BHP, Rio reports are bad news for iron ore

Strong production results from mining heavyweights BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO) last week have reaffirmed the opinions of many analysts that there will indeed be an oversupply of iron ore for the latter half of this year.

The commodity has climbed 11.6% since the beginning of the month and rose above US$130 last week, however, analysts from National Australia Bank and ANZ both believe that the price hike is the result of inventory restocking from Chinese mills.

Last week, BHP announced that it had produced 170 million tonnes of iron ore for the year, which marked a 13th consecutive annual record production of the commodity, however, its fourth-quarter production rate was the true highlight. The annualized rate for its fourth quarter was 217 million tonnes, implying that its supply will only increase in future periods.

Meanwhile, Rio’s iron ore production rate was also up 7% compared to the prior corresponding period and it outlined its intentions to increase production to 360 million tonnes by early 2015.

As Chinese growth continues to slow and miners around the globe ramp up their supply of the commodity, it is unlikely that recent prices can be sustained. The Australian Financial Review highlighted that the Baltic Capesize index – an indicator of shipping activity – turned marginally lower, which further suggests that Chinese trading activity will slow.

Despite the recent price hike, the steelmaking ingredient is still valued significantly lower than its levels in February this year when it was priced at just under US160.

Foolish takeaway

Although the reports from BHP and Rio last week were strong, if demand for iron ore decreases globally then so will its price, which would negatively impact the companies’ revenues. As such, both companies are heavily focused on cutting costs and divesting in non-core projects. The advantage that BHP and Rio both hold is that they run diversified projects and are not restricted to iron ore like companies such as Fortescue Metals Group (ASX: FMG). Fortescue is set to release its production report on Tuesday.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned in this article.

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