BHP Billiton plc’s Future Looks Bright Thanks To China’s Mistake

China’s mistake

Around the beginning of this year, Chinese steel mills suddenly stopped buying iron ore. Unfortunately, this was disastrous for the price of the commodity, which slumped from $150 per metric ton to $115 per ton over the space of a few months.

Some suspected that the Chinese stopped buying the commodity in an effort force prices down, so they could restock for less when the time came. However, the Chinese steel mills seeming misjudged the market and were caught out by a resurgence of construction activity within China. This forced the steel producers to rapidly restock their iron ore reserves, at whatever price they could. 

Rising prices

Unfortunately for the steel mills, this sudden rush to restock sent the price of iron ore skyward. Still, steel mills had no choice but to continue buying the commodity to feed the insatiable demand for steel within China.

Indeed, this surging demand for iron ore sent the price of the commodity up 20% in two months, from a low of $115 per metric ton during June, to $137 per metric ton during August.

What’s more, the effect of this sudden demand rippled across the whole resource industry. In particular, demand for ships to transport ore around the world has rocketed with hire rates for Capesize vessels, each able to haul at least 150,000 metric tons of cargo, touching $32,945 per day during September, the highest rate since November 2010.

Meeting demand

As one of the world’s largest iron ore miners, BHP Billiton (LSE: BLT) (NYSE: BHP.US) is set to benefit from this trend. Actually, BHP is one of the lowest cost-per-ton iron ore producers in the world. For example, my calculations show that BHP is able to produce one ton of iron ore for around $60, which indicates profit margins of more than 100% at current prices.

Furthermore, it would appear that BHP is seeking to capitalize on the worlds demand for the ore. Indeed, the company recently revealed to investors that it was going to cut spending on oil and gas exploration within India, instead focusing on ramping up its production of  iron ore.

In addition, within the same market update, the company revealed that it was upping its iron ore production target for 2014, as a multi-billion dollar work over program achieved better results than expected. What’s more, BHP raised its 2014 iron ore output target by 3% to 212 million tonnes.

Elsewhere, BHP’s peers are also seeking to capitalize on the worlds seemingly insatiable demand for iron ore. In particular, Rio Tinto recently announce that it was upping ore output by 10% for this year. Moreover, Australia based, Fortescue Metals Group ramped up September shipments by a staggering 62%.

Foolish summary

Overall demand for iron ore remains robust around the world and BHP is in prime position to benefit. BHP is one of the worlds largest iron ore producers with a low production cost-per-ton, which should ensure the company remains profitable despite the volatile price of ore. Additionally, China’s recent mistake should boost BHP’s second half results. 

Investing in the resource industry can be highly lucrative. However, the industry is highly cyclical and it's almost impossible to predict where the market will move next. Still, committed investors with a long-term outlook should be able to profit.

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> Rupert does not own any share mentioned in this article.