BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) have faced enormous scrutiny this year for their role in seeing the iron ore price fall lower.
At a time when Chinese demand growth is waning, BHP and Rio Tinto have both aggressively increased their production rates. As any eighth-grade economic student would tell you, that's a recipe for falling prices.
While the commodity's price fall may have come faster and harsher than what most in the industry were expecting, it is clear how damaging the strategy has been on the sector as a whole. Iron ore is now trading at just US$71 a tonne – down from US$135 in 2013 – which is posing as a very real threat to the very existence of Australia's junior miners, such as Atlas Iron Limited (ASX: AGO) and BC Iron Limited (ASX: BCI).
Given their higher cost operations and lower quality ore (which receives a discounted price), the junior miners need the commodity to trade well above today's levels to turn a reasonable profit. In fact, at US$70 a tonne, it's very possible that these companies could now be operating at a loss.
As highlighted by The Australian Financial Review, even Fortescue Metals Group Limited (ASX: FMG) is under enormous pressure at these depressed prices, with UBS estimating that the miner needs prices to trade at US$73 a tonne to break even. It's no wonder the shares have fallen so heavily this year…
To make matters worse, BHP's plans have revolved around increasing its efficiency and reducing its overall costs based on the belief that Chinese demand would peak at around one billion tonnes between 2020 and 2025. Now however, fresh forecasts from one of the industry's top officials, Li Xingchuang, suggest demand could instead peak at 740 million tonnes in 2017.
Indeed, BHP's plans are now an area of confusion for investors. While the miner said in October that it was targeting annual production of 290 million tonnes in 2017, it more recently said that its era of big iron ore expansion was over. While the world's largest miner is one of the best positioned to cope with the lower price environment, its expansion strategy could certainly prove damaging to its overall margins in the long run if iron ore prices do continue to fall.
Given the high level of uncertainty facing the sector, investors would be wise to instead focus their attention on other investment prospects, such as the one our top advisors just named their #1 dividend stock for 2015.
