Rio Tinto has begun to feel the iron ore pain

When iron ore giant Rio Tinto Limited (ASX: RIO) starts freezing staff salaries, clamping down on employee travel and looks for other costs savings, you know the falls in the iron ore price must be bad.

According to a report by Fairfax Media, CEO Sam Walsh told employees this week that there will be no pay increased in 2016. “Late last year, we saw market prices continue to rapidly fall. What we see ahead is very sobering. This situation is not temporary and our industry is moving into the new normal which means we must continue to be one step ahead.

Iron ore prices have fallen from above US$60 a tonne a year ago by more than a third to below US$40 a tonne, as booming supply and falling demand both take their toll on the spot commodity price.

The news that Rio, almost universally acknowledged as the world’s lowest cost iron ore producer, is feeling the heat, will bring shivers to other iron ore miners. Rio had cash costs of around US$15 to US$16 a tonne, and that is falling (one of the benefits of falling oil prices), similar to that of BHP Billiton Limited (ASX: BHP), and lower than that of the other iron ore miners Vale and Fortescue Metals Group Limited (ASX: FMG) – although Fortescue is getting closer to Rio.

Rio may now be less optimistic about iron ore demand from China as steel production falls in the wake of massive oversupply. Both BHP and Rio had forecast that demand for iron ore would continue to grow as steel production rose.

In his comments above, Mr Walsh may have let the cat out of the bag – suggesting low commodity prices are ‘not temprorary’ and that the company had to get used to a ‘new normal’. In other words, commodities prices are likely to stay low for an extended period of time. While Rio does have other commodity assets including coal and copper, combined, they are dwarfed by the iron ore division in production tonnage as well as revenues and earnings.

Mr Walsh has also reportedly cancelled many travel trips and asked the company’s executive council members to follow suit. The company also flagged that it will look closely at other expenditure  including on contractors and consultants.

Foolish takeaway

When the world’s lowest cost iron ore producer starts taking desperate measures to cut costs, you know there’s going to be blood in the streets amongst the higher-cost producers.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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