Rio Tinto’s attack on costs to continue

Rio Tinto says the focus on productivity, cost reductions and capital discipline will continue as volatility in the resource sector continues.

Releasing its annual report this week, the global miner outlined its plans for the future, and the decision making process around plans to slash its capex.

Rio Tinto’s capital expenditure reduced by 37 per cent to $US8.2 billion in 2014, compared with the 2012 peak level of $US17.6 billion.

It is expected to be further reduced to less than $US7 billion in 2015, of which around $US2.5 billion is expected to be sustaining capital.

Last month a leaked memo from iron boss Andrew Harding revealed that cost cutting measures would include quarterly performance reviews of site superintendents, reductions to stores and warehousing, a recruitment freeze, and renegotiation of supply and service contracts.

The move is largely in line with other miners in the sector as Rio points out.

“Inefficiencies are being exposed, and so reductions in costs and capital expenditure, productivity improvements, and project deferrals and cancellations have become widespread across the mining industry,” it said in a company statement.

Rio pointed to the cyclical nature of the industry for an explanation as to why the sector has found itself in this precarious position.

It says that following a decade-long growth phase, the sector has now firmly entered a period of lower prices, driven by a subdued global macro-environment, combined with strong supply.

The company expects the current phase of margin compression to continue as previously committed supply enters the market and the key drivers of demand taper off.

“Meanwhile, volatility – a feature of the macroeconomic environment since the global financial crisis- is expected to continue, bringing with it further short-term risk.”

For commodity markets this means lower prices as the subdued global macro environment meets an overwhelming strong supply.

The effects of this coupling have already been seen in the iron sector, which Rio Tinto described as “one of the most resilient commodities in 2013”.

Fast forward two years, and the value of iron ore is down by more than 60 per cent, with the company sceptical the situation will improve.

“The addition of seaborne iron ore capacity exceeded demand growth, tipping the markets into oversupply,” the company’s annual report stated.

“Pressured by falling prices, about 125 million tonnes of high cost production from China and non-traditional seaborne suppliers exited the market in 2014.

“The continued ramp-up of committed supply is expected to once again exceed the growth in iron ore demand in 2015. However, with further exits of high-cost producers anticipated, the market will be more in balance.”

Coal had a similar crash, with both thermal and metallurgical coal falling to five-year lows in 2014.

Rio said production has been slow to react to the new price environment, particularly in China where state-owned enterprises account for a large share of output.

Looking ahead, Rio says economic growth is likely to remain modest and only mildly supportive for commodity demand in the near term.

While the fall in oil prices and exchange rates are expected to provide some relief, Rio said these factors could also delay the exit of high cost producers, which could lead to further commodity price pain.

In his executive statement, Rio Tinto CEO Sam Walsh said 2015 would focus on adapting and responding with “urgency” to changing conditions while sustaining focus on efficiency in areas that make a difference including to: “rein in our costs, ensure every dollar is spent wisely and remove wasteful working capital”.

The company is wasting no time it its bid to squeeze costs and held a meeting with suppliers last week.

"It's important that we reduce waste, remove duplication and simplify the way we do things. If we can improve together, then we will thrive together," a Rio spokesperson said of the meeting.