Rio Tinto And BHP Billiton: Breaking The Status Quo With Copper

Aug.23.13 | About: Rio Tinto (RIO)

The metal and mining industry is expected to face headwinds from the falling demand of metals, market uncertainty due to increased prices, and failed retention of skilled labor. However, metal and mining company Rio Tinto (RIO) is performing well despite these headwinds.

Growth from copper

Recently, Rio Tinto announced its second quarter earnings report in which its major revenue generating segment -- iron ore, registered a small growth. However, the growth from copper and coal production surpassed iron ore. The global iron ore production for Rio Tinto increased 7%, year over year, during the quarter as compared to 10% and 23% growth in copper and coal respectively.

Iron ore production at Rio Tinto only grew slightly because of unseasonably high rainfall, which led to a production outage in its major iron ore mill in Pilbara, Australia in June. Iron ore's price has fluctuated greatly in the last few years. Hence, Rio Tinto decided to capitalize on diversifying its activities by developing copper production from its Escondida mine in Chile and Oyu Tolgoi mine in Mongolia.

The Escondida mine in Chile is its biggest deposits of copper and accordingly one of its major copper producers. Rio Tinto has a 30% stake in this major mine, and BHP Billiton (BHP) is the operator. BHP Billiton and Rio Tinto are planning to capitalize on this mine with the addition of a new desalination facility. The copper production is directly related to the desalinating rate of water. The faster the rate of desalination of water, the better is the rate of copper production.

To minimize reliance on the region's underground water, BHP Billiton and Rio Tinto agreed to invest $1.97 billion and $1.03 billion respectively for a new desalination facility for the mine. This marks the first major capital approval from BHP since May 2012. It announced last year that it would delay any capital approval until June 2013 due to falling commodity prices. Copper production accounts for 17% of the total earnings of BHP and the major portion of copper production comes from the Escondida mine. This approval for the desalinating facility bounced the stock price of BHP by 13.28% on July 25, 2013 to $63.80, after a month's low of $56.32.

BHP is also expected to complete a new copper concentrator, OGP1, by the first half of 2015 to enhance its copper production from the mine. On completion, the copper concentrator is expected to produce 152,000 tons of copper per day. The new desalinating project will ensure a continuous water supply to the new copper concentrator. The desalinating project and the copper concentrator are expected to increase BHP's copper production from the mine. In its fiscal year ending in June 2013, its copper production from the mine was 1.1 million tons, which is expected to rise to 1.3 million tons per year in fiscal year 2015.

Securing a sustainable water supply in the desert region of the mine was the top priority for the Escondida mine. The construction of the new facility started in late July with a capacity of desalinating seawater at 2,500 liters per second. The facility will include development of two pipelines, four high pressure pump stations, and a high voltage infrastructure. BHP owns 57.5% stake in the mine, and BHP's revenue growth will reflect its majority stake. The growth prospects of the Escondida mine have further grown BHP's stock price to $67.54 on Aug.16, 2013, and the mine's long-term production growth is expected to continue increasing its stock price in the long run.

Additionally, Rio Tinto is betting on its Oyu Tolgoi copper mine in Mongolia. The copper shipments from this mine started on July 8 with a supply of 600 metric tons, followed by shipments of 5,800 metric tons of copper until July 23. The company started copper production in February, but only started shipments after it resolved disputes with the Mongolian government regarding royalties, management fees, and project financing. The Oyu Tolgoi mine is expected to produce around 85,000 metric tons of copper for commercial supply this year. When it reaches full capacity in the next few years, the production from this $6.2 billion mine is estimated to account for one third of Mongolia's economy.

The developments in Rio Tinto's huge copper mines, Oyu Tolgoi and Escondida, are estimated to increase Rio Tinto's revenue from copper supply at a rate of 10% over the period of 2012-2014 to $7.81 billion.

Although Oyu Tolgoi is a profitable long-term bet for Rio Tinto, recently Oyu Tolgoi's underground expansion plan faced litigation. Turquoise Hill Resources (TRQ) announced on June 28 that it entered into an agreement with Rio Tinto for a short-term loan facility of up to $225 million. Rio Tinto lent money to Turquoise Hill for conducting underground mine expansion operations. Turquoise Hill holds 66% working interest in the Oyu Tolgoi mine. On July 15, 2013, Turquoise Hill announced its second quarter production report of fiscal year 2013 for the mine. In the report, the company expects its copper production from the mine to be more than 75,000 tons per day by the end of this year compared to 70,000 tons per day in July 2013. I feel it overestimated these figures considering the litigation of Oyu Tolgoi's underground expansion operations.

The underground expansion plan is vital for the lower-grade copper production of the mine. However, the Mongolian government put the underground expansion plans on hold on July 30 because the parliament is in summer recess. Other issues regarding the clearance of underground expansion are cost overruns, employment issues, and taxation, which are not expected to be resolved quickly. Therefore, Rio Tinto suspended underground expansion work. The suspension of work resulted in Turquoise Hill's stock lowering to $4.03 on July 31, 2013 from last year's high price of $18.46.

On Aug. 15, 2013, the suspension resulted in laying off 1,700 people out of the 11,750 employed in the mine. Following the suspension announcement, Turquoise Hill expects to start lower-grade copper production from the mine in 2018, instead of the earlier estimated 2016. Turquoise Hill expects that these delays will further reduce the mine's workforce. The long-term delay in production and reducing workforce is expected to decrease its stock price for a longer term.

Coal shining like gold

To capitalize on the rising demand of coal from Japan, Korea, Taiwan, and China, Rio Tinto expanded coal production capacity of its Kestrel mine extension project. This extension is a $2 billion project located in Queensland, Australia. The Kestrel mine started in 2008, and its extension, Kestrel South, is expected to reach full coal production capacity by next year. Kestrel South is expected to add 20 years of additional life to the existing operations. This extension is forecasted to increase the mine's existing capacity by 5.7 million tons of coal production annually. Due to the increasing production from this major coal mine, the company's total coal production is estimated to increase from 51 million tons last year to 62 million tons next year.

Bottom line

Rio Tinto is betting on its production of copper and coal for long-term growth in total revenue. The company expects its total revenue to increase from $59 billion last year to $71 billion next year, growing at a rate of 9.7%. Copper production will increase from its mines, Oyu Tolgoi and Escondida. Coal production is expected to rise with the extension project at the Kestrel mine. These long-term growth aspects prompt us to have an optimistic view of the company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.