Rio wants bigger savings from iron ore

Management is laying out its goals, but what will the market think?

Rio Tinto (ASX: RIO), Australia’s biggest iron ore exporter, has told analysts at a tour of its Pilbara operations in Western Australia that it is aiming to cut costs to as low as US $35.50 per tonne by 2020.

In 2012, Rio recognised a cost of US $47 per tonne on shipments of the steel making ingredient but its new forecast will also include capital to maintain operations. In addition to efficiencies in production, capital expenditure savings are also expected to be a key focus of the company.

The mining giant is adamant that the cost target can be met by its Pilbara operations because of a number of factors including lower labour, contractors and services, a lower Australian dollar and technology improvements. It will also receive benefits of scale as it aims to increase production to 290 million tonnes by May. Lower royalties as a result of weaker commodity prices will also reduce costs.

To put the costs into perspective, Fortescue’s (ASX: FMG) cash costs are around US $36 a tonne and smaller miners, like Atlas Iron (ASX: AGO), produce their product for around $49 per tonne. However Vale of Brazil holds the title of lowest cost producer, estimated to be as little as $15 per tonne – leaving healthy margins even if the price drops substantially.

Coming into a period of uncertainty surrounding demand, supply and the price of iron ore, Rio must decide whether it continues to ramp up production (as was suggested to in May) or continue to focus on efficiencies and returning to shareholders. Currently around $138.70 per tonne, iron ore is lucrative but if the price drops substantially, investors must recognise that revenues and profits will fall as well.

Foolish takeaway

The biggest problem plaguing our iron ore miners has been a run up in costs over the past decade. If Rio can start to turn this around before prices begin to find their way lower, then it could make for a worthwhile investment. However in this Fools opinion, to buy Rio shares now would be foolish because there’s too much uncertainty, not enough upside and too much downside. When there are so many other higher-yielding companies with less debt and without the uncertainties why risk it?

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Motley Fool contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies. 

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