01/12/2010 - 08:07

Analysis: Iron ore prices to keep rising

01/12/2010 - 08:07

Bookmark

Save articles for future reference.

When is a 9 per cent iron ore price rise bad news? When it is the Christmas surprise miners will receive later today, revitalising the case for a resource super-profits tax.

Analysis: Iron ore prices to keep rising

When is a 9 per cent iron ore price rise bad news? When it is the Christmas surprise miners will receive later today, revitalising the case for a resource super-profits tax.

Iron ore mega-billionaires such as Gina Rinehart and Andrew Forrest might even have to reach for their bullhorns and march in the streets again when news of the latest price hike hits the headlines, taking the contract price of iron ore to around $US140 a tonne.

At that level, which is forecast to be the price applicable on ore delivered in the first three months of next year, the profit generated by some mines will top the $US100/tonne barrier.

The expected price increase is the result of the new quarterly pricing system which applies to iron ore following the collapse of the annual pricing system.

Big mining companies use slightly different formulas for calculating their quarterly prices but all refer in some way to the spot, or on-the-day prices, achieved for small cargoes. Rio Tinto uses a three-month average of spot prices. BHP Billiton uses one and two month averages.

Driving the spot price higher since September, and therefore dictating what happens to the contract price in the March quarter of next year, was a ban imposed earlier this year on exports by the Indian state of Karnataka, tightening the worldwide market in iron ore and pushing up the daily price.

More important than the price per tonne is the profit margin that the miners will be earning making it easy for the pro-tax crowd to claim that iron ore has moved into a super-profits category and can afford to pay much more in tax.

Rio Tinto's profit margin on iron ore is a useful case study which explains why the mining giant last week announced plans to add 100 million tonnes of capacity to its WA iron ore system at a cost of $US13.4 billion - and why there has been a rash of takeovers among small iron ore miners and explorers.

In the half year to June 30, Rio Tinto generate revenue of $US9.9 billion in iron ore sales from its worldwide operations, and kept $6.7 billion as earnings before interest, tax and depreciation. In percentage terms that's a profit margin of 67 per cent, a windfall return that most other businesses dream about.

When the 9 per cent price hike kicks in for the March quarter, and assuming it sticks for more than three months, it adds close to $US1 billion to Rio Tinto's half-year revenue, and $US2 billion on an annual basis.

Most of that extra cash will go straight to the bottom line as profit, potentially boosting Rio Tinto's pre-tax iron ore profit margin to more than 75 per cent.

In fact, the numbers could grow even further next year because the rise in the spot price is showing no signs of slowing as the Indian export exit limits global seaborne trade, demand for steel continues to rise in Asia, and expansion plans by big Australian miners are limited by railway and port access issues.

Earlier this week the spot price for iron ore with a 62% iron content hit $US167/tonne, an increase of $US50/t, or 43% on the spot price last July of $US117/t.

What's particularly interesting about looking back at that July price, the lowest for the year, is that it was being quoted at the start of the great Australian mining tax debate, and while $US117 a tonne looks low against the current $US167/t it was actually a very profitable price.

Today, the price looks magnificent, or obscene, depending on whether you're a miner, a customer, or the Australian Government seeking extra tax revenue.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

Subscription Options