BHP Billiton (LSE: BLT) (NYSE: BHP.US) and its peer Rio Tinto (LSE: RIO) (NYSE: RIO.US) are going to war.
The two mining giants are ramping up their output of iron ore, dumping the additional supply on an already oversupplied market, in a move designed to put drive high-cost miners out of business.
Getting aggressive 
The price of iron ore has plunged from its February 2013 peak, by around 44% as BHP and Rio have brought mine expansions online. Specifically, the two miners will have dumped 130 to 150 million tonnes of new low-cost supply on the market by the end of this year. In comparison, demand for iron ore is only expected to expand by 30 to 50 million tonnes this year.
As a result, many City analysts expect the price of iron ore to slump further over the next six months. Investment bank Morgan Stanley expects prices to drop as low as $80, echoing a similar forecast from Goldman Sachs.
Low cost
Pushing others out of the market by forcing the cost of iron ore lower is a strategy both BHP and Rio can afford to undertake. The two mining giants are the world’s largest iron ore producers and with size comes scale, which has pushed production costs to rock-bottom levels.
For example, according to City analysts, the price of iron ore only needs to be higher than $45 per tonne for BHP to break even. Rio’s operating cost is around $44 per tonne. Around 80% of China’s mines have operating costs at around $80 to $90 a tonne — only just above the current iron ore price of approximately $96 per tonne.
Starting to work
It would appear that this aggressive strategy is already starting to work. During the last few weeks a number of high-cost domestic Chinese producers have already shut up shop, as they have struggled to react to the ramp-up by BHP and Rio.
Indeed, according to Mike Henry, BHP’s president of marketing:
“…As a lot of low-cost supply came to market over six to 12 months…But over the past few weeks, you’re starting to see some of that high-cost supply shut in…So it’s really important for the high-cost suppliers to shut in a reasonably efficient manner in the face of that – otherwise you just see a compounding of supply in the market…”
According to the China Metallurgical Mining Enterprise Association, around 20% to 30% of China’s iron ore mines have already closed. A huge shift in the market.
However, BHP is not planning to slow down just yet. The company expects to produce 217 million tonnes of iron ore this year, up from 187 million tonnes produced during 2013. What’s more, the company is targeting output of 270 million tonnes over the longer term.
Hopefully, as Chinese peers leave the market, BHP and Rio will be able to consolidate their position within the mining industry, ready to reap the profits when iron ore prices begin to rise again.
