BHP and RIO - Deeper Dive into Economics of End Markets
BHP and RIO are considered best in class for the mining industry. So we should have a position in these two, but they are not pure play base metal companies. And we want exposure to base metals for our energy transition thesis. So are the non-base metal end markets attractive? The largest market for both companies is Iron Ore and second is Copper for BHP and Aluminum for RIO. The demand profile for copper and other base metals is well documented and demand is expected to double in the coming decades. So we will focus on the economics of Iron Ore and Aluminum in this article.
Rio and BHP have a competitive advantage with their Iron Ore Reserves. They are the highest grade producers of Iron ore. This is important because the world is focused on decreasing emissions and High Grade iron ore is the best way to produce steel with less carbon output. 86% of the worlds high-grade iron ore is located in Australia, where the above companies are the biggest players. And Australia has current reserves of 60+ years. So BHP and RIO are high grade, low cost iron ore producers in a country with a skilled mining workforce and strategic location next to China, the largest Iron Ore consumer in the world.
The above sounds fantastic, but there are risk. China is committed to decreasing their reliance on Australian Iron ore. They have set a target of 45% iron ore self-sufficiency by 2025. The plan is to increase domestic production, foreign direct investment in Iron Ore mines and utilize more electric arc furnaces. Its very possible we could see an erosion of demand in Australian Iron Ore. This is a risk, but doesn’t mean Iron Ore demand will drop off a cliff. The companies will most likely be making great returns on these assets for years to come. They are still the lowest cost, highest quality iron ore in the market and Chinas Iron Ore output has actually dropped 20% over the last decade. So lets see what happens, but something to keep an eye on.
There are other risk such as ports getting blocked and interest rates rising. But these are a short term risk and are hard to predict. So we just want to do a macro look today since OWI would actually take advantage these short term risk when the long term economics look good.
A quick look at Aluminum shows us a little better demand outlook. Most reports are showing a 40% demand increase by 2030. Although not the lowest cost producer, RIO is a strong integrated player and could possibly have an advantage as the lowest emissions producer. They are investing heavily on energy efficiency technology and has a large hydro plant that produces relatively clean aluminum. With large companies like Apple looking for zero emission aluminum, RIO could become a leader in this.
Although BHP and RIO are not pure play base metal companies, they are cheaper on a valuation bases than Glencore or Freeport and the dividends are bigger. As discussed in previous articles these companies look attractive as investments, but we might focus on accumulating Freeport shares going forward if the markets gives us another buying opportunity. Since they are more of a pure play on base metals.
