By Rhiannon Hoyle at MarketWatch
SYDNEY--The slump iron ore prices to a near decade low is turning the spotlight back onto the world's biggest miners and their strategy of churning out ore at record rates.
While prices have been weak for a while, fears of a global glut have deepened in recent days following evidence of slowing steel output in China, the world's biggest consumer of the steelmaking ingredient, by far.
The price tumble comes at a bad time for major producers such as Anglo-Australian BHP Billiton Ltd. and Brazil's Vale SA., which are counting the cost of a deadly dam failure at their jointly-owned iron ore mine in Brazil earlier in November. The two firms are the world's top shippers of iron ore, along with Rio Tinto PLC.
Iron ore fell to $43.40 metric ton Tuesday, down 12% this month and far below the 2011 high above $191, according to data provider The Steel Index.
The slump raises questions over whether the determination of big producers to keep pumping record volumes into a falling market is working.
BHP and Rio have drawn criticism from some investors and from rivals and lawmakers who say they are depressing prices by digging up more than the market needs. Australia's government in May considered holding a parliamentary inquiry into the matter, although that proposal was ultimately discarded.
The two Australian mining giants have long argued that iron ore is freely traded in a global market, and their expansions were planned years ago and are in the best interests of shareholders.
Their strategy is to produce as much ore as possible for the lowest cost, rather than extract less in the hopes of bolstering prices. Thanks to economies of scale, they still generate a healthy margin on each ton they ship, even with prices down.
Still, profits for both producers--which rely heavily on iron ore for earnings--have nose-dived. BHP's net profit plunged 86% in the year through June.
The company's financial health is being closely tracked by the market following what Chairman Jac Nasser recently called "one of the most difficult" years in the company's 130-year history.
Shareholders worry that the miner won't be able to sustain its long-held pledge to maintain or raise dividends each year amid the slump in commodity prices.
"At spot prices, cuts to BHP's progressive dividend policy seem inevitable," Australian bank Macquarie said Wednesday.
BHP's share price sagged close to a decade-low in Australia in recent weeks, following the Nov. 5 Brazilian dam collapse that sent mud cascading through remote mountain valleys, ripping apart small colonial towns.
Some analysts have estimated the cleanup costs will eventually amount to around $1 billion, although both BHP and Vale have said responsibility for the mine's operations lies with their Samarco joint venture, which is operated independently.
Despite production cutbacks by some higher-cost producers, the iron-ore market will likely still be oversupplied by 150 million tons by 2018, UBS metals and mining analyst Andreas Bokkenheuser forecasts.
BHP's production rose 14% to a record 233 million metric tons in the year through June. Rio Tinto is also producing more.
Meanwhile, in Brazil, Vale is building a $16 billion operation that it touts as "the biggest project in our history and in international mining."
"Clearly we are nearing the threshold point of pain for some Australian miners, but that does not mean that prices can't fall further," said Westpac economist Justin Smirk.
Rising supplies could push prices below $40 per ton early next year, according to Citigroup, further pressuring miners' earnings as China makes less steel. Its output was down 3.1% in October from a year earlier, according to the World Steel Association, an industry body.
To be sure, prices may soon find a temporary floor after the recent sharp falls. "A further stabilization in China's steel prices in coming days could be a sign that iron-ore prices are close to a bottom," Australia and New Zealand Banking Group analysts wrote in a note.
The world's No. 4 iron-ore exporter, Fortescue Metals Group Ltd., has been racing to shore up its finances. On Wednesday, it said it had agreed to buy back US$750 million in debt, a move it said will save US$56 million in interest costs annually.
Meantime, the industry's smaller fish with higher production costs are feeling the strain.
On Tuesday, BC Iron Ltd. Chairman Anthony Kiernan said the small Australian producer was preparing "to step outside the iron ore space."
There is "no point" in building a current and future strategy on the hope that iron-ore prices will recover, he said.