Chinese Slowdown Puts Pressure on Australia’s Iron Miners1

Thursday October 4, 2012, 4:00am PDT

By Chad Fraser2 - Exclusive to Iron Investing News3

http://ironinvestingnews.com/4528-chinese-slowdown-australia-iron-miners-bhp-billiton-rio-tinto-fortescue.html

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Australia’s iron ore output has soared in the past decade. According to figures5 from the US Geological Survey (USGS), the country’s mines produced 480 million metric tons (MT) in 2011. That’s up more than 160 percent from just 180 MT in 2001.

Now, as then, the country is the world’s leading iron ore producer. Its 2011 total put it well ahead of second-place Brazil, with 390 million MT of production. (China actually produced 1.2 billion MT of iron ore in 2011, according to the USGS, but that total consists of crude ore, as opposed to the usable ore the organization measures for other countries).

China’s rise has been a boon to Australian iron ore production

The country’s iron ore production has grown in lockstep with China’s surging demand for steel — the result of more of its population moving from the countryside to its ever-expanding cities (iron ore is a key element in steelmaking).

To put the size of this trend in perspective, in the past 15 years, China has built 90 million new homes, according to a recent article6 in The Guardian. That adds up to nearly three homes for every person in Canada.

Thanks partly to Australia’s close proximity to China, the latter now buys roughly 25 percent of Australia’s total exports, including 70 percent7 of its exported iron ore. Japan and South Korea account for much of the remaining 30 percent.

As a result of that close trade relationship, the boom has fueled a sharp rise in the Australian dollar. The flip side? China’s cooling economy is now taking the Aussie dollar down with it. On Tuesday, the Reserve Bank of Australia unexpectedly lowered8 interest rates by a quarter point in a bid to spur the country’s slowing economy. That cut a half cent off the Australian dollar’s value and sent it to a three-week low versus the US greenback.

“The Board judged that, on the back of international developments, the growth outlook for next year looked a little weaker,” said9 the bank’s governor, Glenn Stevens.

BHP Billiton is pushing back a big harbor development in Australia

Because China is the world’s biggest iron ore consumer, its slowdown has been dragging down the price of the metal as well. Benchmark iron ore now trades10 at around $104 a tonne, down11 more than 20 percent in the last three months.

That, in turn, has been weighing on shares of companies with iron ore mines in Australia. BHP Billiton (NYSE:BHP12,ASX:BHP,LSE:BLT), for example, has seen its stock fall over 16 percent since early February. Iron ore accounted for 31 percent13 of BHP’s revenue in its 2012 fiscal year, which ended June 30. Much of the company’s production comes from Australia’s Pilbara region, one of the world’s most productive iron ore areas.

BHP has big plans for its Pilbara operations, which it owns through a number of joint ventures. The company has said that it aims to boost14 its production capacity in the region above its current level of 240 million MT per year. Any expansion beyond that level will require BHP to go ahead with its $22 billion expansion of the harbor at Port Hedland.

However, in light of falling commodity prices and rising operating costs at its Australian operations, BHP decided15 to put off its decision on the port for 12 months in late August. The news was not unexpected: just two weeks earlier, firms working on BHP’s projects in the area began16 laying off engineers and designers. Subcontractor GHD, for example, recently cut 35 jobs.

Rio Tinto’s Pilbara expansion is “on time and on budget”

Meanwhile, Rio Tinto (NYSE:RIO17,ASX:RIO,LSE:RIO) is continuing with its Pilbara expansion, despite weaker iron ore prices. The company currently operates 14 mines in the area with a total capacity of 230 million MT a year, as well as a significant amount of transportation infrastructure, including two port facilities (at Dampier and Cape Lambert) and Australia’s largest privately-owned railway.

Iron ore accounted18 for 46 percent of Rio Tinto’s revenue in 2011. The company aims to boost the capacity of its Australian operations to 283 million MT in 2013 and to 353 million MT in 2015.

“The expansion remains on time and on budget,” Greg Lilleyman, president of Rio Tinto’s Pilbara iron ore operations, recently told19 Dow-Jones Newswires. He added that delays of other miners’ big projects in Australia “can only be positive for the medium-term supply-demand balance, and therefore prices and returns on Rio Tinto’s industry-leading Pilbara project.”

To lower its costs, Rio is making cuts in areas outside of iron ore. For example, it has laid off20 an unspecified number of workers at its Argyle diamond21 mine. It is also looking to cut jobs at its coal22 division and plans to close its Blair Athol coal mine in Central Queensland.

Fortescue is heavily reliant on Australian iron ore

Unlike Rio and BHP, Australia-based Fortescue Metals Group (ASX:FMG23), another major that’s active in the Pilbara region, is solely focused on iron ore.

The company’s mines currently produce24 55 million MT of iron ore annually. Its board of directors recently approved25 an $8.4 billion expansion that will raise that total to 155 million MT.

However, low prices have forced Fortescue to retrench as well. In an effort to cut its costs by $1.6 billion, the company is now delaying part of its planned expansion and is laying off 1,000 workers. The decision means Fortescue will push back26 40 percent of the new production it had planned in 2013.

Production increases, Chinese uncertainty cloud iron ore’s longer-term outlook

Despite current weak iron ore prices, demand for the metal should rise over the longer term. That’s because despite the current slowdown, the underlying trend of urbanization in developing countries is expected to continue. That will fuel steel demand.

However, ongoing expansions by Rio Tinto, BHP and others have raised concerns about a possible iron ore glut. In a September report, Citigroup said27 that increased output in Brazil, Australia and elsewhere could boost global seaborne exports by about 35 percent from 2010 levels. If those projects go ahead as planned, they could create an iron ore surplus by 2015.

Last month, analyst Tom Price of investment bank UBS issued an outlook calling for an iron ore rebound to $120 per MT by the end of this year as Chinese steelmakers rebuild their inventories. In addition, today’s low prices could make it cheaper for the country to import more iron ore than to increase its own production.

“That supports the case for imports to lift and prices to lift over the next couple of months,” he said28. However, UBS also sees uncertainty ahead: the bank is forecasting longer-term prices of $85 to $90 per MT based on its assumption that Chinese steel production will peak in 2015.

Securities Disclosure: I, Chad Fraser, hold no positions in any of the companies mentioned in this article