Only the perma-bulls still think that the iron ore price will return to the heady heights of 2013 any time soon. As I pointed out some time ago, a combination of increasing supply, and flattening demand mean that prices are probably going to weaken. As Motley Fool contributor Owen Raskiewicz points out, even BHP Billiton Limited (ASX: BHP) is heavily reliant on strong iron ore prices. However, Rio Tinto Limited (ASX: RIO) is even more reliant on iron ore prices, so it is particularly important that the company drives down the cost of production. Here are two ways Rio can lower production costs.
1) Rio can use solar power to reduce diesel costs. My favourite renewable energy company, First Solar Inc (Nasdaq: FSLR) recently announced it will provide Rio with a solar-diesel hybrid solution "that provides maximum fuel savings while maintaining system reliability." The Rio Tinto Alcan General Manager of Weipa Operations Gareth Manderson said that: "We expect the use of solar power will reduce Weipa's annual diesel consumption and its carbon dioxide emissions by around 1,600 tons." While Tony Abbott has signalled he will withdraw support for renewables and continue subsidising diesel, solar will still offer savings in the long term.
The installation is supported by the soon to be cut Australian Renewable Energy Agency (ARENA), but should pave the way for greater co-operation between the solar industry and the miners. RenewEconomy quotes ARENA CEO Ivor Frischknect describing the project as "the tip of the iceberg." As oil supplies diminish, the cost of diesel becomes more significant for miners: there is "huge potential off-grid use of renewable energy in Australia." As a first-mover, Rio Tinto will be first in line to take advantage of potential savings.
2) Rio can also reduce production costs (per tonne) by increasing output. In April, Rio reported that: "Our Pilbara iron ore business has again set new benchmarks for production, shipments and rail volumes for the first quarter." However, other miners such as Fortescue Metals Group Limited (ASX: FMG) are also increasing production. Fellow iron ore exporter Arrium Ltd (ASX: ARI) also recently announced "record year-to-date shipments." The hilarious predictability of this behaviour ensures that iron ore prices can't rise much (and are more likely to drop). Inevitably, those miners with higher costs of production – such as Fortescue – will be most severely impacted.
It is worth noting that iron ore prices are usually weaker in May, probably due to demand-side cycles. As prices do weaken, larger companies can keep costs of production low, due to efficiencies of scale, though BC Iron Limited (ASX: BCI) looks to be the pick of the smaller companies. It's interesting to note that over the last 12 months Fortescue, BC Iron and Arrium have all outperformed the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO). The question is, will they repeat that performance in the coming 12 months (or 5 years)? It's impossible to deny the fact that the iron ore miners look cheap, but I won't be buying (even Rio or BHP). Simply put, there are much safer companies to invest in.
