Fortescue chairman Andrew Forrest might be feeling a little less rich this morning: Rio Tinto chief Sam Walsh last night threw down the gauntlet to his global competitors in iron ore, vowing to ramp up production even though prices have fallen 20% in the past 12 months. The inevitable result will be downwards pressure on prices.
Only those with the fattest profit margins will survive, and that is Rio's clear intention, as Fairfax columnist Malcolm Maiden wrote here
. On last night's one-and-a-half hour half-year earnings call, reporting a 21% jump in profits to US$5 billion, Walsh positively crowed about Rio's position on the global iron ore cost curve, declaring "we are the lowest-cost producer".
"We're seeing a number of producers starting to get the wobbles," Walsh said. "Now is not the time for the best producer in the world to step back. Now is the time for others … to make decisions".
Iron ore represents 92% of Rio's underlying earnings, and it is on track to lift production from 290 to 360 million tonnes a year by the end of 2015. When the competition has been forced out, Rio will come away a higher market share and will be able to nudge prices back up.
For good measure Rio told us just how much money it is raking in, producing iron ore from the Pilbara at a staggeringly low cost of US$20 a tonne and selling it in today's soft market for US$99 a tonne -- which is about where Rio expects prices to stay in the medium term.
So even at today's low iron ore prices that suggests a gross profit margin of up to 75% (admittedly, before royalties, freight, interest and other costs), which just highlights yet again what a boon the Pilbara is -- a resource that in one sense is owned by all Australians -- for largely foreign-owned Rio and BHP Billiton.
Are these super profits? It got quickly lost in the mining tax debate, but the Henry Tax Review's original Resource Super Profits Tax was an attempt to extract revenue from the profits that can be attributed to the value of the ore in the ground, rather than any skill or work done by the miner. To simplify, the profits from mining above a normal risk-adjust profit, can be thought of as representing this value. The thinking was that when miners are enjoying profit margins of 40%-plus, some part of that has got to be coming from the value of the ore itself itself.
The argument was shouted down and the RSPT was replaced by the Mineral Resources Rent Tax, and analysts on last night's earnings call were eager to hear when that would be abolished and how much it would lower Rio's tax bill. Rio's finance chief Chris Lynch, former boss of Transurban, said it was difficult to estimate but said the company's overall tax rate would come in around 30-33% in 2014. At least Rio is paying tax -- US$1.8 billion this half -- unlike some of its peers.