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Why Iron Ore Companies Are Still Going Ahead with Expansions

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Production plans

BHP Billiton’s (BHP) (BBL) management expects total production to increase by 6% in fiscal 2016 to 247 million tons, driven by improved efficiency. BHP has underpinned productivity as the only source of volume growth at WAIO in fiscal 2016. This will contribute to BHP’s iron ore eventual production target of 290 million tons per year.

Rio Tinto (RIO) said it expects its global shipments to reach 340 million tons per year in 2015. Vale SA (VALE) announced a curtailment of 30 million tons of higher cost iron ore production. However, this decline will be offset in the short term by an inventory equal to 50 million tons and in the long run, Vale is ramping up its S11D project, which should bring an additional 90 million tons per year in iron ore online from 2018 onward.

In addition to these major iron ore companies, Gina Rinehart’s $10 billion Roy Hill project is also expected to come online later this year, which will add another 55 million tons per year of iron ore to the already oversupplied iron ore market.

These are low cost projects, which in the face of a reduction in high cost capacity can garner more market share. That is the major reason that iron ore majors are pressing ahead with their expansion plans despite existing oversupply.

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Oversupplied market

While some high cost supply is exiting the market from China and elsewhere, the current state of the world’s largest iron ore consumer, China, is not good enough to absorb all the supply expansions planned. As we’ve seen previously in the series, most of China’s manufacturing and construction indicators remain weak. Expanding supply coupled with weak demand doesn’t bode well for the fortunes of the seaborne iron ore players mentioned above.

Impact on US companies

China is also trying to offload the excess steel output overseas as domestic consumption remains muted. The US (SPY) is one of the major victims of this excess supply. Its steel companies, including Nucor (NUE), Steel Dynamics (STLD), and US Steel (X) are negatively impacted, and so is the iron ore pellet supplier to these companies, Cliffs Natural Resources (CLF).

BHP Billiton, Rio Tinto, and Vale form 32.1% of the iShares MSCI Global Metals & Mining Producers ETF (PICK). The SPDR S&P Metals and Mining ETF (XME) also provides exposure to this space.

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