Diggers at dawn

Rio Tinto is winning in dirty ore wars

Skill, timing or just geological good luck - whatever the cause, Rio Tinto is winning the ore wars. Iron prices fell in the first six months of 2015 as the miner ramped up its output by 12 per cent. Underlying earnings plunged 43 per cent year-on-year, but Rio is moving towards its implicit goal - to drive higher-cost producers out of business. This is market forces at their most brutal.

The 46 per cent year-on-year collapse in the iron ore price hurts Rio less than others. Costs in the industry vary hugely. At the bottom, below $30 per tonne, are the Australian reserves of Rio and BHP Billiton, with Fortescue and Brazil's Vale not far behind. At the top, some mines need almost $140 a tonne to be profitable. The current price is around $57 a tonne.

In theory, it will all shake out in Rio's favour. The big four iron suppliers are targeting combined future output of 1.3 billion tonnes a year, over 90 per cent of world seaborne iron demand in 2014. Rio's costs are falling as it finds new economies of scale and technology.

By economic logic, more expensive producers in Malaysia or Iran will soon be left on the scrap heap. But it may take time. Some higher-cost producers can find cash elsewhere to subsidise production while waiting for higher prices. Also, miners and governments are often reluctant to follow market signals, since closing mines brings extra costs, social as well as financial.

The fight could therefore be long. Many who should shut down won't. And even then, once prices have settled around the costs of the weakest supplier, it will take a rise in new demand to make them go any higher. Right now, that looks like a distant prospect, as gross domestic product growth is slowing in China without increasing much in other theoretically iron-hungry countries.

Investors seem to be looking ahead to more rational times. Rio's stock trades at 15 times its next year forecast earnings. A year ago it traded at 10 times. But while the stock market is Rio's friend right now, the iron ore market is set for destruction and disappointment.