Rio Tinto - Getting more for its iron ore

Mining giant Rio Tinto (LON:RIO) has joined rivals BHP Billiton (LON:BLT) and Vale in switching from annual to quarterly pricing reviews for its iron ore sales. Whilst the 2009/2010 annual iron ore contracts were negotiated at US$60 per tonne, demand has recovered so much that the price for the prevailing quarter is likely to fall somewhere between US$110-120 per tonne. If this jump of 80-100% was not enough, should the spot price of iron ore increase later this year, prices will be renegotiated and this will filter through to Rio's bottom line.

With iron ore prices rising steadily, news that Rio’s 2010 Q1 iron ore output was close to 40% higher than in the corresponding period of 2009, was welcomed. However, the 43 million tonnes produced was 8% lower on the previous quarter as factors such as the weather, mine maintenance work and lower grades all took affect. Elsewhere, the company's key commodity production levels were lower when compared to the preceding quarter. Mined copper came in 19% lower at 165,000 tonnes and US coal was 41% lower at 10 million tonnes. On a more positive note, production of refined gold came in at 174,000 ounces, 18% higher than the final quarter of 2009. And whilst key production levels may have disappointed (particularly in light of strengthening commodity prices) we can see Rio making up any lost ground later this year as encouragingly all operations are back at capacity.

Elsewhere, the proposed tie up of Rio's Pilbara iron ore operations in Western Australia with those of great rival BHP is also coming under increased pressure. The tie up is set to yield US$10 billion worth of synergies and as such the stakes are high. Although the two miners will not be collaborating with respective sale price, Australian, European and Chinese regulators are all looking into the matter and are set to raise objections.

Whatever the outcome, we believe long term earnings at Rio are secure not only due to higher commodities prices but also because of a strengthening balance sheet. The group's asset disposal program combined with the high commodity prices has helped to significantly reduce the group's debt position (net debt stood at US$45 billion at the end of 2007) and Rio now stands on firmer financial footing.

During the quarter the group's debt was reduced by a further US$4.5 billion thanks to robust cash generation. Rio Tinto has now completed divestments in excess of US$10 billion since the beginning of 2008 and US$3.5 billion so far this year. The group's remaining portfolio of assets remains high quality and long life. The Mongolian Oyu Tolgoi project is a perfect example. The deposit is one of the world's largest untapped copper-gold deposits and Rio's exposure comes via its stake in Ivanhoe Mines. The development has moved ahead after it satisfied the conditions to the precedent of the Investment Agreement and first output is expected in 2013, followed by 5 year ramp up to full production.