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Rio Tinto plc (RIO -0.78%)
Q2 2019 Earnings Call
Aug 1, 2019, 5:00 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

John Smelt -- Head of Investor Relations

Good morning, everyone. Hello. Great. It's 10 o'clock. So, we'll get going. Thank you very much for coming along to our Half Year Results. [Operator Instructions]

Okay. With that, I will hand over to J-S. Thank you.

Jean-Sebastien Jacques -- Chief Executive Officer

All right, thank you, John, and good morning, everyone. I am delighted together with Jakob and the team. So we've got Chris, we got Simon, Arnaud, Steve, Bold, Vera, I mean long list today, to welcome you to our 2019 half year results.

It has been a very strong financial performance. We have delivered an EBITDA margin of 47%, the highest in the last 10 years. And the return on capital employed of 23%, in line with the best-in-class industrial blue-chip companies. We have delivered free cash flow of $4.7 billion, up 65% compared to the same period last year.

We have maintained a very disciplined approach to capital allocation. We have paid $7.8 billion of cash return to our shareholders so far in 2019, delivering on our commitments. And we have just announced, we will return a further $3.5 billion in dividends. As a result, our shareholders will receive $12 billion in cash returns in 2019. We have invested $2.4 billion in our asset, a similar level to last year, and we have one of the strongest balance sheet in the sector with a net debt at $4.9 million, which highlight the financial strength of Rio Tinto.

So our financial performance was very strong. Thanks to a robust iron ore pricing environment. However, I want to acknowledge upfront, we have experienced operational challenges this year, including fully optimizing our iron ore system. This is not good enough and we are taking clear actions. I will take you through this. I will also cover our plans for you to go and update you on other growth options. As has already mentioned, a number of the team are here today with me, and they will be happy to take additional questions you may have after the presentation.

Now let me turn to one of our operational highlights of this half, safety. As I've said it before, safety is our number one priority. There is nothing more important. In 2019, we have had no fatalities, AIFR has improved, our severity rate has reduced, and there has been a reduction in process safety incidents. But we are not complacent.

We continue our focus on major hazard risk management, integrating our tailings and water storage management in even more detail. After the tragic incident in Brazil, we continue to look at everything we do. And as you know, in February, we disclosed our global tailings and water storage facilities, and our controls and approach to managing them. We provided even further information in June.

We are working with the ICMM and our peers in this space to develop an international standard on tailings storage facilities. Our aim is to continue to improve our safety performance, which is a core part of our approach to sustainability. Sustainability is an absolutely vital part of doing business in the 21st century. It is not a new initiative, but central to the way we run our business. Key to our approach to sustainability is profitability. We are not -- if we are not profitable -- if we are not profitable, we cannot contribute positively to the world around us, in the long term.

We have three key areas of focus. First, running a safe, responsible and profitable company; secondly, collaborating to enable long-term economic benefits; third, pioneering materials for human progress. We progress on all three of these in the first half. I've already covered safety, so let's take a look at a few more of the performance highlights.

In February, we published our first climate change report, aligned to the TCFD framework, which outlines our key areas of focus. Two; number one, supply essential metals and minerals for the transition to a low-carbon economy; two is reduce our own carbon footprint; three, identify and access physical risk exposures for partner and advocate for policies that advance climate goals.

In the first half, we made further progress to reduce our Scope 1 and Scope 2 emissions. Let me give you an example. We close our coal-fired power plant at Kennecott, and switched operation to renewable electricity purchase from the grid. We are currently investing in various climate related initiatives around the globe, from our partnership with customers like Apple and Elysis to produce carbon free aluminum, to our partnership with Geneva University to the World Bank and a few others. We are also working hard on our plus 2020 emission reduction target. These targets will be well flowed through and you will hear more on these next year.

We are also committed to transparency. We have shown that this is not only in the area of tax paid, but also in the disclosure of some contracts with governments. We finished number two in the Corporate Human Rights benchmark of global companies only behind Adidas. And we are proud of our innovative partnerships. For example, our collaboration in WA to create qualification in automation. We do not claim to have all the answers on sustainability. It is a complex area, we do -- we do though understand and mitigate against our major risk and you will see us do more in this area.

And I, now at this point, will return to you Jakob on the financials.

Jakob Stausholm -- Chief Financial Officer

Thank you, J-S. Ladies and gentlemen, good morning. As J-S has already told you, we have today disclosed a set of strong financials. When you look at the profit and loss and cash flow statement, from top to bottom, you will see that all underlying comparisons from the first half of this year to the first half of last year have improved.

Our top line has improved by 3%. However, if you exclude the coal businesses that we divested last year, the underlying growth is 7%. We saw a double digit improvement in EBITDA, and we saw an even stronger improvement in cash from operations and free cash flow, due to our high cash conversion in the first half.

Following our project update on Oyu Tolgoi announced on the 16th of July, we have impaired the asset value with a net income impact of $0.8 billion. We've taken a cautious approach, which captures the average of a range of potential outcomes. This Oyu Tolgoi impairment represents the main variance between IFRS net earnings of $4.1 billion, and underlying earnings of $4.9 billion. J-S will provide a further update on Oyu Tolgoi later. Because of strong earnings and a strong cash conversion, the Board was able to both increase the interim dividend to $3.5 billion, while we continued to strengthen our balance sheet as demonstrated by the reduction in pro forma net debt.

Now let me step back before diving into the details of our results. The value creation expressed in terms of profitability and growth, is strong for Rio Tinto. Our profitability continues to improve and reached the highest level on recent record in the first half. We saw our return on capital employed reached 23% and this is based on underlying net earnings after tax. Despite being in a very capital-intensive business, our ROCE is not only the highest among our industry majors, but as J-S said, at the top end among industrial companies in general. We are also a growing company. Over the last three-and-a-half years, our growth have been a CAGR of 2.5%. The first half of 2019 was affected by weather and operational issues at the Pilbara. We expect though to return to production growth in the second half of the year, of course, always driven by our value or volume mantra.

China's economy -- economic growth has been strong in the first half, supported by fiscal stimulus, while the rest of the world has experienced a weakening growth. In aggregate, this impact on our portfolio has in fact been positive with strong iron ore demand somewhat offset by weaker demand for aluminum and copper.

The iron ore business has faced rather unusual conditions. We saw a strong growth in steel production in the first half. At the same time, we had a very high level of iron ore supply disruptions, starting from the tragic incident in Brazil in January and carrying on with exceptional weather conditions. And we have furthermore experienced operational issues, which J-S will cover later in the presentation. As a result, the iron ore price increased significantly throughout the first half.

Aluminum demand growth moderated to only around 1%, impacted by in particular the transportation sector. On supply, as we anticipated, restructuring in the Chinese aluminum industry has been modest today. And in January, we saw the sanctions on Rusal lifted, meaning that more supply came to market. As a result, there has been a declining price during the first half, compared to both the first and the second half of 2018. The mid-west premium though has stayed stable to the tune of 400 million -- $400 per ton.

Now moving on to copper. The slowing economy, world economy has impacted market sentiment and demand growth. Combined with limited disruption in supply, this has resulted in an 11% deterioration in the copper price compared to the same period last year.

Our underlying EBITDA in the first half of '18 was $8.6 billion, when you exclude the coal business that we still had last year. Higher prices were driven by the iron ore, and favorable exchange rates particularly by the weaker Australian dollar. Overall, the lower EBITDA compared with the flexed EBITDA for the same period last year is entirely due to weather conditions or weather disruptions in the first quarter.

When we last presented to you here, we set out a target for this year to reach a run rate productivity improvement of $1 billion. Given the revised guidance, production guidance in iron ore that will not be achieved. The weather in the Pilbara removed around $200 million from our productivity initiative, and as a result, we have seen a run rate reduced from $0.4 billion at the -- at last year to $0.2 billion in the first half of 2019. However, more importantly, the planned improvements in productivity, primarily in iron ore was not achieved and hence we are updating the full-year guidance.

As a group, we are though confident that we will improve from here in the second half of the year. Our updated target run rate is $0.5 billion for 2019. We've recognized the operational issues we have experienced in the Pilbara and addressing them with rigor. However, looking forward, we anticipate generating between $1 billion and $1.5 billion of additional free cash flow by 2021. This new range is subject to an increase in iron ore volumes, which will be dictated by market conditions of course, and a reversal in raw materials costs primarily in our aluminum business.

Now, let me move to the results of each of the product groups. As previously mentioned, we've seen a significant hike in the price of iron ore. This is progressively developed throughout the half year. On average, the improvement in the realized price was 35%, whereas prices toward the end of the period are materially higher.

Shipments in the first half fell short of our expectations. We had expected higher shipments compared to previous year, and instead we saw an 8% fall. The shortfall against last year can explain -- can be explained by weather impacts and a fire at Cape Lambert A and the operational issues which J-S will cover later.

The overall operating cost measured in U.S. dollars is at the same level as last year. Hence the lower volume is entirely driving the 9% increase in unit costs. As a result of lower production guidance and additional total material moved, we have also updated our operating cost guidance from $13 to $14 per tons to $14 to $15 per tons.

The financial metrics are very strong and we saw improvements in revenue, EBITDA and cash flow. And it is important to note, that we have increased our investments in sustaining CapEx to improve the future reliability of our world-class assets.

Our integrated aluminum business has faced a challenging price environment that kicked in, in the second half of last year, and has further deteriorated in the first half of this year. You will see the achieved aluminum price is down 15% and the alumina price is down 17%. We saw a slight increase in bauxite production, as the Amrun ramp-up exceeded the negative weather impact. Our integrated aluminum business is, like the rest of the industry, experiencing right now a tough environment. Our financial metrics demonstrate this difficult environment, and we ended up with a return on capital employed of only 4% in the first half.

Fortunately, we are well placed to weather the storm. We have the highest margin in the industry, and it looks like we have only extended that position in the first half of this year. We also tried to take advantage of this by doing everything we can to improve efficiency and reduce cost. You will see that our unit costs have gone down by 5%, and we had a 1% production creep in the first half. Nonetheless, profitability is not at all at the level where we want it to be, and hence we are therefore also very disciplined in our uses of capital, protecting the free cash flow for aluminum.

Copper & Diamonds as a product group faced lower prices in the first half, but demonstrated stable performance against a strong prior-year. The continued productivity improvements at Kennecott were a particular highlight. We saw a significant reduction in unit costs, mainly due to higher production of byproduct, which we do not expect will continue into the second half. Copper production was down 5% and at the lower end of our guidance. This was due to lower grades from where we are currently mining in the pit, rather than a performance issue.

Overall, the financial metrics are fairly stable. It was a good first half last year and it was a good first half this year. We see stable margins and a small variance in the financial statements. Return on capital employed of 6%, include significant development CapEx of not yet producing assets and significant expense costs for developing our growth options of Resolution and Winu.

Finally, Energy & Minerals experienced a strong recovery after a year of disruptions in 2018. Production is up significantly, at RTIT, two rebuild furnaces were restarted in the first half, the third will start in the second half of this year. Also IOC was impacted last year by a strike. The financial metrics have improved significantly with revenue up by a third, and EBITDA more than doubled.

Energy & Minerals obviously benefited from that high prices enjoyed for iron ore pellets, but also from higher titanium prices. Return on capital employed continued to improve ending at 15% for the first half. Overall, it's a profitable and highly cash generative business. We continue to explore opportunities to further grow our business. In the first half, we approved $0.5 billion for further investments in the Zulti South project in South Africa.

During the first half of the year, we have continued with a disciplined approach to capital investments. In total, we invested $2.4 billion, similar to what we invested in the first half of last year. What you will see though is that we have invested more in sustaining CapEx, so that we are taking best possible care of our existing assets and ensuring the future sustainability and reliability of our operations. Investments in growth projects was somewhat lower than anticipated, mainly because of completion of Amrun and less ramping up of our spending in Oyu Tolgoi than expected.

Overall, the picture remains the same. We are in a phase of ramping up our investments from $5.4 billion last year and we expect around $6 billion this year, and around $6.5 billion next year. We know we're going to spend the money, But there will always be some uncertainty over the exact phasing and some of this year's investments may tick over into next year.

The strong cash generation and disciplined approach to capital means that we are able to further strengthen our balance sheet. Adjusting our reported net debt for future commitments regarding share buybacks, the return of disposal proceeds, tax lags combined with the new IFRS 16's rules changes, shows a very consistent pattern of deleverage, taking the pro forma net debt from $8 billion at the beginning of the year to $5.6 billion at the end of June.

We are very comfortable with this level of net debt. It provides optionality and the ability to provide superior cash returns to our shareholders. As previously announced, we have paid out $7.8 billion in the first half. On top of this, we have $0.7 billion of our ongoing share buyback program still to be completed between now and the end of February.

Today, based on our first half results, the Board has approved an interim dividend of $2.5 billion, which again represents 50% of underlying earnings. We have also approved a special dividend of $1 billion that brings the overall payout ratio to 70%, and takes our total cash return paid in 2019 to approximately $12 billion.

In summary, we have today disclosed a set of strong financial results. We are a very profitable company and our profitability is increasing. This enables us to make significant investment in further improving our world-class assets and pay superior returns to our shareholders. However, we fully acknowledge that we have had operational issues in the first half and we are working hard to address those.

Before closing, I'm delighted to announce that we will be hosting a Capital Markets Day here in London on October 31st. I look forward to seeing as many of you as possible on that date.

On that note, let me hand back to you, J-S. Thank you.

Jean-Sebastien Jacques -- Chief Executive Officer

Thank you, Jakob. Now let's focus on the macro outlook and the fundamentals of our industry. Overall, they remained positive. As you know, there are two key drivers for mining business, GDP growth and trade. On the first, economic growth is relatively stable. Despite consumer confidence being at record high, the U.S. economy is showing sign of slowing, and we saw it last night. And we see trade tension starting to weigh on industrial indicators.

Now in China, our main market, as expected, growth is slowing. But we're still strong at 6.3% for the first six months of 2019. I mean this year has been quite a tougher [Phonetic] time in China, and on one of my visit, I mean, I attended the CEO Council of global business leaders where I heard directly from the Chinese Premier, that the government is focused on targeted stimulus measures, to support domestic growth. And we see evidence that this policy shifts are working. For example, regional light rail projects, urban renewal programs, and increased infrastructure investments are ramping up.

On the second driver, trade. Volatility and risk remain, and while we see these reflected in sentiment, we have not yet seen total volumes of global trade meaningfully impacted. This is why I remain the optimist in the room, and I'm still hopeful that common sense will prevail. Now, of course, the real question is, what do these macro conditions mean for those of us in the commodity business.

Let me share some thoughts on iron ore, on aluminum and copper. We'll continue to see a positive outlook for iron ore on the back of strong demand and supply disruptions globally. There have been record levels of steel production in China, at a run rate above 1 billion tons per annum over the past few months. Stimulus measures, I mentioned, have encouraged property and infrastructure investment, which has largely flowed through into consumption. At the same time, supply has been weak.

In 2018, for the first time this century, we saw no growth in iron ore seaborne supply. It remained almost flat at 1.6 billion ton. The industry has experienced a material level of disruption, equating to around -- for the full year in 2019 around 100 million ton, which compares to around 40 million ton in 2018. There are multiple reasons, including the tragic events in Brazil, operational and weather issues in Australia, and significant weather impacts in Northern Brazil. These combined factors, I've seen a lowering of Port stocks in China. We were around 26 million ton drawn down in the first half.

As we have been saying for some time, the opportunity for supply side response from Chinese domestic mines is less now than in the past. Driven by several factors including permitting environmental regulations, driving transition to underground mining, and small artisanal miners have stop producing some time ago. So, all in all, we see the outlook for iron ore remaining positive.

As we are on the topic of iron ore, let me share what we are doing to fully optimize our Pilbara system to maintain product quality, and the reliability of our supply chain, particularly the Pilbara Blend of flagship iron ore product in China. The value of the Pilbara Blend for our customers is clear. It's very consistent chemistry, provides a baseload of burden management, in their blast furnaces and sinter plants. This is reflected in the pricing comments [Phonetic]. This Blend combines all from a network of mines, including Tom Price, Hope Downs, West Angelas, the Brockman hub, and from 2021, Koodaideri will be a major contributor.

Of course, let's be clear, the Pilbara Blend is not the only product. Overall, iron ore comprises four ports, 16 mines, 1,700 kilometers of rail and around 400 trucks, the big trucks, of which around 150 are autonomous today. As you would expect, the focus for us is to run the system first and foremost safely, and then to maximize profitability by providing the quality product our customers want, but not at the expense of short, medium and long-term sustainability.

So, let me first talk about the mines and then the rail. We have been ramping up all parts of the Pilbara system for several years, including port and rail, in the context where we defer capital on Silvergrass and Koodaideri for a number of years. It was the right decision to preserve capital, but it did require us to run our existing mines harder.

As we disclosed in June, we are experiencing operational issues, particularly at our Greater Brockman hub. We have fallen behind in mine development and waste movement. This resulted in us producing a higher proportion of lower grade ore, and restricted our ability to access the right ore at the right time to produce at Pilbara Blend. This is a sequencing issue that happened for several reasons, including a challenging transition to autonomous trucks at Brockman 4, and more broadly, some pockets of inadequate equipment and workforce retention. None of this is acceptable, full stop.

So we have made two major decisions to protect our Pilbara Blend. One, we have reduced planned production in 2019 and changed our production guidance to between 320 million and 330 million ton. Two, we are increasing our planned total material movement across Pilbara mines by a few percentage points. To do this, we have brought in extra equipments and contractors. We spent around $80 million in 2019 on this activity. The work is well under way and further investment will be required in 2020 to increase the resilience, the health of the system. We will not stop until we have fully optimized our system.

As you know, our other main focus is the Pilbara -- in the Pilbara is rail. It's worth remembering that our 1,700 rail system in Pilbara is one of the most utilized heavy rural rail networks in the world. To further optimize our Pilbara system, we continue to invest in the maintenance of our rail network to ensure reliability and sustainability of these critical assets. This includes a major shift toward the end of Q3, which we advised you of last month. This will be an ongoing feature of our rail maintenance program.

In this context, subject to market condition, we will continue to optimize our business from here with three principles in mind. One, the quality of our product and relationship with our customers; two, EBITDA margins; and last, strengthen the health of asset base, underpinned by the right level of costs and sustaining CapEx. We will provide iron ore 2020 guidance at our upcoming Capital Market Day in Q4.

Moving to aluminum. There is no doubt that the current aluminum market is challenging, with three key factors impacting on the market right now. One, resell [Phonetic] inventories that were built during the U.S. sanctions are still flowing into the market as we're having this conversation. Two, the global auto sector is currently at a cyclical low and a slow restructuring in China. However, stocks inventories continue to decline.

As we look ahead, the long-run fundamental for aluminium remain positive with demand driven by return to trend growth on automotive, lightweighting and electrification, and on the other side, on the supply side, governed by restructuring in China as well as market forces. On copper, macro conditions and market sentiment continue to impact the price, as demonstrated by investment flows into copper future.

On the physical side, despite low mine disruption in the first half of around 3% compared with the recent historical average of just over 5%, we expect mine supply to contract by around 1% in 2019. And we expect the market will remain relatively balanced in the short to medium term. Longer term, copper fundamentals remain strong, driven by the adoption of electrical vehicles, the electrification of industry and the growing share of renewables in the energy mix. On the supply side, ongoing resource depletion will require considerable investment in new and replacement supply in the long term.

Moving to growth. We had a strong pipeline of future growth options in iron ore, in copper and in minerals to number a few. Starting with iron ore, we are investing in new projects in Pilbara, including Koodaideri, our most technologically advanced mine to date than Robe River sustaining mines. At Koodaideri, engineering and construction is progressing to plan, and we are starting a study on Koodaideri Phase 2. At the Robe River joint ventures, we have West Angelas and Mesa B, C and H sustaining projects under way. All are progressing well, except Mesa H, where we have some delays with environmental approvals. We are working with both the state and federal governments to resolve it, as quickly as we can.

Of course, all investments are not limited to iron ore. In the first half, we have also approved an investment in Zulti South at RBM. The project offers an attractive return with an IR of 24%, and is expected to come into production in late 2021. This investment of around $463 million, Rio Tinto share of $343 million, will be fully self-funded from RBM's cash flows. We are working on the framework agreement with the provincial governments and communities and we have all the permitting and approvals to proceed. We expect to start investment in that project in the coming weeks.

On the copper side, our project in the U.S. resolution is progressing well. And we expect the environmental impact assessment to be finalized in the coming week. And of course, we are also progressing our copper project Winu in WA, which I will touch on shortly.

Now let me give you an update on the Oyu Tolgoi in Mongolia. OT or Oyu Tolgoi is one of the best undeveloped copper resources in the world and has been in the operation since 2013. It is one of the safest and most productive mines we have. The underground project is where the bulk of the value lies. It is also one of the most technically complex underground mine construction in the world, in one of the most remote location.

The project has three main components; the above ground infrastructure, the shaft and below ground infrastructure, and the mine development. As you can see, substantial progress has been made in all three areas over the last three years. We have installed most of the above ground infrastructure, the control center, the overland conveyor, 5,500 person cap, and the batch plant. And we are well under way with the large equipment on the ground, such as the production and ventilation shaft, the larger jaw crusher and facilities for workforce.

We have also done a significant amount of underground mine development. As we have progressed, we have experienced tougher than expected geotech conditions, which are impacting on a number of fronts and have resulted in slower than expected mine footprint advancement, slower conveyor to surface progression and the growth in the overall quantum of work.

As we drill underground, we identify weaker rock in the western side of Panel 0, which could cause stability issues. And that's meant we need to consider mine design options, as we progress. The schedule and cost ranges, we have disclosed to develop the underground project are driven by four key factors; mid access drive requirement and location, lateral development productivity, location of our ore handling facilities, and panel boundary's transitions. It is also important to note that none of the options under consideration will impact the existing, already built underground infrastructure. It is all about what is ahead of us.

The team is doing the work to define the best way forward and to minimize the impact. The mine design work will continue to early next year and the definitive estimate will be completed in the second half of 2020. We have significant experience in block caving within the Group and we are working with the best people in the industry on the productivity improvement program with the aim to accelerate the delivery of sustainable production. We are also looking at ways to improve the assumptions made and to optimize the scope of work.

Above all, the key considerations are the following, number one safety, followed by value and sustainability. We continue to believe OT is a highly attractive valuable resource. While the underground is a technically challenging project, unlocking the value of this Tier 1 resource will underpin our copper business for decades to come and we are totally focused on doing so. We need to get this right and we are working with all OT shareholders to find the best way forward.

Moving on to Winu. As we announced earlier in the year, an intensive drilling program is under way. Results are encouraging with data now in from further 42 drill holes. They show wide intersection of mineralization close to the surface. The primary studies have begun including around 12 baseline studies geotech and metallurgical test work. And we are progressing quickly with around 200 people and 11 drill rigs on site. Work will continue throughout 2019, and we will then be in a position to provide a further update. Winu is a great example of the value of our exploration program. By the way, we have invested $138 million in the first half on eight commodities in 18 countries.

So, in summary, once again we have delivered a strong financial performance. Our EBITDA margin and return on capital employed was the best in the last 10 years. Our cash performance and conversion were strong. Our balance sheet is strong. We have world-class assets. But we have room for improvement. We have the right plan to address the challenges we face, and our priorities are clear. We will keep the focus on safety, drive EBITDA margin and free cash flow, protect the quality of our products and strengthen the relationship with our customers, focus on our performance in the Pilbara, and deliver our growth plans including work at Oyu Tolgoi. We will do this while maintaining our capital allocation discipline and balance sheet strength. Our consistent track record over the last three-and-a-half years speaks for itself, with $32 billion -- $32 billion return in form of cash to our shareholders, including $12 billion to be paid in 2019. For us, it's all about creating superior returns for our shareholders in a short, in a media and in a long term.

And then at this point, we don't -- we open the Q&A. Wait for the...

Questions and Answers:

Paul Gait -- Bernstein -- Analyst

Thanks very much. Paul Gait from Bernstein. I just wondered if you could sort of elaborate a bit more on OT. And in particular, I mean if you had the benefit of hindsight, what sort of...

Jean-Sebastien Jacques -- Chief Executive Officer

That's a good question.

Paul Gait -- Bernstein -- Analyst

Wonder what technical work could you have undertaken ahead of time that would have identified the issues that you're now sort of dealing with, and the sort of learnings for that when we then sort of think about something like Resolution, and potentially other block caves?

And then sort of carrying on from that theme, and then I'm just also thinking about the impairment that you've made sort of on the asset. Using an 8.3%, sort of cost of capital, given the discussions that have been going on in sort of Mongolia with the government, how should one sort of think about that? Is that -- and I suppose what I'm thinking about is, if that's 8.3%, how should -- what's the discount rate for the Pilbara? Right.

And then finally, TRQ have already stated that they're going to run out of cash by the end of 2020. So clearly some kind of recapitalization needs to take place there. And again, how does -- how are you thinking about recapitalization of your sort of participation in OT from the state you've got now? Thanks very much.

Jean-Sebastien Jacques -- Chief Executive Officer

Yeah. So -- thank you, Paul. I think, I'll deal with the last one, it's an easy one. The funding of Turquoise Hill is a question for the Board of Turquoise Hill. So let them do the work. And then we are a shareholders of Turquoise Hill, and we'll discuss with them when the time is right. So I think this one was an easy one to deal with.

The first one, I'll let Jakob to deal with the discount rate and impairment. But I think the first one is very important which you had, what is the level of drilling we have done and we could have done? So, as you want technical answer, I know, I'm going to ask Steve who is there, who is going to tell us what drilling we have done. I know, don't try to make it too complicated, Steve. If we can go back to the slide as well if -- the slide where you have the footprint and so on. Go for it. Explain the level of drilling we've done from the surface, and then what we could see, what we couldn't see and then the drilling that we're doing now on [Indecipherable] would be great.

Stephen McIntosh -- Group Executive, Growth & Innovation

All right. Thank you, J-S, and thanks for the question. So, of course, in terms of defining the resource at OT, that drilling was done from surface. A lot of drill holes, 2 kilometers to 2.5 kilometers deep, and vertical to sub vertical drilling. So obviously what we do there is get a very good definition of the ore, sorry the resource grade.

But what happens is that, that in essence disproportionately will identify more the horizontal structures, because you're drilling vertically downstream. It wasn't until we got underground that we can really start to see the vertical structures in more detail. We can see some of them, but not in detail. As soon as we've got underground, as soon as we've had access to Shaft 1, we started drilling out horizontal holes. They're really the key ones in terms of understanding the infrastructure that you need to put in ahead of you. That drilling was done from the south to the north, and it wasn't therefore until we are able to drift up or develop up to the site of Panel 0 as we can see here, and start drilling across it that we actually see the more north-south running fault systems.

So, in essence, you have to be underground, you have to get off to the side of the ore body, and you have to be able to drill across pretty much at right angles to be able to illuminate all of the structures in 3D. And it was at that point that what we could see were faults on that southwest corner of Panel 0. That's where we are planning, as J-S said, to build critical infrastructure, things that we call mid-access drives, ore handling systems, ore passes. And obviously, in those pieces of the more broken ground, we either need to work out, where to move them to, or how to protect them, as we move forward, and that's the basis for the mine design under way.

Jean-Sebastien Jacques -- Chief Executive Officer

So, I think, the important point is, this is typical for block cave. Okay. There is nothing new there, and we said in the past, is until you get into the ore-body, that's where you can refine your design in that sense. So that's what we're going through. And here, at this point in time, we are looking at multiple options. Okay. So, some of the question, as I mentioned, where are we going to put the mid-access drive, the ore handling, you can shift it, do you need to have a mid-access drive, can you have it and so on and so forth. There are lots of questions, and we're looking at multiple options, and we believe, we will land on something early next year, and then we need to give time to the team of Steve to go through all the mechanics of doing the costs and so on and so forth, in order to get the definitive estimate.

So, there was so much drilling we could do from the surface, and we're doing the last batch of drilling as we speak, and still drilling as we are having this conversation, and we are refining the model to make sure we really understand the stability. And remember the model is 1 meter by 1 meter block, OK, as we have in there in order to make sure we understand. And that what is important is, I thought Steve was going to say, it's a 4D model. Time is of the essence here. So not only you've got the three dimensions, but the model is run forward. So as and when we run the cave, then we can see how the stress is going to move into the system, and so on and so forth. So it's a 4D model.

So as you can imagine you've got million of sales and people have to run those model in order to see what is the situation on day one, one months, one year, 10 years and so on and so fourth. So, it's complicated, it's block cave, we just have to go through the process, either any concern about the ore-body per se in terms of copper content and gold content. The answer is, no, from what we can see today. But what we need to get right, and I said, safety is the priority number one on this one is to make sure we have something which is stable and sustainable. We're going through this process, multiple option being looked at, we should have a better answer. We should have an answer in the early next year, and then the team will do the costing and we will come back to the market with a definitive estimate.

That's what we are going through. No different from -- I mean you know that as much as I do. Some of the other block caves globally that -- so that's where we are, but I thought it was important to bring Steve today, just to give you a better sense of what we could have seen. And your question is absolutely being on the money, is what could we have seen from the surface and there were so much you could do and so on and so forth.

On the discount rate, an easy one for you Jakob.

Jakob Stausholm -- Chief Financial Officer

Yeah. Thank you. So look with the project update on 16th of July, we also wrote that that was kind of a trigger for full impairment assessment. And what you do there, you have to kind of separate out. We have a very systematic approach to discount rate because actually all project specific risks you're building with contingencies in your projections. We gave some updates on ranges to cost and schedule and we have basically weighted a number of multiple development options together. And then all the cash flow has been discounted, and you quoted a number, and just first thing, because just so that the people don't misunderstand that. That number is in real terms. So you have to add the inflation to it, that's important. So it is of course a higher number.

Our -- and actually, you can read it in the accounts because we have smaller impairments in this side as well. Our WACC is to the tune of 6.9%. When it comes to gold business, we have a lower WACC, and therefore the weighted -- the weighted WACC would be for the Oyu Tolgoi is 6.3%, and we add 2% country risk on it. We have carefully reviewed that, looked at a number of external measures for that, and I think, it's an entirely appropriate risking in. So that's how we have done it, and that's consistent with how we are doing impairment system in any assets across the world.

Jean-Sebastien Jacques -- Chief Executive Officer

So maybe, Paul, I'm going to give on this one, and I'll ask Arnaud, who is in charge of copper, in charge of Oyu Tolgoi. I mean, he's been involved now for a few years, and dealing with the government and so on and so forth. So, Arnaud, do you want to give us an update on the discussion with the government and how you see the sovereign risk from that facility, because we've been in this project since a long time, and discussion with the government has been the feature from day one and will be a feature for a long time. Arnaud, do you want to give us an update on this one?

Arnaud Soirat -- Chief Executive, Copper & Diamonds

Thanks, J-S. It is good to be in London, actually for a change. So we are in ongoing discussions with the government as you know. We've agreed a year-and-a-half ago on working together on some four critical opportunities that are addressing the needs of the government, and that are looking at how together -- we can work together within our existing agreements to create more value for all shareholders in Mongolia.

So the first working group is dedicated to power. And as you know, next year we made an announcement, where we agreed with the government's framework, critical framework to be able to build the power station at Tavan Tolgoi on the core deposit, and so we're working with the government to progress that project. And to know the commitments that we made in the investment agreement about sourcing 100% of our power within Mongolia from [Indecipherable].

The second working group is on the tax. We had tax audits a year-and-a-half ago, that's found that the government thinks that we should have paid more tax. And so we're working with the government to resolve this issue. And we're working in a very collaborative way. The third working group is on interest rates. Within our investment agreements, there is a provision to review the interest rate every seven years, and so we are in discussion with them on this. And the fourth working group is dedicated to increasing our support for the development of the economy.

If you look at -- and particularly the local economy, if you look at the big picture, Oyu Tolgoi is a major contributor to the Mongolian economy, if --already now with the open-cut mine. In the future, what we are working with Steve's team in building the underground project is going to make Oyu Tolgoi among the third or fourth bigger -- biggest copper mine in the world. And so this is going to be a huge booster of benefits to shareholders.

And so, we are currently with around 17,000 employees, the biggest employer -- private employer in Mongolia, and 90% of our employees are from Mongolia. We've invested around $9 billion in country. We've paid around $2.4 billion of tax or so since the beginning of the project. So, the economic benefits to Mongolia is already very tangible. And so we are continuing to work with the government to look at how we can even further increase the benefits within our existing agreements.

Jean-Sebastien Jacques -- Chief Executive Officer

Thank you, Arnaud. Okay, Paul. Dominic? And then we will take -- I'm looking for David, we will take question from the conference. So, Dominic first and then...

Dominic O'Kane -- JP Morgan -- Analyst

Hello. I'm Dominic O'Kane, JP Morgan. Two quick questions. Just on the CapEx guidance. So your 2019 CapEx guidance is in change, but you're guiding to higher sustaining CapEx. So could you just help us understand what are the changes in terms of gross CapEx allocation? And when we look at the 2020, '21 numbers, which are kind of unchanged. Is there anything in there for the OT CapEx revisions, i.e., should we expect when you announce at the end of next year upside risk to those 2020 numbers?

Jean-Sebastien Jacques -- Chief Executive Officer

All right. So, Dominic, I'll pick up this one very quickly. There is no change in the CapEx guidance. And we had already in the past guided that over time, we will increase also sustaining CapEx. So there is nothing new from that perspective. All right. There is no change whatsoever. We're coming out of a long period of high investment as you know, and we have the sweet spot where we don't have to spend a lot of money to maintain our assets.

But we said that six months ago or a year ago, I think we've guided this one for some time that we will increase the sustaining CapEx going forward. As we would increase as well the replacement CapEx, particularly in iron ore going forward, because as and when you move 1 million ton every day, then at some point in time, you need open new mines. Hence, for example, decision we made on Koodaideri, $2.6 million. So there is no change on this one.

The second part of your question on the CapEx on the Oyu Tolgoi, there will be no increase per se, because what you're going to have to do is, it will take more time to build the mine and so on and so forth. So that's why there is a link in our range between the timetable, the timing and the CapEx per se. But are they going to be -- spent more money in the short term, the answer is no for that.

Dominic O'Kane -- JP Morgan -- Analyst

And so my second question...

Jean-Sebastien Jacques -- Chief Executive Officer

I thought that was two question...

Dominic O'Kane -- JP Morgan -- Analyst

No, well that was two questions within one question. And just understanding the sort of the capital framework. So pro forma reported net debt $6 billion. And I think back in May, you indicated that $6 billion was the level of net debt that you were comfortable with.

Jean-Sebastien Jacques -- Chief Executive Officer

We had said, $5 billion to $7 billion, but OK.

Dominic O'Kane -- JP Morgan -- Analyst

So as we look forward, is that the type of net debt number we should be thinking about Rio? It is comfortable with in terms of capital headroom and implications for future shareholder returns?

Jakob Stausholm -- Chief Financial Officer

Yeah. Look, I'm very happy. I'm going to disappoint you a little bit, because we are really not setting a target debt. I was describing the capital framework last, I presented here in March, and we are very happy with a strong balance sheet. But ideally we want to be able to act a little bit countercyclical, and that means that, net debt can go up and down right now where we have very strong results. We are comfortable, we're seeing very low levels of debt.

So I don't think you should take that as the parameters, the key parameters is, that we are -- have a disciplined approach to capital investments, independent of the cash flow we are generating and focusing on providing a superior return to the shareholders.

Jean-Sebastien Jacques -- Chief Executive Officer

Thank you, Jakob. I think, Dominic is -- there is no absolute formulaic solution to your question. I think what we'll do is, to be on the point of Jakob is, we will look at it on a regular basis on the back of two or three items. One is, how we see the outlook in terms of commodities? That's one important. What is the capital program that we have ahead of us? And therefore, what is the risk profile and what is the level we want to have on the net debt? But, you know that if you step back, the equity story of Rio is pretty simple. It's about the resilience of the business case, the resilience of value proposition under any kind of market environment. Okay. And it's a combination of few things. I'm sure, you've heard the four piece before.

The quality of the portfolio with world-class asset like, Winu, which deliver 72% EBITDA margin in the first half. It's about the strength of our balance sheet, and we fully accept that we are conservative or some people would accuse us of being conservative. But maybe, we could return more cash or return to our shareholders on the back of the strength of our balance sheet. But we look it through the cycle, and at the end of the day, it's a cyclical business, it's a capital-intensive business. And therefore we believe, it's a belief. People may have the strategy from that perspective. There is a belief that having a strong balance sheet at the end day is the best insurance policy you can have. And if you go back to your models in last 10 years, 15 years, I think the proof point is there.

Why don't we take a question from the call, David? And then I'll come back to room.


Thank you. And your first question comes from the line of Lyndon Fagan. Your line is open.

Lyndon Fagan -- JP Morgan -- Analyst

Thanks very much. Look, the first question was just to try and break down some of the iron ore performance. Just wondering, if you could perhaps share the root cause of some of those issues. Just look -- listening to your commentary, you've linked the waste stripping to deferrals of Silvergrass and Koodaideri. And I guess, I just wanted to try and understand, it's a bit more, are you saying that those assets would have provided better access to higher grade ore, and therefore that got deferred. And that's what's causing some of the issues? Or I just don't quite understand how we got into this position.

And then the next question is just to share, perhaps if you could share some of your views on Chinese steel production next year. So we're still annualizing 9% growth in China in June. Just wondering, looking into 2020, whether you expect further growth in China's steel production on an annual basis? Thanks.

Jean-Sebastien Jacques -- Chief Executive Officer

All right. Thank you. Chris, do you want to crack on the first question.

Chris Salisbury -- Chief Executive, Iron Ore

Yeah, thanks, Lyndon. Chris Salisbury. Thanks for your question. Just firstly, I think what J-S was describing about deferral of Koodaideri, that was a good decision, still is a good decision. But what it meant was, we do have to exit -- have to run our existing mines, our brownfield mines harder. If I then dive into more specifically the issue that arose at Brockman hub. Brockman is a very large part of our system. It's about 100 million ton coming out of the Brockman hub, and more specifically, if I get to the root cause of the downgrade that we made that was associated with Brockman 4, which is 40 million tons of the 100 million tons.

And to be very specific, it was simply around conversion of IHS. It was a convergence of events. We had some poor fleet performance. We brought in a backup fleet, while we're converting some trucks. That backup fleet didn't perform to expectations. And secondly, and at the time, there was a lot of labor turnover. The market is tight, labor market is tight in Western Australia. So we actually had literally some trucks standing because we didn't have the people. So none of that is acceptable, and we're going to fix it, already started fixing it, and as J-S said, we brought in extra equipment to do it. And then secondly, looking further ahead, we will continue to invest to ensure that we've got a robust and reliable system right across the Pilbara.

Jean-Sebastien Jacques -- Chief Executive Officer

Well, thank you, Chris. I mean, let's be clear, is we knew the plan will stretch. We knew that because of all the reason mentioned by Chris that we had to run the mine hard. And if you look at the slide here, it's a blend. Okay. And we attract -- because it brings so much value to our customers in attractive premium, but it's complicated to get there, and we were running at a very high level, right. No. As we said, it's not acceptable withering the resources to deal with it and so on and so forth, right.

But we had a choice, we had a choice. And the choice we made with Chris and with Simon. Simon Trott was dealing with the customer was very simple. We made the choice to protect the quality of our blend. We made this choice. It is absolutely essential, and I will link it to the next part of the question about the market demand and so on so forth. We made a choice to protect the blend, not to damage, not to lessen the quality of the product. That could have been an option. We took the decision to protect the quality of our product, and to protect the relationship we have with our customers.

And as a result, we took two major decision, as I said. One is to reduce the production of the Pilbara Blend, and the second one is to throw resources to fix the problem and so on and so forth. But that was a very important decision. And that was the conf call, I mean that was with Simon, Simon in Korea, at that point in time when we had this conf call with Chris and few others.

The decision was in the current environment, when you look at forward -- when you look at the market conditions and look at the market demand from a customer -- mainly in China, in the context, the need to provide high quality product, the need to build a strong relationship with our customer, we took this fundamental decision to protect the quality of our product, and therefore we did reduce the guidance, and so on and so forth.

And I've got no doubt because when we took the decision, I was in Korea, on my way to China. So I was getting the 11:00 p.m. flight from Seoul to Beijing and met with Cesar. Cesar, the key association for mining and metals and a few orders. I've got no doubt in my mind, that was the right decision. We didn't want to pass on the program to our customers, because that is not sustainable. All right. So that's the first part of it. I mean Simon, do you want to talk about the China and the demand, how optimistic you are?

Simon Trott -- Chief Commercial Officer

I'll have to stand up here. I'm shorter than my colleague, I know, so people can see.

Jean-Sebastien Jacques -- Chief Executive Officer

You are looking at me.

Simon Trott -- Chief Commercial Officer

Thanks for the question, and good morning, all. Clearly, we have seen really strong numbers out of China during the first quarter, and in fact, the first half. [Indecipherable] meeting over the weekend and the notes released, I think, what you have seen consistently is China taking very targeted measures to continue to support. And as we expect China continues to slow, and those target measures are having impact. So, you're seeing really strong construction numbers for the first half and that certainly underpin the steel demand. As we go forward and we will see fluctuations in those numbers, but the overall macro conditions continue to be sound and those targeted measures will continue to flow through.

Jean-Sebastien Jacques -- Chief Executive Officer

So, I mean, to add on what Simon was saying, there is no doubt that the Chinese economy will continue to slow down. Okay. So $6.3 million in the first half will continue to slow, and they are managing directly, very smartly, to be honest. I've got no doubt that they will put stimulus package in place. I have to say the stimulus package if put in place so far, have been, how can I put it this way, heavy on steel. All right. So, do I believe that the Chinese government will continue to implement stimulus package going forward. The answer is, yes. Okay.

And there are couple of areas which give us some confidence about the future. One is the work they have started to do on rebuilding cities or refurbishing cities or part of the cities that were built 20 years, 30 years ago of not the right quality. And that is a great piece of news for us, OK. And then further investment, especially in some of the Tier 2 or Tier 3 cities around building subways, light rail train, and so on and so forth, which will give us some comfort as well. But is -- the economy is going to continue to slow down, the answer is, yes.

Now the second point we should never, never forget. There is no doubt that the Chinese government will continue to implement their environmental policies, taking capacity out in order to underpin their blue sky strategy and so on and so forth. So seen from a Rio standpoint seen -- seen from a Rio standpoint, there will be an ongoing demand for high quality iron ore going forward. Hence the decision to protect the Pilbara. Thus, we did.

So are we having any issues at this point in time, in placing our produce? The answer is, no. But we have to place the right product and making sure we have a strong and good and sustainable relationship with the customers. So, what we're going to do in the next two weeks, so flying to the U.S. next week to the roadshow in the U.S., and then after we're going -- bring back to us for a few days with Chris to be underground and then we're flying back to China to meet with our customers and so on and so forth. But for us, at this point in time we have seen no material impact on trade and we have seen no material impact in relation to demand from our customer in China. So if we move to another question from the conf call and then I'll come back to the room.


Thank you. Your next question comes from the line of Paul Young from Goldman Sachs. Your line is open. Please go ahead.

Paul Young -- Goldman Sachs -- Analyst

Yeah, good morning, J-S and team. J-S, first question is on the Pilbara rail maintenance. Maybe question for Chris actually, can you add some context at to this, i.e., what percentage of the rail capacity is impacting? And you also mentioned, this is continuing into 2020. So, how this impact shipments in 2020? That's the first question.

Second question is to you, Arnaud. It's really complex in the study phase of the mine. But looking at that 13 -- sorry, 16 to 13 month delay on the project, it's a very wide range. So considering the study time frame, things quite fixed. What are the one or two mine items that are driving that 14 months range? Thanks.

Jean-Sebastien Jacques -- Chief Executive Officer

All right. Very good. So I'll go over to Chris in one minute, but the rail maintenance is very simple. The macro level is, as I said in the speech, it is one of the most heavily used rail work system on planet Earth. So, we will have to maintain it at a high level. And what we did today is -- because I thought we had done it in the past, but clearly people didn't pick it up, is there will be a series of shuts on a regular basis to maintain and strengthen the health of the assets. So, we want to flag or to reflag the fact that we have a super shut at the end of October for a couple of weeks, and you will -- sorry end of September, my mistake.

And then there will be a series of super shut next year, and there will be a series of super shut the year after, and the year after, and the year after. So we're just flagging that you know there will be a heavy load of maintenance, I can say, forever in the Pilbara for the reason. So, Chris, you want to say much more on that, and I think we have disclosed some level of cost as well so.

Chris Salisbury -- Chief Executive, Iron Ore

Yeah, thanks. Thanks, Paul, for the question. Look, just to be clear, this is already built into our guidance, but we chose to be transparent, because it's a fairly major shut, it's two weeks, it's going to take over two weeks, it's 25 kilometers of rail. We're going to shut the whole line for three days, and then actually east line for five, and the west line for five. So it's a major piece of work. It's already built in the guidance, but because it was so significant, we decided to flag it...

Jean-Sebastien Jacques -- Chief Executive Officer

And next year, we got a few limits.

Chris Salisbury -- Chief Executive, Iron Ore

And of course, we will then as part of the detailed planning for 2020, continue to plan these super shut to have appropriate time and appropriate scale.

Jean-Sebastien Jacques -- Chief Executive Officer

And Paul will give you, as I mentioned the 2020 guidance for iron ore at the end of October. That's right. It was confused between the Capital Market Day. So we'll give you more granularity around this piece. Study, Steve, what are the key element? I thought we had the slides showing the key decision point, but go for it.

Stephen McIntosh -- Group Executive, Growth & Innovation

So Paul, thanks for the question. So basically, what we have looked to do here is book in at the range of different options through the study phase. And to J-S' point, with the view to making sure that we can both safely construct, operate and protect our investment looking out over 25 years to 50 years ahead.

So -- and again to this image that we have here, we have some critical questions that are right ahead of us, as J-S also noted. Are we able to hold things like what we'd call a mid-access drive? That drive, essentially, a horizontal tunnel that cuts transversely across the resource across the mine footprint actually is in three different levels. So in what's called the apex, the undercut and the extraction level. We get enormous construction efficiency by having that drive in, because as you can see with those areas, it means that we can develop north-south into those headings. If they are removed, we have to develop all the way from the south, all the way to the top of Panel 0. So there's a schedule impact.

So we're looking at everything here. How do we keep, protect the critical infrastructure in the mine footprint through that complex 4D modeling that J-S referred to. And we will sequence our way through each of those decisions. But basically, if we remove some of them, and we have to then actually take the ore handling system potentially outside the footprint of Panel 0, that has a time -- a schedule impact for us.

So as we do the modeling through the back end of this year, by the end of the year, into Q1 next year, we expect to take the final -- essentially, design into feasibility. And then we will take that final design that we have approved into the definitive estimate process. And so in half two 2020, we'll have that final definitive estimate.

Jean-Sebastien Jacques -- Chief Executive Officer

And probably as we hear, there are multiple options, that we said, multiple scenario because just to make it, to give a sense of we're looking at all options, including maybe not a full map, the map needing mid-access drive, we could have only half of it, and so on and so forth. So that's the level of optimization that we're doing, so we've thrown in the best resources we have in order to get the best solution to unlock the value of this world-class resource. But keeping in mind that the priority number one is safety. I mean, that is absolutely clear as well.

Why don't we go back into the room? [Indecipherable]

Unidentified Participant

I'll try and exhaust a few more Oyu Tolgoi questions. So three things. First of all, on the impairment, because back in December, you had $3 billion of headroom in your annual report. So it looks like quite a big impairment. Have you changed any long-term pricing? I mean, the WACC's obviously moved up a little bit, but why is it such a large impairment to the NPV?

Secondly, I was reading this kind of financing support agreement from the Turquoise Hill website, and I was getting a bit confused because as I read it, it looks like you have an option to basically determine whether they do an equity issue if there's a cost overrun. Is that -- I mean just to get more clarity as to the position with Rio in Turquoise Hill and deciding how the cost overrun gets shared out.

And then the other one was around a parliamentary working group because there is a lot of noise and it looks like they're going to put some proposals forward to change the Dubai agreements and add some stuff. How should we -- should we see that as just noise at this point, or how worried should we be around the agreements?

Jean-Sebastien Jacques -- Chief Executive Officer

Yes, Arnaud, do you want to pick up the last two? I thought you had provided that on the debt. But if you can give more details about the working group? And then the financing agreement, I think you should cover it, Jakob.

Arnaud Soirat -- Chief Executive, Copper & Diamonds

Okay. Good. Yes. Thanks. Thanks for your question. So you would all be aware that the Parliament decided to do some audits on the benefits that OT are bringing to the country. So we fully collaborated with those OT tariffs. We provided thousands of pieces of information for months. And out of these quite extensive audits, a report was published. And that report has been shared with a subset of the Parliament which is called the Economic Standing Committee. So the Economic Standing Committee has nominated some parliamentarians to review all this information and to come up with a recommendation to Parliament and to the government, which is called the Parliamentary working group resolution. So that work is in progress. And we see how things are evolving in the coming weeks.

In -- meanwhile, in parallel to this, there are some typical positions that are being taken by some politicians around OT, around the agreements. You're referring to the UDP and so on and so forth. I think it's important to understand that the UDP has been an important agreement because, fundamentally, it has clarified some of the previous agreements, and it has an enabled for the project financing. So the $4.4 billion that we've borrowed to around 20 different international lenders and institutions is underpinned by all of those agreements.

So the UDP is as important as the ARSHA, as it is important for the investment agreement. And those agreements are really foundational. This is on those agreements that we've been able to borrow money, and this is on those agreements that we are able to continue heavily investing through TRQ in Mongolia. So as I said before, we are in continuous discussion with the government and working collaboratively with them to look at what can we do using our existing agreements to create more value for our shareholders.

Jean-Sebastien Jacques -- Chief Executive Officer

Thank you, Arnaud. Jakob, if you can cover the repayment and the financing agreement.

Jakob Stausholm -- Chief Financial Officer

Yes. The impairment part is -- it's very well captured by you that you have carefully read our annual accounts. So you are in part right. We gave an update and explained that we had some delays, on particularly the main production shaft. And we built that into our cash flow and we came to a result where there was headroom of $3.1 billion. At the same time, we raised the issue that the ground -- the weakened ground condition might lead to significant redesign of the mine below the orebody. But we couldn't state anything else that we would get on with that. And therefore, what we convinced ourselves was that what we knew at that time was that there should be sufficient headroom to cover for that uncertainty. So you could say the headroom that we saw in March was between 0 and 3.1. We were just not able to establish that. Now with the update on 16th of July, that was a trigger, and we have new information and we have done this thoroughly and we have come to -- on a 100% basis, the $2.3 billion -- $2.2 billion lower asset value.

Jean-Sebastien Jacques -- Chief Executive Officer

Do you want to cover the Turquoise Hill financing?

Jakob Stausholm -- Chief Financial Officer

Turquoise Hill, I mean they have independent governance, so it is really for them to talk about the financing. We are very happy to enter the dialogue with them. And when there is news, it will come out.

Jean-Sebastien Jacques -- Chief Executive Officer

Any other question from inside?

Richard Hatch -- Berenberg -- Analyst

Good morning. Richard Hatch, Berenberg. Two questions. First one, just on your iron ore costs, perhaps it's too early to ask a question, maybe it comes with the Capital Markets Day. But do you expect your costs for 2020 to trend back down to the 13, 14, or is it too early to say?

Jean-Sebastien Jacques -- Chief Executive Officer

I think it's too early to say. Now, I made two comments right away is to say, we will continue to drive iron ore business on the back of EBITDA margin. Okay. And as I mentioned in the speech, is what we need. I will give you more details when we are in Capital Market Day, is to make sure we have the right level of costs and sustained CapEx to maintain the health and maintain the resilience of our business, and so on and so forth.

So the important piece, if there is message to take away from this one is we drive this business on the back of EBITDA. If you drive it only on the back of cost, then you may have a very, very different outcome. And look, first half of this year is 70%, 72% EBITDA margin. So we'll provide more details at the time of the Capital Market Day. Chris will cover here.

Richard Hatch -- Berenberg -- Analyst

Okay. Thanks.

Jean-Sebastien Jacques -- Chief Executive Officer

And the second question, yeah.

Richard Hatch -- Berenberg -- Analyst

Yes, on aluminum, just the operating efficiency, $1 billion to $1.5 billion. If we're seeing the costs stay as they are and they don't retreat back in the aluminum business, what does that $1 billion to $1.5 billion do just out of interest?

Jean-Sebastien Jacques -- Chief Executive Officer

It's in the range. So what we want to flag I think is the following. So we know that the costs last year, the impact on the bottom line was around $500 million of cash -- cost input. And it was not only aluminum. There was -- a big chunk of it was aluminum. Do we believe that some of the costs have reverted as we're having this conversation? The answer is, yes, but not to offset totally the $500 million that we had last year. So there is an element there.

But the important piece is, why we give a range. And that's a fundamental [Phonetic] point is to say, we will -- and that's back to the first question about, we will continue to drive our iron ore business on the back of EBITDA margin, and it links back to the value over volume. What I'm not ready to do is to drive volume for the sake of it in order to have a fixed cost absorption, and therefore, to meet a target, which is slightly artificial in that sense.

We will continue to drive the iron ore on the back of EBITDA margin. If it means producing more, yes, if it creates value. If it means not producing more, so be it. And I think that is absolutely essential. So that's why we're trying to flag. What we are to flag is we could be at $1.5 billion, we could be at $1 billion. There are two key elements to the driver. And the main driver is iron ore. It's not the aluminum cost. You can make the sensitivities, but the bulk of it -- of the range is about aluminum volume.

But the message I want to convey is we will take a decision about the iron ore volume on the back of the value over volume. And I think what we've decided is a good example of it. I want to protect the Pilbara Blend. I want to protect the premium. And that's why. So what we're just flagging is -- and maybe we had done it before and maybe we didn't do it well enough and so on and so forth. At the end of the day, it's about EBITDA, it's about cash, and not just picking a target on costs and so on and so forth.

Now am I continuing to put Chris and the team and the other, ex member under pressure on cost? Absolutely, because I don't want the business to drift along the cost curve. But the priority to run this business is on EBITDA margin, otherwise, you have the wrong outcome. That makes sense?

Another question. I mean, in the third row from the back. Yes? Don't move. It's coming. It's coming.

Jatinder Goel -- Exane BNP Paribas -- Analyst

Good morning. Jatinder Goel from Exane BNP Paribas. A couple of questions. First, on iron ore, would you be happy to keep this year's volumes in Pilbara if you can't get to your optimal blend until Koodaideri comes in? And in that scenario, does the $1 billion to $1.5 billion improvement still hold?

Jean-Sebastien Jacques -- Chief Executive Officer

I think I've just answered the question on this one. I've just answered exactly the question, which is value over volume is we will add volume in any year, at any point in time only if it creates value and so on and so forth. Hence, the range we're giving on the mine to market.

Jatinder Goel -- Exane BNP Paribas -- Analyst

So the $1 billion to $1.5 billion still holds even if you don't increase any volumes from this year in iron ore till Koodaideri comes in?

Jean-Sebastien Jacques -- Chief Executive Officer

I just said it. Is to say, if you get to $1.5 billion on the cost target, if you increase the volume above and beyond where we are today. Okay? But we will take this decision only if it creates value on the EBITDA margin. Yes, go ahead.

Jakob Stausholm -- Chief Financial Officer

I mean, look, we're not going to guide today about future volumes. That's clear. But I can help you a little bit. The updated guidance for this year actually is quite a significant step-up in production in the second half compared to the first half. So I think you can get half the answer there.

Jatinder Goel -- Exane BNP Paribas -- Analyst

Thank you. Second question on OT. Obviously, every investment competes with each other. But if it makes financial sense, would you be comfortable taking more attributable country risk if it comes to that point by increasing your ownership effectively?

Jean-Sebastien Jacques -- Chief Executive Officer

I think well for the answer to the question is discount rate, if you want to pick it up, Jakob?

Jakob Stausholm -- Chief Financial Officer

Yes. But I just want to understand fully what's behind your question. Sorry, just one thing...

Jatinder Goel -- Exane BNP Paribas -- Analyst

So you are adding 300 basis points as country risk premium to your impairment calculations. If it comes to a point, would you be comfortable increasing your attributable country risk by increasing OT ownership at some point?

Jakob Stausholm -- Chief Financial Officer

Yes. So there's two different things. But I actually said, 200 basis points real term. And look, that has nothing to do with the project. That has something to do with the country risk, yeah? And the ownership, we are very comfortable with the current shareholder composition. It's very normal that major projects, this joint venture, and you have some kind of share risking. That's our position.

Jean-Sebastien Jacques -- Chief Executive Officer

I'll pick it up on this one. It's pretty simple. I mean there is no change of policy because your question is about M&A. Do we have a working brief on M&A? The answer is yes. There is no change. And are we looking at opportunities, options? Yes. But we will trigger the options only if it means creating value for our shareholders and nothing else.

All right. Why don't we take a question from the conf call, David? David, any -- OK, one more, let's wait. David, any chance, otherwise we come back to room.


Thank you. Your question comes from the line of Hayden Bairstow from Macquarie. Your line is open. Please go ahead.

Hayden Bairstow -- Macquarie -- Analyst

Hi, J-S. Just a couple of quick ones. Firstly, we've obviously done iron ore to death [Phonetic]. I just want to touch on IFC a little bit. Realized pricing seemed a bit soft. Can you just remind us how they sell iron ore versus spot and how we should think about that just given it did seem -- it didn't seem like all the spot premium prices came through in that half. And then just on Pacific aluminum back here, it's back to an EBITDA loss. I mean where are you sitting with that asset base, there's obviously the power price pressure in Australia, thanks.

Jean-Sebastien Jacques -- Chief Executive Officer

So you want to pick up IFC and I'll pick up PacAl, thanks.

Jakob Stausholm -- Chief Financial Officer

There's a number of factors in the IFC pricing including, for example, Japanese fiscal year including some lag similar to our iron ore business where the prices are reflecting a prior period. So that's the main two you've actually got in the realized pricing.

Jean-Sebastien Jacques -- Chief Executive Officer

All right. Thank you. And then on PacAl is -- absolutely. I mean there is an energy cost issue in Australia. I mean it's a well-known one, which is -- it shouldn't be the case if you step back and you think about Australia being very mineral and energy rich, that should be one of the most competitive place to have energy. Right?

So we are working very closely with the federal -- the feds and the state government in order to find a solution to this challenge, all right, because the energy cost is massive. We are not making money in those assets and so on and so forth. So those conversations are now taking place as we speak. But we inform the market, we did -- in the appropriate manner, but we are taking it very, very seriously, and there are active discussion because the current situation is not sustainable here.

I know that we -- the market -- the aluminum market is not being helpful in the sense of, for the first time is, in terms of demand, the demand on aluminum is pretty weak. Historically, we said -- and it's the case, that the demand for aluminum products is above GDP growth rate, whereas currently, it's around 1.4, 1.5, which is pretty low. And the reason being why the aluminum demand is low is because of the situation around transportation, and automotive and so on and so forth.

So we have a situation where the demand for aluminum product is pretty low. At the same time, as I explained, the supply side is being challenged for a series of reason. One which did not surprise us too much which is the pace of the restructuring of the aluminum industry in China. But the second point is, as and when one of our competitors was under sanction, they didn't stop producing. They did build a big inventory. And as we are having this conversation, they are releasing and monetizing this inventory.

So we have a pricing environment which is not very favorable, but at the same time is we have challenges, especially in Canada in relation to the cost structure, and energy is a big component of it, and that's why we are having those conversations.

So I see John telling me that I'm going to have to wrap up this meeting. So I think we have a -- we had a pretty good conversation. We did cover lots of ground. I'm sure a few of you still have a few questions. And I understand there are a few of the meetings coming up, so we're looking forward to it.

So now let's step back. We had a very strong set of results. I mean look at the results. I mean 47% EBITDA margin, 23% return on capital employed. This, combined with all the hard work over the last few years, a very strong balance sheet. So all in all, we are in a position to return $12 billion of cash to our shareholders this year. Yes, we had operational issues. We fully acknowledge it. It's mining. Are we addressing those issues? Absolutely. And that's -- the team is working on as we speak and we're making good progress.

And looking at the outlook, the outlook is positive. China is slowing down. We talked a lot about it. But we have a strong position to work from. This range is working. And what the shareholders should expect from us is what we've been doing for the last 3.5 years is to continue to create value, a superior value in the short, medium and long-term.

That's all I have on my side today. And on this note, thanks for coming and I look forward to the ongoing dialogue. Thank you.

Duration: 90 minutes

Call participants:

John Smelt -- Head of Investor Relations

Jean-Sebastien Jacques -- Chief Executive Officer

Jakob Stausholm -- Chief Financial Officer

Stephen McIntosh -- Group Executive, Growth & Innovation

Arnaud Soirat -- Chief Executive, Copper & Diamonds

Chris Salisbury -- Chief Executive, Iron Ore

Simon Trott -- Chief Commercial Officer

Paul Gait -- Bernstein -- Analyst

Dominic O'Kane -- JP Morgan -- Analyst

Lyndon Fagan -- JP Morgan -- Analyst

Paul Young -- Goldman Sachs -- Analyst

Unidentified Participant

Richard Hatch -- Berenberg -- Analyst

Jatinder Goel -- Exane BNP Paribas -- Analyst

Hayden Bairstow -- Macquarie -- Analyst

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