BHP Hits the Brakes and the Iron Ore Price Jumps

Iron ore texture

BHP Billiton’s [ASX:BHP] decision to defer a US$600 million project at Port Hedland has had an immediate effect on iron ore prices. Iron ore was trading at US$54.04 a tonne overnight, raising the price of the mineral by 5.9%.

BHP now expects to miss its initial target of producing 290 million tonnes by 2017. In the short term, BHP’s production will still hit 250 million tonnes up to June this year. But the news will relieve some of the pressure that has forced iron ore prices to plummet in the past 12 months. The move will help lower BHP’s total outputs, and the industry expects that total production of iron ore will drop by 160 million tonnes this year.

Investors will also welcome the news. Some have accused the industry’s major producers of oversupplying the market, even as prices have tumbled. Equity brokers CLSA’s head of resources research, Andrew Driscoll, expects the decision to defer the project will free up cash flow to help support BHP’s ‘dividend [payouts] and balance sheet’.

But iron ore producers claim that the desire to maintain their market share is the reason for their high outputs amid lower prices. Not that it will come as any comfort to the hardest hit smaller producers. Australian producer Atlas Iron [OTCMKTS:ATLGF] is struggling to stay afloat, and shares have suspended trading since early April.

BHP’s decision means that all three major Australian iron ore producers have postponed projects that would have raised their total production.  Rio Tinto [ASX:RIO] last year pushed back its Silvergrass mine project to 2016, reducing Rio’s ability to meet their 360 million a year tonne target. And Fortesque [ASX:FMG] scrapped plans for a new processing plant, reducing their output projections.

But the short gains these decisions produce may not have any lasting effect. Iron ore prices have fallen by almost 70% since last year, dropping from US$140 per tonne to US$50 per tonne as of April. Rio Tinto’s and Fortesque’s project delays have had a minimal effect on long term prices. BHP’s decision is likely to produce similar results.

Iron Ore Price Graph

Source: Bloomberg

[Click to Enlarge]

These moves to delay or scrap projects should be seen as ploys to improve confidence among investors. The threat of losing their market share to competitors is falling away as more iron producers come under financial pressure.

The long term outlook for prices remains sobering. US based investment bank Goldman Sachs [NYSE:GS] expects iron ore prices to hit as low as US$40 per tonne in the next five years.  But at least it means that Australia’s major iron ore producers can switch their focus from chasing market share to increasing the value of stockholdings for shareholders.

Mat Spasic,

Contributor, The Daily Reckoning


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