Today, Rio Tinto (LSE: RIO) announced that its Kitimat aluminium smelter in Canada is preparing to restart production, after the ageing smelter had been shut down for a major upgrade.
“The modernisation of the aluminium smelter will increase production capacity by 48 per cent and result in Kitimat becoming one of the lowest cost smelters in the world. Rio Tinto is now focused on safely ramping up towards its annual production rate of 420,000 tonnes… At full production, Kitimat will be one of the most efficient, greenest and lowest-cost smelters in the world” the company said in a statement today.
Aluminium prices in the North American market have fared much better than most other metal commodities, because demand from car manufacturers has been steadily growing and supply disruptions from smelter shutdowns. The price of aluminium varies significantly around the world, because the metal is difficult to transport and exports are limited.
Rio’s operations, which focus on North America, have therefore benefited from the higher North American premium pricing; but that premium has been greatly reduced in recent months. Nevertheless, Rio is looking to expand its market share in the aluminium market in North America and Asia, because long-term supply growth is not expected to keep up with growing demand. It is also looking at making its smelting operations more competitive, by targeting cost cuts of $1 billion annually.
Lower iron ore prices will have a much greater impact on Rio’s earnings though, as iron ore accounts for 87% of its underlying earnings in 2014. Iron ore prices have fallen by more than 15% in the last week alone, following the turmoil in Chinese equity markets.
Unless iron ore prices rebound in the next few months, Rio would struggle to generate sufficient cash flows to cover its capital investment budget and ongoing dividend payments. On a positive note, net debt is just $12.5 billion (or 0.64x EBITDA); so Rio has the financial flexibility to wait for at least a few years before it needs to adjust its dividend payout policy.
In recent weeks, copper prices have fallen too, hurting shares in Glencore (LSE: GLEN) and Antofagasta (LSE: ANTO). Copper prices have hit a six-year low, having fallen 7% over the past week to settle at $2.44 per pound on Comex.
But, the medium term structural imbalance of demand and supply for base metals makes copper and nickel more attractive than iron ore. Despite, worsening investor confidence in China, demand from the country is likely to remain robust. On the supply side, large copper and nickel mines are ageing, leading to lower grades and higher production costs.
The current excess supply situation in copper and nickel markets is therefore likely to transition into a deficit by as early as 2016. This should mean that Glencore, which has significant copper and nickel developments; and Antofagasta, a copper pure play, are relatively more attractive.
Nevertheless, as commodity prices are highly correlated with Chinese equities, we may not yet have reached the bottom of the market. Thus, it would probably be much safer to avoid mining stocks altogether, at least for now.
