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As Iron Ore Falls Further, It’s Getting Worse For BHP Billiton plc And Rio Tinto plc

2014 was a bad year for the iron ore industry… and it’s starting to look as if 2015 could be even worse. 

According to industry date, net supplies of ore will increase about 60m to 75m metric tonnes in 2015, in line with a 75 million tonne rise in 2014, as mine expansions in Australia and Brazil more than offset closures in China.

So far, BHP Billiton (LSE: BLT) and Rio Tinto (LSE: RIO) — two of the world’s largest iron ore miners — have managed to power through the weak iron ore price environment without much trouble. For example, both Rio’s and BHP’s full-year 2014 results met or beat City expectations and profit remained robust. But this could all be about to change. 

A new low

The price of iron ore fell to its lowest level since May 2009 on Friday, to $59.49 dry metric tonne as supply continued to outpace demand. This supply-demand imbalance is only set to continue as output increases. Global seaborne supply is set to increase by 4.6% this year, while demand is only set to rise by 3%.

Unfortunately, if supply continues to increase at this rate, according to analyst figures the price of iron ore could fall to $50 per tonne this year. Moreover, in the worst cast, some analysts are predicting a price slump to $30 per tonne if China’s economy slows further and the major produces continue to ramp up production. 

Now, BHP and Rio can cope with the price of iron ore trading in the mid-sixties, they can also turn a healthy profit with the price in the 50s. However, if the price of iron ore falls to $40, or even $30 per tonne, there will be serious consequences. 

Specifically, analysts believe that BHP’s iron ore production cost stands at around $30 per tonne on average, while Rio is producing for around $25 per tonne. These costs include transportation of ore to the vessel for shipping but exclude other corporate costs, such as debt interest, admin costs and capital spending.

Corporate and transportation costs could add another $20 per tonne to production costs.

Dividend cuts

If the price of iron ore does fall below $50 per tonne, it’s reasonable to assume that Rio and BHP will have to go into money-saving mode — and this could mean dividend cuts. 

For example, the price of iron ore averaged around $65 per tonne last year and Rio managed to earn $6.5bn. Of this total, the company returned $6bn to investors through dividends and share buybacks — leaving little room for error.

Similarly, BHP reported net income of $13.8bn for 2014 by issued dividends totalling $6.4bn and spent $15.8bn on capital projects. It seems as if something will have to give if the price of iron ore falls further. 

So if you brought either Rio or BHP for income, now might be the time to sell up and look for other income opportunities elsewhere.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.