CLYDE RUSSELL: Cash-flush iron ore miners target next drivers of profit

Launceston — Major iron ore producers are awash in a sea of cash, and are likely to remain so despite a recent retreat in the price of the steel raw material. Where they diverge is what they think will be the next big drivers of profit.

Rio Tinto, the world’s biggest iron ore miner, posted record first-half profit on July 28, with underlying earnings almost tripling to $12.17bn from the same period a year earlier.

The surging profits were largely built on the back of the rise in iron ore prices to record highs, despite Rio shipping 12% less iron ore in the second quarter, compared with the same period a year earlier, as storms affected its Western Australia operations.

Australia’s second- and third-ranked iron ore miners, BHP Group and Fortescue Metals Group, have yet to report quarterly financial results but are likely to join Rio in reporting record profits.

BHP reported record full-year iron ore production for the 12 months to end-June, though output in the fourth quarter dipped slightly, while Fortescue beat its full-year estimate for iron ore shipments on the back of a record fourth-quarter performance.

The spot price of iron ore for delivery to north China, as assessed by commodity price reporting agency Argus, slumped at the end of last week, dropping to $180.15 a tonne, down 10.5% from a week earlier.

However, it is worth noting that iron ore is still at extremely high prices by historical standards, having traded below $100 a tonne from mid-May 2014 to June 2020, with only a brief spike above that level in May to August 2019.

If China, the buyer of about 70% of global seaborne iron ore, does continue to cajole steelmakers to limit production, and if supply continues to rise from top exporter Australia and number two Brazil, it is possible that prices will further moderate.

However, with Rio reporting a cash cost of $18-18.50 a tonne for free-on-board iron ore at its Western Australia ports, it is clear the major miners are going to be strong cash generators even if iron ore posts further losses.

Inevitable decline

What the miners are doing with all that cash reveals much of where they are thinking they will be able to harvest profits once iron ore demand inevitably declines over time, as China’s industrialisation eases and the country sources more ore from new projects being developed, such as Simandou in Guinea.

Rio is still investing in copper, with expansion under way at its troubled Oyu Tolgoi mine in Mongolia, but the miner also recently approved a significant investment in lithium, a key metal for batteries that will be pivotal in any successful energy transition from fossil fuels.

The London-based miner said on July 27 it will invest $2.4bn to develop its Jadar lithium project in Serbia, with a four-year construction programme due to start next year.

The mine will make Rio the largest lithium supplier in Europe and will give the continent’s major carmakers, such as Volkswagen and BMW, another source of the metal, which is vital for plans to switch their vehicles to run on electricity.

Fortescue is also seeing a future in new energies, but is backing hydrogen as a future winner. It has in recent months entered into a range of agreements aimed at exploring hydrogen projects in India, Brazil, Africa and Tasmania, Australia’s island state.

The common thread is that Fortescue is looking at ways of producing green hydrogen, mainly through using hydropower, and then using the resultant hydrogen as a fuel in industrial processes, including making steel.

BHP has substantial investments in coking coal, which is used to make steel and oil, within its portfolio. It is taking a somewhat different path from its Australian peers, with its major pending investment being in potash.

The board of the world’s biggest listed miner is expected to make a decision within a few months on whether to proceed with the $5.7bn project in Canada’s Saskatchewan province to produce the agricultural fertiliser.

Potash is a key element in plant nutrition and can make crops more drought resistant, something that is likely to become increasingly important if climate change does alter rainfall patterns across the world.

It could be argued that BHP’s planned foray into potash is part of a response to climate change. However, instead of trying to lower carbon emissions as Rio is doing with lithium for batteries and Fortescue with green hydrogen, BHP is seeking a product that will be in higher demand as the world deals with the effect of climate change.

Reuters