These Miners Are Well Placed to Ride out Declining Iron Ore Prices

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After putting in a strong performance during 2013, iron ore prices have fallen to an eight-month low in the past few weeks as concerns about a property bubble within China hit the demand for steel. However, while the falling demand for iron ore will impact high-cost producers, the world's largest iron ore miners, BHP Billiton (NYSE: BHP  ) , Rio Tinto (NYSE: RIO  ) , and Vale (NYSE: VALE  ) should all be able to navigate through the storm.

But at what cost?
One of my favorite ways to evaluate mining companies is to work out their production costs per ton. This is extremely helpful when trying to establish how profitable a company will be in the future. For example, one of my favorite miners, listed in the UK, is Ukrainian based Ferrexpo. Ferrexpo mines iron ore at a cost per ton of just under $60, which makes the company extremely cash generative and profitable. 

Of course working the cost per ton figure out for Rio, Vale, and BHP Billiton will not be totally indicative of how good their results will be. These mining behemoths are well diversified and produce many commodities, so a rally in iron ore prices will not necessarily mean a good quarter. That said, all three companies get the majority of their income from iron ore production, so some knowledge is always helpful.

Crunching numbers
Firstly, let's take a look at BHP Billiton. The company produced 98 million tonnes of iron ore during the second half of 2013, which generated revenue of $11.8 billion, or 37% of total revenue, indicating that the company sold its iron ore production for an average price of $120 per tonne. All in all, on revenues of $11.8 billion the company produced earnings before interest and tax, or EBIT, of $6.6 billion, indicating a cash production cost per tonne of $53.01.

As BHP reports in the UK, the company uses the metric long tonne. One long tonne is worth approximately 1.1 short tons, indicating that BHP's production cost per short ton is around $48.2.

Using the same calculation I believe that Rio's cost of production was in the region of $77 per tonne, or $70 per ton for full-year 2013.

Meanwhile, Vale has reported that during fiscal 2013 the company's cash cost of production per metric ton of iron ore was $25, $5 lower than the year before. This is a really impressive metric and explains how the company was able to generate record operating earnings before interest, tax, depreciation, and amortization of just under $23 billion, a record for the company during 2013 -- remember 2013 was a bad year on the whole for the mining industry.

Not just low costs
Aside from a low cost of production, there is another reason why these miners are in a great position to ride out the weakness in the iron ore price.

You see, to combat a devastating smog currently engulfing much of China, the Chinese authorities have imposed strict emission limits on many industrial companies. This includes steel producers. As a result, there has been a rise in the demand for 'lump,' a higher quality iron ore that doesn't require sintering before being used in steel production. Sintering is essentially turning lower quality iron ore into lump, but the process is energy-intensive and a major contributor to pollution. The demand for lump has meant that the lump market has seen somewhat of a bubble recently, with prices, in comparison to standard ore, almost doubling. Further, some analysts believe that this is only the start of a bull market for lump as more sintering plants close down in China's drive to combat pollution.

Overall, this is great news for BHP, Rio, and Vale, as they produce some of the best quality iron ore in the world. Meanwhile, lower-quality producers are likely to suffer, and this could lead to a decline in supply of iron ore -- great news as the market could be considered oversupplied.

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Rupert Hargreaves

Rupert has been writing for the Motley Fool since December 2012. He primarily covers tobacco and resource companies with a passion for value-oriented investments. .

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