47 billion), are remarkable given that iron ore prices actually fell 20 per cent over the period.
After slashing costs, capital expenditure and debt, management hinted at higher dividends and more buybacks. If the mining boom is supposed to be over, no one told Rio Tinto.
The really interesting element to the result concerned production increases. Although lower iron ore and coal prices stripped $US1.4 billion from underlying earnings, volume increases, particularly in iron ore, offset that fall by more than $US900 million. All up, iron ore contributed more than 90 per cent of total profit.
With China slowing and the country’s government frantically shifting spending away from capital expenditure towards consumption, which dampens demand for ore, Rio Tinto and BHP are expanding output.
It sounds counter-intuitive but the move contains a deadly logic. Rio, BHP and Brazilian-owned Vale enjoy major cost advantages over almost every other producer. The greater their output, the more pain they inflict on the competition.
If the big three can push the price of ore low enough, they can induce a global shakeout in the industry by forcing higher cost producers into bankruptcy.
After that, the Chinese become price takers – a prospect that must terrify them – and the big three will recover all the money and more they’re prepared to lose to control global output and prices.
Logistics, not mining
As the fourth most common element in the earth’s crust, the world is not short of iron ore. The difficult (and more expensive) bit is getting it to the customer. That such an abundant mineral can be dominated by three miners reveals the true nature of this business – it’s about logistics, not mining.
Big cost advantages await those that can amortise large-scale production across the huge costs of mining equipment, rail lines and ships involved in transporting ore. And as prices fall that advantage actually increases.
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