Why Rio Tinto has a lower cost structure

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Operating conditions

Rio Tinto’s (RIO) biggest product contribution comes from iron ore. Iron ore isn’t performing well this year. Iron ore prices are down ~40% this year. The prices are down because of oversupply in the market. Also, prices were impacted by weaker-than-expected demand growth from China. China accounts for two-thirds of the global seaborne iron ore demand.

Coal prices are also down ~25% this year. This is also putting pressure on the company’s profitability.

cash cost

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As a result of the conditions, iron ore producers—including Rio, BHP Billiton (BHP), and Vale SA (VALE)—are in a cost-cutting spree. Smaller players—like Cliffs Natural Resources (CLF)—are being pressured by the low-cost and big players on the supply side. The smaller players are also impacted by weaker-than-expected demand conditions in China and elsewhere.

Cost cutting

Rio announced steep cost cuts in 2013—amounting to $5 billion. Sustained weakness in coal prices led Rio to cut jobs in Queensland, Australia. Rio also restructured its coal portfolio—including the sale of its Mozambique coal assets. This is a part of Rio’s disciplined approach to capital allocation. It cut $3.3 billion, or 9%, of its 2012 cost base in the 12 months ending December 2013.

Rio’s cost cutting efforts were successful. Its profits for the first half of 2014 roughly doubled.

Cost structure

Rio Tinto has one of the lowest cost iron ore reserves in the world. Its cash costs for iron ore production were $20.80 per ton in 2013. Rio’s target is to achieve all-in cash costs of $35 per ton by 2020.

Its rival, BHP, wants to become the lowest cost iron ore producer. It plans to produce at a cash cost $20 a ton. Currently, BHP has a cash cost of $27–$28 per ton. There’s a difference of ~$8 per ton between BHP and RIO for C1 cash costs. VALE has C1 cash costs of ~$23 per ton.

These costs include mining, process, and administration. The costs don’t include royalties, exploration, sustaining capital, depreciation and amortization, interest, and taxes.

RIO has lower costs because it’s ahead of its peers in automation. It also has more volume in its higher grade Pilbara blend.

Investors can also invest in the SPDR Metals and Mining (XME). XME provides diversified exposure to all of the stocks mentioned above.

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