Why Rio Tinto Limited is a huge threat to the junior lithium miners

Source: Wikimedia Commons

Rio Tinto Limited (ASX: RIO) made headlines yesterday when the miner’s new CEO, Jean-Sébastien Jacques, suggested his company is done chasing a growing share of the iron ore market.

Companies around the world have rapidly increased their production of the commodity, which is used for making steel, only to see demand growth fall in recent years. That has forced iron ore’s price from a peak of around US$185 a tonne in 2011 to just over US$56 today, according to The Metal Bulletin.

Rio Tinto has played a key role in iron ore production, with the commodity accounting for the vast majority of the miner’s earnings in recent years. In what would be a change of pace, however, the company has reportedly suggested a shift in focus towards ‘value’ by improving productivity and operational efficiencies instead of pumping up its volumes.

According to The International Business Times, part of this move will include the shelving of Rio Tinto’s US$20 billion Simandou iron ore project. Jean-Sébastien Jacques argues that, given the conditions in the iron ore market right now, the huge costs of developing the mine are not justifiable in the current iron ore environment.

The Wall Street Journal also noted that the new strategy could involve acquisitions – assuming they can be made at a reasonable price – and even a foray into new commodity markets to drive the next wave of growth. These moves could be to the horror of some of the country’s junior lithium miners.

Don’t underestimate this threat

Lithium prices have soared in recent times due to the resource’s use in rechargeable batteries. Not only are these widely used in everyday devices such as smartphones, but demand is also expected to boom over the coming years as electric cars and home battery packs from innovative companies such as Tesla become increasingly common.

While this boom may have gone unnoticed by many investors, others have generated huge gains over the last 12 months by holding shares of some of the country’s lithium producers.

Orocobre Limited (ASX: ORE), for instance, has risen 136% since this time last year, while General Mining Corp Ltd (ASX: GMM) shares have exploded 1,322%. Meanwhile, Galaxy Resources Limited (ASX: GXY) shares are up 1,281% and Altura Mining Ltd (ASX: AJM) is up 632%.

Needless to say, those are some enormous gains, particularly when you consider the short space of time in which they have been achieved. However, it’s also fair to presume that momentum and speculation have played a role in that.

As my colleague Mike King noted in May: “Companies only have to mention the word lithium these days to see their share prices fly, thanks to soaring commodity prices and the prospect of even higher lithium prices ahead.”

The company he was referring to was Prospect Resources Ltd (ASX: PSC), which soared 217% in a single day. It’s up 967% over the last 12 months.

Mining is an extremely capital intensive industry to operate in, while there is also no guarantee of success. It’s possible that many of the smaller companies (whose share prices have skyrocketed) will fail to live up to expectations, which could result in heavy losses.

What’s more, companies such as Rio Tinto aren’t going to sit idly by when there are big profits to be made. The Wall Street Journal noted that Rio Tinto is spending millions of dollars studying the possibilities for a lithium deposit in Serbia, which could mean a bigger push into the sector in the future.

If Rio Tinto is doing it, there is no reason that other businesses such as Vale or BHP Billiton Limited (ASX: BHP) won’t do the same in the future if lithium prices do remain strong and demand grows. Higher supply would likely force prices lower again, which would be bad news for some of the smaller producers overshadowed by huge operating costs.

Personally, I wouldn’t want to be holding onto their shares if or when that does happen.

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The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Tesla Motors. Motley Fool contributor Ryan Newman has no position in any stocks mentioned. 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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