Iron ore is copping a caning as Chinese growth slows, causing mayhem amongst the listed Australian resource stocks that rely on Asian demand for steel.
For Glencore to be sniffing around Rio Tinto should not be a massive surprise but the opportunity looks to be in abeyance at least for another six months.
At the same time as the August discussion between RIO and Glencore was being chewed over by the market, BHP was busy revving up analysts about its newfound zest for growth in Pilbara iron ore projects, albeit at much lower investment intensity levels.
The effect of all these low-cost tonnes on the seaborne iron ore market will probably hurt the privately-owned operators most. Chinese State-owned capacity will continue to operate regardless of the iron ore price as the motivation is entirely different to private investment. So the lower iron ore prices only hurt the likes of Australian and other iron ore producers that can’t match the subterranean cost levels of BHP and RIO.
BHP and RIO have been thinking this way for a long time. It’s likely that part of the rationale for the proposed merger of RIO and BHP back in 2008 would have relied on the massive cost advantage to be gained from the combined operations. Indeed, when the deal between RIO and Chinalco fell over in June 2009, RIO immediately moved to create a discrete iron ore joint venture with BHP that was subsequently cancelled in October 2010.
BHP and RIO regularly report the enormous iron ore resource base that each company has at its disposal within the Pilbara region. Is it better that they develop those resources, at competition-punishing low cost levels, or is it better to allow the higher cost competition to thrive in order that all players benefit from higher iron ore prices? Each tonne not sold by BHP or RIO is a dollar in someone else’s pocket: a notion that management and Boards would acknowledge doesn’t align with shareholder expectations.
The new thinking in terms of growth in iron ore is arguably the polar opposite to previous management ideology. The US$20 billion Outer Harbour project now joins the US$25 billion Olympic Dam expansion on the sidelines as global commodity prices languish once again.
Back in 2011 when BHP was reporting record operating income of almost US$32 billion and enjoying iron ore prices around $170 per tonne, both projects looked set for the starter’s gun. As we know, commodity process had already begun to slide putting the decision-making process into low gear, luckily. Both were effectively canned by August 2012.
True, the mining tax would have played a significant part in the non-decision to expand Olympic Dam into the world’s largest open cut mine, but technological developments and Australia’s poor industrial relations environment were also factors.
The lesson learned from that period seems to have been that the era of the mega-project may be over.
The new approach, as espoused by BHP’s latest iron ore plans, shows that low capital intensity expansion is certainly possible.
The corollary to this may be that the mining services industry will need to reshape itself in order to survive on more meagre rations of exploration and expansion expenditure from the major companies.
But what of the smaller iron ore companies?
Most of these have substantial amounts of cash on balance sheets but each faces the same struggle to access low cost infrastructure to export product.
The BC Iron (BCI) takeover offer for Iron Ore Holdings (IOH) is close to completion now with compulsory acquisition underway. But the value of the deal has halved in two short months since it was announced. IOH shareholders have accepted this nonetheless although BCI shares have dropped by a much greater percentage.