Why Rio Tinto Limited is betting $3.5 billion on a “game changer” iron ore mine

The Rio Tinto Limited (ASX: RIO) share price is 2% higher to $73.46 today after the giant iron ore miner revealed it is to invest US$2.5 billion (A$3.5b) into its Koodaideri iron ore mine in Western Australia.

The miner’s management team is talking up the investment in what will be its most “technologically advanced mine” ever thanks to increased levels of automation and digitisation driving cost savings, safety improvements and overall productivity at the mine.

Koodaideri will deliver a new production hub for Rio Tinto’s new world-class iron ore business in the Pilbara, incorporating a processing plant and infrastructure including a 166-kilometre rail line connecting the mine to the existing network. Construction will start next year with the first production expected in late 2021. Once complete the mine will have annual capacity of 43 million tonnes underpinning production of the Pilbara blend, Rio Tinto’s flagship product“.

In fact Rio Tinto’s chief executive, J-S Jacques  went as far as to call the new mine a “game changer” that will ensure “we continue to deliver value for our shareholders and Australians”.

While Rio Tinto can work to increase production and improve efficiencies it’s still captive to the volatile iron ore price and the strength of Chinese demand for the key steel-making ingredient.

It also faces powerful competitors in the likes of Brazil’s Vale and BHP Billiton Limited (ASX: BHP) or Fortescue Metals Group Limited (ASX: FMG). All of them can lift iron ore supply themselves which can keep a lid on prices due to the basic laws of supply and demand.

Just take a look at a chart of Rio’s share price since January 1999.

Source: Google Finance as at November 29, 2018

As you can see today’s share price is actually below levels hit back in 2006, with the volatility largely due to the fact that Rio is reliant on an iron ore price it has little control over. This means it’s a cyclical business where it’s possible to book capital gains but only if you time the cycle or hold for the very long term.

Over the medium term you’re better off looking elsewhere for wealth-creating investment returns….

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Motley Fool contributor Yulia Mosaleva has no position in any of the 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 Scott Phillips.

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