Rio Tinto’s Jacques: low-grade ore discount here to stay
The growing discount for the lower-grade ores produced by the likes of Andrew Forrest’s Fortescue Metals could become a permanent feature of the iron ore market, said Rio Tinto chief executive Jean-Sebastien Jacques.
Speaking to The Australian in the wake of Rio Tinto’s first-half profit result, Mr Jacques said he was increasingly confident the widening gap between higher- grade and lower-grade ores was here to stay.
Lower-grade ores with an iron content of about 58 per cent have typically sold at a 10-15 per cent discount to the benchmark spot price for 62 per cent iron ore, but the discount blew out to an average of 27 per cent for Fortescue during the June quarter.
While Rio and BHP Billiton have been affected by the discounting, the phenomenon is more keenly felt by Fortescue given a much higher proportion of its output is lower grade.
Fortescue chief executive Nev Power last week said he was confident the discount would revert back to historical levels over the remainder of this year, but Mr Jacques said he believed the widening discount would persist.
He noted that China had ordered the closure of poorer quality, high-polluting steel mills as part of the nation’s efforts to combat pollution, with the remaining mills turning to higher-grade inputs to maximise their output.
“The Chinese steel industry is being restructured, but it doesn’t mean they will reduce the steel output,” he said. “In order for them to maintain the steel output with a lower capacity base, the only option for them is to increase the grade of the quality of the product they put into the blast furnace to create steel.”
He said the discount between high and low-grade ore had widened to as much as 40 per cent in recent months.
“Even a few months ago when the iron ore price was under pressure the delta (discount) didn’t shift; it remained very, very significant,” he said. “It’s early days, but that tells you it could be a structural shift. That’s what I believe is happening.”
Fortescue has argued that the discounting phenomenon may have already run its course. Mr Power said the Chinese steel market would begin to stabilise as the recent spate of mill closures were absorbed by the market.
“We believe that, as steel production increases to absorb those tonnes that shut down, margins will return to normal levels and steel mills will be more worried about the cost per tonne or value in use and our products will become more in balance with the higher-grade iron ores,” he said.
“For a 65 per cent iron ore, the steel mills are paying a very high premium per iron unit compared to the price they’re paying on our ores. Our products are very good sintering products, and we think steel mills, as soon as they’re looking at their cost of production, again will revert to a more even balance.”
Stronger iron ore prices over the first half helped Rio’s profit to surge. The miner on Wednesday announced an underlying first-half profit of $US3.9 billion ($4.9bn), up from $US1.5bn a year ago, and said it would pump $US3bn into a record interim dividend and share buyback. The capital returns helped overshadow a narrow miss in actual earnings.
“Unlike previous periods of higher dividends and a lacklustre outlook leading to poor post-results share price performance, we think with the current healthy dynamics in iron ore and aluminium coupled with capital disciple and appropriate returns to shareholders, the stock can now attract generalist investors and a higher valuation,” Credit Suisse said.
Deutsche Bank analyst Paul Young said the result showed Rio was executing “the most compelling strategy in the mining sector”, with the higher payout likely to be the start of a longer-term trend for the group. “Shareholder returns should step up significantly in 2018, unless commodity markets deteriorate and/or M&A options become available,” he said.
“We now assume a $US2bn annual buyback from 2018 onwards. On our estimates, even with this level of capital return, net debt would continue to fall.”
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