It turns out that the steep drop in the price of iron ore had no chilling effect on major iron ore miners BHP Billiton, Rio Tinto, and Vale. According to the latest second-quarter operational reports, these companies delivered strong iron ore production and promised to mine more in the future. Is there anything that can prevent their domination?
Even with iron ore at less than $100 per ton, the big three are feeling comfortable. The reason for this confidence is low costs. With cash costs of slightly more than $20 per ton of iron ore, BHP Billiton, Rio Tinto, and Vale could tolerate further price downside. All-in costs are higher, as the ore has to be shipped to customers. Here, Vale is at a disadvantage, as it takes longer to ship ore from Brazil than from Australia. However, it does not prevent Vale from making money in the current price environment.
The story is much different for weaker iron ore producers like Cliffs Natural Resources. Big miners push prices down, and there's little that Cliffs can do about it. Cliffs Natural Resources also has facilities in Australia, but its cash costs there are higher than BHP Billiton's and Rio Tinto's. Cliffs sold iron ore from its Australian operations for just $80.38 per ton in the second quarter. This number could go even lower in the third quarter.
Big miners are ready to optimize their portfolios in order to free money for iron ore projects. In its second-quarter operational report, BHP Billiton stated that it was considering the next phase of portfolio simplification. Rio Tinto tried to sell its diamond business last year but dropped the sale because of poor market conditions. Chances are it will try to do this again. In turn, Vale sold all its shares in aluminum producer Norsk Hydro at year-end 2013 to further focus on iron ore production.
More to come
Vale has just recorded its best second-quarter iron ore production ever, delivering 79.4 million tons of iron ore. Rio Tinto has also reported record first-half iron ore shipments. BHP Billiton's Western Australian iron ore segment achieved its 14th consecutive annual production record. This momentum is going to continue, and major miners expect to ramp up iron ore production further.
Is there an end to this process? Certainly not in the near future. While BHP Billiton and Rio Tinto have mostly finished their major iron ore projects, they have the capacity to tweak the existing facilities to bring more ore to the market. For example, BHP Billiton produced 225 million tons in Western Australia in a year and plans to ramp up production in the region to 245 million tons annually.
The next round of big spending has yet to start for BHP Billiton and Rio Tinto, but the latter has already signed a deal to develop the massive South Simandou iron ore deposit in Guinea. In turn, BHP Billiton could be eyeing the northern part of the Guinean mine. Vale is not yet finished with the current round of expansion, with more ore to come in 2016.
Big players are doomed to increase production
Would it not be a better idea for big miners to scale back and push iron ore prices higher? Unfortunately, this is not an option anymore. If any one of the big three decides to cut back production, it will just lose the market share to other two players. Perhaps companies are not that happy with current pricing, but they have to proceed with the existing game plan. All they can do is sit and wait for weaker players to leave the market, causing prices to rise.
Major miners will continue flooding the market with cheap iron ore. Their safety cushion is big because of low costs, and they could afford a severe pricing downturn. When weaker players leave the market, BHP Billiton, Rio Tinto, and Vale will celebrate. Currently, it looks like they won't have to wait for long.
Vladimir Zernov has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.