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Instant Analysis: Rio Tinto Admits Commodities Rout "Not Temporary," Freezes All Employee Pay

By Rich Duprey - Jan 19, 2016 at 6:00PM

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Even the world's second largest and lowest cost producer is feeling the effects of iron ore's price decline.

What happened?
The toll from the global commodities rout continues to mount, and Rio Tinto (RIO 0.92%) says the situation is "not temporary." To prepare for the lean times ahead, the world's second largest iron ore miner is initiating a pay freeze that impacts all employees.

Does it matter?
Commodity prices are in free fall. Oil closed down below $30 a barrel last week, about 45% below where it traded a year ago, and almost 60% below its 52-week high. Gold is down 15% year over year and iron ore has fallen about 40% to $40 a tonne, consistent with the annual declines the mineral has experienced since 2013.

Yet iron ore is also the commodity most closely aligned with the health of the Chinese economy -- China is not only the biggest iron ore producer, but also the world's largest consumer -- and as the country's growth dramatically slows, the prospects of iron ore pricing turning around any time soon dims. The decision by Rio Tinto's management to rein in spending follows what's occurring elsewhere in the industry.

BHP Billiton (BHP 1.24%) wrote down the value of its shale assets by a massive $7.2 billion last week as oil prices plummeted, the second time in six months it was forced to do so, while Vale (VALE -0.30%), the world's biggest miner, is reducing its 2016 capital expenditure program to $6.2 billion from more than $8 billion. Rio Tinto is cutting the coming year's capex spending by $5 billion.

Yet the miner's decision to freeze all wages is significant because Rio Tinto is widely regarded as the industry's lowest cost producer, suggesting that if it's feeling the pressure of the slowdown then it may very well be a protracted and secular decline.

According to Australian Mining, which obtained a copy of an email Rio Tinto CEO Sam Walsh penned to employees, he said he expects 2016 will be worse than 2015, but perhaps not as bad as it will be in the future.

"This situation is not temporary and our industry is moving into the new normal which means we must continue to be one step ahead," Walsh wrote. "The pressure this is placing on our industry is significant and it is a tough time across the sector. It is important we recognise that the pressure isn't going to let up."

While many miners have lost 80% or more of their value as commodities have collapsed, Rio Tinto's losses have been among the least, perhaps reflecting its better position in the industry. It's not much, but it may be the only solace investors can take away from the dying outlook for minerals.

Rich Duprey 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.

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Stocks Mentioned

BHP Group Stock Quote
BHP Group
$57.25 (1.24%) $0.70
Rio Tinto plc Stock Quote
Rio Tinto plc
$60.21 (0.92%) $0.55
Vale S.A. Stock Quote
Vale S.A.
$13.17 (-0.30%) $0.04

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