There are two ways of looking at Rio Tinto’s decision to close one of its major iron ore mines over the Christmas period: to take the company’s explanation of operational reasons at face value or to see the move as part of a wider strategy.
Rio told its employees at the Hope Downs 4 mine in Western Australia that it would close the operation for two weeks at the end of the year.
The 440 workers affected can either take leave, bring forward leave or apply for shifts at Rio’s other mines in the remote region of Western Australia, the Australian Financial Review (AFR) reported.
The reason for the closure was that the mine will have achieved its annual production target early, with the email expressing congratulations “on a fantastic effort throughout 2016 as we safely deliver our planned production at the right cost”, the AFR said.
The face value explanation of Rio’s move is quite simple: the mine has achieved its goals and extra output isn’t needed at the current time.
There is also the likelihood that Rio’s rail and port capacity wouldn’t be able to handle the extra tonnes mined should Hope Downs 4 continue operating as usual over the festive season.
The face value explanation is certainly plausible, however, it also pays to consider the wider dynamics at work in the iron ore market in order to put Rio’s decision into context.
Iron ore has enjoyed a stellar year, with the spot price almost doubling so far in 2016, notwithstanding a sharp drop on Tuesday as profit-taking finally hit the market.
Iron ore futures in China, which buys about two-thirds of seaborne supplies, have also rallied hard this year, jumping 161 percent since the end of last year to Tuesday’s close of 617 yuan ($90) a tonne.
IRON ORE CORRECTION?
The problem is that hardly anybody, including the major miners, believes these sort of prices are sustainable over the medium to longer term for iron ore.
Certainly, the Dalian Commodity Exchange’s forward curve points to lower prices next year, with November 2017 futures trading at 504.5 yuan a tonne, an 18.2-percent discount to Tuesday’s close for the front-month contract.
Iron ore remains a well-supplied market, and the last of the two major projects built over the past decade, Australia’s Roy Hill and Vale S11D, are currently ramping up, thereby adding millions of new tonnes to the market.
Prices have rallied this year largely because Chinese steel output has risen modestly rather than falling sharply as most analysts had expected, and also because Chinese domestic iron ore output and the grade of ore produced have been declining.
If Chinese steel output remains steady in 2017, there is a reasonable expectation that iron ore imports will also be steady to potentially somewhat higher as Chinese steel mills favour higher quality imported ore.
However, it’s still likely that the iron ore market will be in a state of oversupply next year, just perhaps not by as much as many in the industry fear.
Rio hinted at this in the email to its Hope Downs 4 workers, saying the temporary shuttering of the mine would “reduce operating costs and maximise cash to strengthen the business”, the Financial Times quoted the email as saying.
By taking some tonnes out of the market, Rio may well keep prices higher for longer into the start of the new year, delaying what many see as an inevitable correction.
There is also a political angle to Rio’s actions, as it shows that iron ore mining is still vulnerable at a time when one of the political parties in the ruling coalition in Western Australia state wants to raise taxes.
Voters in the state, Australia’s biggest by area but only fourth out of six by population, go to the polls in March to elect a new state government, with the ruling Liberal-National coalition struggling in the polls against the opposition Labor Party.
The National Party, which is the junior partner in the coalition and has its base in rural areas, wants to raise the production rental fee for Rio and rival BHP Billiton to A$5 ($3.77) a tonne from 25 cents currently.
This levy would only apply to Rio and BHP and not to smaller rivals like Fortescue Metals Group, which holds its mining leases under a different arrangement.
The production rental is also in addition to the 7.5-percent royalty the iron ore miners already pay, a charge well above the 2 percent levied by Brazil, home to top-ranked miner Vale.
While it’s most likely that Rio is closing a mine for a couple of weeks for operational reasons, it certainly doesn’t hurt that it gets to send a message to politicians and the broader market at the same time.