BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) have both been slammed for their role in driving iron ore prices lower, with the pair aggressively increasing their production rates to allegedly force other miners from the market.
The iron ore price has fallen more than 65% since January 2014 while it has fallen almost 25% in the last five weeks. According to the Metal Bulletin, the commodity is now fetching just US$47.08 a tonne, which is below the price where most miners are estimated to 'break-even'. In fact, even Fortescue Metals Group Limited (ASX: FMG) – the world's fourth largest miner – is likely operating at a loss at these depressed prices.
BHP and Rio Tinto, together with Brazil's Vale, have been ramping up their production rates in an effort to improve their average cost per tonne. In doing so however, they have flooded the market with ore that it simply does not need, forcing prices to a new decade low.
The Fairfax press even quoted Brian Gilbertson, a former chief executive of BHP Billiton, as saying their approach is "very expensive for everyone", stating that the majors can't control demand so should instead be cutting back on supplies. Instead, they remain committed to their expansion plans which will surely drive the commodity's price even lower.
As it stands, BHP and Rio Tinto are both still making a profit at this price, but their margins are thinning at a rapid rate and having a drastic impact on their profits. Fairfax said that by Gilbertson's estimates, it was costing investors $5 billion every year (at their current production rates) for every US$10 that the commodity drops in price.
Should you buy the miners?
Obviously, BHP Billiton and Rio Tinto are both in the best positions to weather the commodities storm given their sheer size, low costs and, in BHP's case, high level of diversification. While they might be in a better position to survive however, lower iron ore prices are still going to impact their profits and cash flows, which could ultimately impact shareholder returns.
As such, investors would be wise to avoid the miners until the iron ore price begins to stabilise, or until their shares become too cheap to ignore. Either way, it could be a lengthy wait on the sidelines. While you wait, there are plenty of more compelling opportunities waiting for Australian investors.
