BHP iron ore output and productivity strategy remains rational

There has been a lot of commentary on the iron ore market in ­recent weeks.

Iron ore

There has been a lot of commentary on the iron ore market in ­recent weeks and different views have been debated and critiqued. ­I think now is a good time to step back and take look at the fundamentals.

Iron ore is a strong contributor to the Australian economy and it trades in a global market. Like all free markets, supply and demand determine price. As the debate around iron ore has intensified, it is appropriate to reflect on the facts behind this industry.

China’s growth story is well documented — over the past 15 years we have witnessed a once-in-a-lifetime increase in demand from our largest trading partner. China’s industrialisation stimulated a huge increase in global iron ore production, more than doubling from 950 million tonnes a year in 2000 to 2200mt last year.

These market fundamentals incentivised new iron ore producers to enter the market, and encouraged existing players to expand. It also encouraged domestic Chinese iron ore production to peak at more than 400mt in 2013. Over this time, Western Australia increased its global seaborne market share from 35 to 51 per cent, with excellent co-operation between government and the private sector, in a free market.

As happens in commodity cycles, supply growth eventually exceeded demand growth around 2011. The outcome has been a flattening of the cost curve. The result? A reduction in price. Put another way, mean price reversion will occur in a free market.

The price of iron ore has never been watched so closely, so let’s reflect on the facts. Between 1980 and 2005, the price of iron ore leaving Port Hedland (in 2015 dollar terms) averaged $US30 per dry metric tonne. For the 10-year period from 2005 to 2015, the price averaged $US96 a tonne. And driven by Chinese industrialisation, we even saw once-in-a-generation prices that peaked at more than $US180 a tonne.

As more low-cost supply was added to meet demand, the price of iron ore moved back towards the long-term average. When we look back over the past 35 years, we see the price has averaged around $US49 a tonne.

So the reality is that today’s price still compares favourably with the long-term average, and very favourably with the price before China’s industrialisation.

It is in Australia’s best interests for its iron ore producers to remain competitive. It is not the only supplier of iron ore. Our customers have other supply options in Brazil, China, India and South Africa.

We absolutely and unequivocally believe that BHP Billiton and Australia must improve productivity to remain competitive. BHP’s $US25bn capital investment over the past decade in our WA iron ore business was made because of our confidence in the long-term future. Our iron ore resource underpins our expectation we can mine for over 100 years.

None of this is a surprise. In anticipation of supply growth exceeding demand growth, we have not approved any major capital growth investments in iron ore since early 2011.

Our focus has been on increasing volumes and decreasing costs. In 2012, we deferred around 180mt of additional annual production — 110mt from the outer harbour development and 70mt by not developing two additional berths in the Port Hedland inner harbour; we also announced deferment of the inner harbour debottlenecking project. All responsible decisions.

In the past few weeks, we heard news of China signing agreements to fund the development of Brazilian iron ore producer Vale’s 90mt S11D mine. Vale will continue to add low-cost, high-quality tonnes to the market. China will continue to invest in Brazil and elsewhere to secure ore at what it considers to be a fair price. This is the reality of competition in a free market.

When it comes to geology and geography, Australia is a lucky country. The Pilbara has some of the highest quality iron ore in the world and we are close to our customers. But it is essential that each WA producer focuses on its product quality, reliability of supply and continuously improves to remain globally competitive.

Despite the tens of billions we have invested in our iron ore business, BHP’s share of supply in the seaborne market has remained constant at about 17 per cent. Fortescue Metals has grown its share of seaborne exports to 11 per cent since entering the market in 2007 — they have been the world’s most prolific iron ore growth story between 2007 and the end of 2014.

BHP is not oversupplying or flooding the market. Our strategy to increase production through productivity remains commercial, rational and consistent.

We have also taken tough decisions to improve efficiency. We are generating better margins on almost 2.5 times the volumes compared with the last time the iron ore averaged around $US50 per tonne, in 2006.

There is no doubt that Australian producers and governments have benefited from the phenomenal increase in demand for iron ore. BHP and its shareholders have benefited. We have also created thousands of jobs. And BHP paid more than $8.7bn in taxes and royalties in Australia last year.

Many Australians have a broader connection to BHP, whether through direct share ownership, super funds, or a business relationship. By pursuing our strategy of safe productivity, we will remain competitive in the global market. This will allow us to continue to contribute strongly to the Australian economy. Surely this is in everyone’s interest.

Jimmy Wilson is the president of iron ore at BHP Billiton.