Rio keen to blend mining and marketing
Pilbara Blend. Robe Valley. Yandicoogina Fines. The names may sound as if they belong on a tea caddy or in a wine cellar – but Rio Tinto investors know better. These are the labels under which the company sells Australian iron ore, the prosaic yet hugely important commodity on which its fortunes depend.
The idea of branding a commodity that is shovelled into blast furnaces to make steel may seem strange. But iron ore has many variations in mineral content and purity.
Miners such as Rio say part of their skill lies in matching ores to the right buyers. Their marketing strategies are therefore crucial to their success – more so this year, when a flood of low-cost supply from Rio and its peers helped to drive the iron ore price down by almost 50 per cent.
Now investors have another important reason to consider Rio’s marketing skills: they are central to a possible tie-up with Glencore, the rival commodities group that this year approached Rio about a potential merger.
Glencore is one of the world’s most successful and entrepreneurial trading companies, spanning commodities such as coal, copper, oil and agricultural products. Its pursuit of a combination with Rio next year may hinge on whether Ivan Glasenberg, Glencore’s chief executive, judges he can extract value from Rio’s iron ore assets – the source of almost 90 per cent of its earnings – with better marketing and trading.
The issue of whether Rio is leaving money on the table for Glencore’s traders – is one of the “critical things that people are going to make a call on”, says Paul Gait, an analyst at Bernstein Research.
Miners have been guilty in the past of neglecting opportunities beyond the mine gate. An Accenture report last year said some coal miners could do much more to improve earnings with better trading, marketing and logistics, although Rachael Bartels, managing director for mining at Accenture, says the largest iron ore miners have been better in this regard.
Some analysts are confident Glencore could squeeze savings out of a combination with Rio. When Mr Glasenberg’s overtures to Rio were revealed, analysts at UBS suggested Glencore could aim for $600m of marketing synergies – between $1 and $2 per tonne of Rio’s annual iron ore sales. HSBC said there were perhaps about $1bn in synergies: $3 per tonne of iron ore.
Looking at Glencore’s average ebitda margin on its marketing businesses, Deutsche Bank also assumed Glencore could capture close to $1bn of ebitda from selling Rio’s products. Analysts at Barclays said: “The thought of Glencore’s marketing team applying their skillset to the Rio asset base is exciting.”
Perhaps in response, Rio is becoming more assertive that its marketing efforts are achieving top value for its 300m tonnes a year of iron ore output, pointing to an ability to gain above-benchmark prices.
“Our customer relationships, our technical expertise and our market insights, none of which are easily replicable, allows for the optimal placement of product both in terms of price and volume,” said Andrew Harding, Rio’s head of iron ore, last week.
Blending output from various mines is one way Rio tries to maximise the value of its ore and prolong the life of its assets. This approach, defined by Rio as “technical marketing”, begins before digging – planning the right ore to extract and process.
“Our marketing teams work very closely with our operations, so that our resource management is fully aligned to the market,” Sam Walsh, chief executive, told investors.
Peter Mallin-Jones, research analyst at Canaccord Genuity, says: “Glencore is definitely better in some commodities and there are arguably various businesses where they could make marketing savings. But to assume that they would be better in iron ore trading, compared with one of the big incumbents that already has the relationships with the steel mills and has the technical understanding of the resources, is a stretch.”
Arnoud Balhuizen, president of marketing at BHP Billiton, says miners have been getting more sophisticated. “Understanding what the real value of iron ore quality is, and getting the customer to pay for that value, has changed markedly in the past couple of years,” he says.
According to Mr Balhuizen the “transparency drive” in iron ore trading – with spot and short-term contracts rather than an annually negotiated benchmark price – is helping miners to add value.
“Traditionally people paid one price for iron ore – now they pay a little bit more for some products. That has created enormous value for shareholders,” he says.
Glencore mines no iron ore and its marketing volumes are small relative to Rio: 30m tonnes in the first half of 2014. It emphasises relationships with smaller miners and less widely traded types of ore.
In the prospectus for its 2011 stock market flotation, Glencore detailed its marketing activities, saying it made profits by selling commodities with value-added services such as freight, insurance, financing and storage and also by taking advantage of price discrepancies around the world.
“In contrast, this is not the business model of Glencore’s mainly industrial competitors who are generally not set up to exploit the full range of value-added margin and arbitrage opportunities which exist throughout the commodity supply chain,” the document said.
Highlighting Glencore’s $230bn in annual revenues, against Rio’s $55bn, Mr Gait of Bernstein makes the point that Glencore moves such large volumes of commodities that its muscle should allow it to cut freight rates for iron ore.
As iron ore becomes more widely traded for investment purposes, rather than as a physical transaction between miner and steel mill, it may also become more important to have the kind of trading experience that is central to Glencore. Commodities groups have acquired mining assets to secure supply for their traders. Miners have generally been more reluctant to move the other way into taking trading positions.
“If I was to start a trading business I would need easily $3bn-$4bn in capital. If you have a good trading business you make 4 to 5 per cent. The margin is poor, you run big risks and you make the organisation much more complex,” says Mr Balhuizen. It would be “almost criminal”, he says, not to devote that capital to BHP’s iron ore and petroleum businesses, “which can make returns north of 20 per cent”.
For Mr Balhuizen, even apparently minor tweaks to scheduling and shipping strategies – using different vessels to take better advantage of changing tides at BHP’s Australian iron ore port – are ways for miners to improve sales and squeeze out value in an era when shareholders are loath to endorse heavy investment.
“These are examples of marketing in a miners’ context and we need to do a better job of explaining it,” he says.
Money left on the table
Anglo American is one of the large mining groups to make it clear that it intends to improve its marketing, writes James Wilson.
A $400m boost to annual earnings from marketing and trading was one of the targets set by Mark Cutifani, who took over as chief executive last year, and Peter Whitcutt, Anglo’s commercial director, is candid in saying Anglo has underachieved in marketing.
“There is money that has historically been left on the table,” he says. “That [amount of extra earnings] is not something that is generally available if you have been running a tight ship.”
So far Anglo has touted improvements at platinum – where it has ended a historic contract to supply Johnson Matthey, a refiner, at a discounted rate – and in iron ore, where Mr Whitcutt says the company is outperforming the reference price with output from its Kumba subsidiary in South Africa.
Under Anglo’s former marketing approach Minas-Rio, the company’s Brazilian iron ore operation that is coming on stream, would simply have sold its output at a “free on board” price, independent of Anglo’s other businesses. Now he says Anglo can consider shipping its output and does more to co-ordinate sales with output from Kumba.
Anglo is even being more confident than many mining rivals that it can move on to the commodity traders’ turf. Trading of third-party output “is definitely something we want to do more of”, Mr Whitcutt says.
But more trading and marketing need not imply Anglo taking more risk, he contends. Better marketing also includes Anglo being more aware of the terms and conditions of its contract with clients – something he contends reduces its risks.
Using a baseball metaphor, he says miners need to develop an urge to push hard for the extra few cents from each transaction. “This is not about home runs – it is about many, many singles. You have to get some of those on the board.”