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BHP defends iron ore increase

BHP Billiton (ASX: BHP) has defended its decision to expand its iron ore business, despite warnings of a future supply glut and lower prices.

Even outgoing CEO Marius Kloppers has warned of lower iron ore prices down the track, while commodities trader Glencore’s Australian boss Ivan Glasenberg warns the production growth by iron ore majors, including BHP, Rio Tinto Limited (ASX: RIO) and Brazil’s Vale, will contribute to an oversupply and push prices down.

BHP’s chief financial officer Graham Kerr defended his company’s expansion, at the Bloomberg Australian Economic Summit in Sydney today, saying that, “Even if prices come down in iron ore in the next four of five years it will still be a hugely profitable business for us.”

That’s of course if BHP can find someone to buy it.

Still, BHP, RIO and Vale have the lowest iron ore production costs, and falling prices are likely to hit the highest cost producers first – with the vast majority of China’s iron ore miners in that category. Medium and smaller miners like Fortescue Metals Group (ASX: FMG) and Atlas Iron Limited (ASX: AGO) could come under pressure should the price of iron ore fall below US$100 a tonne for an extended period of time.

That could see higher cost operations shut down as they become economically unviable, allowing the major miners to ship more of their low cost product. That of course relies on the fact that demand doesn’t slump too far either, which will likely hurt all miners.

BHP also has the benefit of being more diversified that Vale or Rio. As Mr Kerr said, “we are not the iron ore-only company”. Both Vale and Rio have much higher proportions of earnings from iron ore compared to BHP.

Foolish takeaway

Here at the Motley fool we’ve warned for some time of a supply glut in iron ore due to the majors ramping up their production, at the same time as demand for the commodity is likely to fall, as China moves from an industrialising nation to a consumer-led economy. BHP is likely to be hurt by falling iron ore prices – but not as much as Rio.

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More reading

The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool writer/analyst Mike King owns shares in BHP.

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