Australian media and politician complaints about the BHP and RIO iron ore strategy are reaching a crescendo which is as naive as it is loud. Jennifer Hewitt today joins the Johnny-come-lately narrative as cipher for FMG’s Nev Power:
Fortescue chief executive Nev Power knows as well as anyone the price impact of the vast expansion in global iron ore supply. He is extremely disappointed, he says, at what he calls the “scorched earth” approach of Rio Tinto and BHP Billiton.
“It will inevitably result in self-inflicted wounds of the sort we are seeing playing out now,” he says. “As we have maintained throughout, Fortescue will continue to reduce our costs and will remain a competitive and reliable alternative for our customers.
“But the scorched earth policy BHP and Rio appear to be engaged in will only encourage Chinese producers [to] stay in the market and even to increase volumes for fear of being faced with another oligopoly.”
Nor that Fortescue, unlike many smaller producers, is at risk…Power says Fortescue needs $US70 a tonne to meet all cash flow requirements at today’s costs and exchange rate.
I’ll keep saying it. Junior output amounts to roughly 100 million tonnes, so when it disappears it still won’t be enough to balance the market through the coming surplus, which is more like 250mt within eighteen months. That leaves FMG as the first large producer in the cost curve and very likely the marginal cost producer. So long as it exists, cost cuts will simply be recycled as cheaper iron ore for China. FMG is at risk.
That intensifies the irony here given it is FMG that brought competition to the iron ore market, it is FMG that expanded by 100mt in the past 9 months, far ahead of the volume growth of both BHP and RIO, and it is FMG that has been leading discounting in iron ore markets. Are BHP and RIO supposed to take this and do nothing?
Threats to FMG may be legitimate enough reason for some folks to argue that BHP and RIO should manipulate the iron ore price but that rather seems to confuse the interests of FMG shareholders (or its executives which JH clearly has a strong relationship with) with the interests of Australian citizens.
MB has long argued that volume is no substitute for price in commodities, and it is the case that the West Australian and Federal budgets would be better off if FMG and the junior miners continued to exist given the higher volume output would boost royalties. But it’s not all bad if rationalisation takes hold in the sector. Marginal mines have sucked in a lot of capital in the past decade absolutely crashing mining productivity. Unleashing creative destruction is going to swiftly reverse this and cleaning out the mis-allocated capital implicitly mitigates the shakeout for the nation.
Still, let’s take the proposition of price manipulation at face value and ask if it’s even possible at this stage of the cycle. If RIO alone were to cut production (as GlenRio for instance) it wouldn’t matter. BHP, Vale, Roy Hill, Anglo, Sino and India are still going to ramp production and RIO will just lose market share as prices still fall.
If BHP and RIO were to get together as a highly illegal cartel (as Colin Barnett brazenly suggests that they should) then that would reduce output growth by about 150 million tonnes over the next few years. It may be enough to stabilise the price at $80 and FMG could stay in business (but juniors go bust). But is that in the major’s interests? The others would still pile in even as both majors stopped growing today and their share prices fell anyway as their returns on equity fell away on sunk capital into useless infrastructure.
Simply put, the emerging competition in the iron ore market is now strong enough that the majors are trapped, at least until they can consolidate the market.
BHP and RIO have twice tried to explicitly manipulate iron ore prices during the shortage by merging completely and then merging sales. For it to work during a glut, they would need to bring more producers into the fold – at least Vale or FMG – and is highly illegal anyway at the commercial level. It could still be done at the national level if, say, Australia and Brazil formed an OPEC-like organisation but that’s not going to happen!
Source: Macro Business
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