China’s Hunger for Rio Tinto’s Iron Won’t Last

Iron was the star of Australian mining giant Rio Tinto’s first half, but the operation is about to hit a rusty patch.

The company’s first-half net earnings fell 6% compared with the same period last year, due largely to an $800 million impairment charge on its Mongolian copper joint venture, which has been beset by cost overruns and political interference. Yet the other key part of Rio’s business—iron ore—is doing smashingly. Underlying iron-ore earnings rose 39% on the year to $4.5 billion, helped by strong Chinese demand and a dam collapse in Brazil that has disrupted seaborne supplies. Ore prices are up over 50% since the end of 2018.

Rio’s underlying earnings, which strip out the write-down, rose 12%, driving big shareholder payouts. There is a record interim dividend of $2.5 billion, up 19%, and an additional special dividend of $1 billion.

Unfortunately, iron ore’s sweet spot is unlikely to last. Brazilian production should continue to recover as mining giant Vale secures approvals to restart processing facilities. Meanwhile, Chinese steel producers, the most important source of demand, are having a rough time.

Iron-ore piles at Parker Point, Western Australia.


Photo:

christian sprogoe / handout/European Pressphoto Agency

Beijing’s determination to avoid a renewed property bubble even as it attempts to stimulate other parts of China’s economy appears to be weighing on construction. Excluding the Lunar New Year holiday period of January and February, China’s construction sector purchasing managers index was its weakest since mid-2017 in July. Steel prices have eased since late spring.

Steel mills, already feeling the pinch from rising iron-ore prices, may be reluctant to keep rapidly boosting output. They upped production by 11% in the first half of 2019, according to the China Iron and Steel Association, even though margins are down sharply. At a meeting in Beijing on Monday, CISA Chairman Gao Xiangming warned that the industry had apparently returned to a vicious cycle of raising output without raising returns. Regulators, who remember how the steel debt crisis of 2015 threatened the financial system, are unlikely to tolerate a sequel.

Unless property demand accelerates again, steel output growth will need to slow. That will dampen demand for iron ore. Rio’s bumper iron-ore earnings will be difficult to sustain.

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