Miners likely to invest $10 billion in iron ore expansions

Economies of scale will work in favour of our two biggest miners, making huge expansion plans more likely.

a woman

Although the iron ore mining boom may be over, many analysts are predicting some of our country’s biggest miners could spend up to $10 billion on expansion plans in the coming years as they take advantage of lower costs of production.

Yesterday’s quarterly production report by mining giant BHP (ASX: BHP), boosted expectations it will expand on its Pilbara operations. CEO Andrew Mackenzie didn’t confirm, but the group’s performance during the quarter suggest it could be likely in coming years.

BHP announced yesterday, that its stellar September quarter has given it confidence it’ll meet a production target of 212 million tonnes of iron ore in 2013-14. In addition, the expansion of the Jimblebar mine is likely to increase annual production beyond 220 million tonnes per year.

However, if BHP wanted to increase production further, it’ll need to improve its port and rail capacity, which would likely cost between $US4 billion and $US6 billion. Despite a promise to rein in spending, Mr Mackenzie said, “Longer term, a low-cost option to expand Jimblebar to 55 million tonnes per annum and the broader de-bottlenecking of the supply chain, is expected to underpin capital efficient growth in capacity to approximately 260 – 270 million tonnes per annum.”

This would almost put BHP’s iron ore production on par with Rio Tinto (ASX: RIO), which has a current goal of delivering 290 million tonnes per year. However, it’s unlikely BHP will catch up to Rio anytime soon, because it’s also planning to increase production.

It is expected that when Rio’s board meet next month, they will approve an expansion of the company’s iron ore operations to 360 million tonnes per year, at a cost $US5 billion. If both BHP and Rio decide to increase production, it will allow them to realise a lower cost per tonne.

At current spot prices of around $US130 per tonne for iron ore, there is plenty of margin between the cost of production and the price they receive. With many companies increasing production targets, more mines coming online every year and the potential for a steep dive in demand looking likely in the short to medium term, the price of iron ore could drop considerably.

At a price as low as $US85 – $US90 per tonne, many of the smaller iron ore companies would not be able to profitably compete with the likes of Rio, BHP or even Fortescue (ASX: FMG) who have the lowest cost bases.

Foolish Takeaway

Rio will likely expand production, because it makes sense to produce more for less and the company has already invested heavily to put infrastructure in place. According to Arnhem Investment Management’s Neil Boyd-Clark, “With iron ore prices where they are, there is very good money to be made and, of the options BHP has to deploy capital for growth across its portfolio, iron ore is one of the better ones.”

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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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