Are the Iron Ore Giants Taking OPEC's Lead?

By Reuben Gregg

The top and bottom lines at iron ore giants Vale SA (ADR) , Rio Tinto plc (ADR) , and BHP Billiton Limited (ADR) are suffering under the pressure of low iron ore prices. So why is this trio still producing record amounts of the key steelmaking input?

Falling prices got them downThere was a time when China was expanding at double-digit rates. The fast-growing nation was devouring commodities as quickly as miners could deliver them. That all started to change around 2011, when commodity prices peaked and China's growth started to slow. That slower growth has led to less demand for commodities across the board.

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Iron Ore Spot Price (Any Origin) data by YCharts

But miners ramped up supply to meet China's appetite. So when demand started to fall off and supply didn't, prices did about what you'd expect -- they fell. In some cases they have fallen really hard. That's the backdrop for today's moribund iron ore market.

The financial results have not been pretty. Vale's revenues from iron ore fell roughly 25% year over year in the third quarter despite increased production because of lower selling prices. The income statements of Rio and BHP basically tell the same story.

Why make more?Which makes it a little odd that this was the lead sentence in Vale's third-quarter earnings release: "Vale S.A. reached iron ore production of 88.2 Mt in 3Q15, the highest quarterly production in Vale's history."

The thing is, Vale isn't alone. Rio Tinto recently highlighted its production achievements: "Third-quarter production of iron ore was 12 percent higher than the same quarter of 2014 and was eight percent above the second quarter of 2015." It called these "new milestones," and it's worth noting that not only was there notable year-over-year growth, but there was sequential quarterly growth as well. In other words, Rio is still expanding production.

BHP, meanwhile, is doing the same. According to the company, "Total iron ore production for the September quarter increased by seven percent to a record 61 Mt." That's a year-over-year figure; the sequential increase was a more modest 2%. This begs the question. Why make more of something that everybody has more than enough of?

A Rio Tinto mine at work. Source: Rio Tinto.

There are a couple of reasonsIn fact, you might look at what these giants are doing and think about OPEC's decision to maintain oil production at high levels. The goal is seemingly to maintain OPEC's market share and push out marginal oil producers. While at some level that may be true for the iron ore giants as well, there are other issues in play.

For example, big mining projects are years in the making before they start producing any material. So the projects that are driving Vale, Rio, and BHP's current production were started a long time ago. The miners are just finishing up what they started, because stopping would have been an undesirable option. Moreover, since iron ore mines are depleting assets, these companies really have to keep investing to some degree, to keep production levels from falling over the long term.

There's also a cost issue to consider. For example, Vale's big expansion project, known as SD11, is expected to produce some of the highest-quality and lowest-cost iron ore on the planet when it's completed. So this mine will make Vale's business run at a higher level and lower cost. A more recent example is the ramp-up of two other new mines at Vale (not SD11, which is roughly 75% complete), which helped improve the iron content in the company's ore from 63.2% in the second quarter to 63.5% in the third quarter. Better-quality product means higher prices.

Fighting fire with fire?So as you look at the iron ore market and see the major players increasing production despite low prices, you might think OPEC. However, there's a lot more to it than that. The biggest takeaways are that increasing production is meeting larger and longer-term corporate needs, and the projects now coming on line are the fruition of plans that were made when times were better. That said, pushing marginal miners to the brink isn't exactly an undesirable outcome, either.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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