EXCLUSIVE

Commodities rout exacerbated by speculative bets

Arrium director and former Rio Tinto strategy chief Doug Ritchie said the dramatic fall in commodities has been exacerbated by speculative bets placed by hedge funds, which has resulted in steeper price falls for iron ore, coal and copper than in previous mining busts.

Arrium's Doug Ritchie: "There hasn't been a huge drop in demand – in fact in some commodities it has been higher."
Arrium's Doug Ritchie: "There hasn't been a huge drop in demand – in fact in some commodities it has been higher." Photo: Glenn Hunt

Savage price slumps in some of Australia's biggest exports have created havoc for resources stocks, including mining giants BHP Billiton and Rio Tinto. Iron ore is down by a third in the last year to $US42 a tonne, thermal coal has fallen below $50 a tonne to hit levels last seen during the 2008 global financial crisis lows and the price of copper is at a six-year low.

Mr Ritchie, who held some of Rio's top executive roles before his departure in 2013, said it was likely to remain tough going for the under-pressure mining sector.

"There hasn't been a huge drop in demand – in fact in some commodities it has been higher," said Mr Ritchie. "But it is becoming so much more sophisticated in terms of the paper that is traded. I wouldn't be surprised if its ten times the amount of the physical commodities that are being traded."

Australian miners including Rio, BHP and Fortescue Metals Group are tipped to ship 868 million tonnes of iron ore this year from 767 million tonnes in 2015, while Australian coal producers exported record amounts of coal last year partly due to onerous take-or-pay haulage contracts

Hedge funds have increased their bearish position on commodities to the largest since US government data began in 2006, according to Bloomberg, with nerves over China's market turmoil unsettling investors.

"With derivatives, when sentiment is upwards its going to have the impact of pushing commodity prices higher. And when sentiment is negative it is going to have a big impact pulling prices lower," said Mr Ritchie. "Given volumes have held up pretty well, there are other reasons why copper is at $US4500, thermal coal is under $50, iron ore is at $US40. It's just not the cyclical nature of the mining industry sending prices lower, put it that way."

With Rio for 27 years

Mr Ritchie, who was appointed a director tof embattled mining and steel group Arrium last year, spent 27 years with Rio, including stints as the group's strategy executive and the head of its Australian coal operations.

He departed in early 2013 along with the mining giant's chief executive, Tom Albanese, after the stunning $US3 billion writedown of Mozambique coal developer Riversdale Mining.

Three years on, BHP has taken a $US7.2 billion ($10.4 billion) impairment on its ill-fated US onshore shale petroleum play after a 40 per cent dive in US crude oil prices in the past six months, while Australia's pure-play oil and gas companies wrote off billions of dollars on ventures in 2015.

Despite the carnage, Mr Ritchie said mining companies must continue to invest through the cycle and not be daunted by short-term price fluctuations.

With derivatives, when sentiment is upwards its going to have the impact of pushing commodity prices higher. And when sentiment is negative it is going to have a big impact pulling prices lower.

Doug Ritchie, Arrium

"If you're in the mining game, you shouldn't be picking winners," he told Fairfax Media. "The only thing you should be picking is assets that sit in the bottom half and probably the bottom quartile of the cost curve. If they are long-life and they meet that, they will survive these downturns."

Rio has placed its Hunter Valley coal assets on the block, with chief executive Sam Walsh of the view that thermal coal prices will remain depressed for at least five years.

A believer in coal

Mr Ritchie said he was still a believer in coal despite the tough times.

"To say I don't want to be in thermal coal – the only reason you should do that is if you have come to the conclusion that thermal coal won't exist in five years' time because some new technology is going to take over – or you've come to a conclusion that the cost structures in Australia are such that you don't want to be in that commodity in that geography."

In iron ore, Rio is pushing ahead with its expansion strategy to lift iron ore shipments in calendar 2016 to about 350 million tonnes. That export drive provoked Fortescue last year to accuse both Rio and BHP of predatory behaviour, by boosting production to drive down the ore price and pressure smaller rivals.

But the Brisbane-based Mr Ritchie said it was folly to suggest a miner should curtail production for the sake of lifting prices.

"If you're a miner, you can't do anything other than produce as much as you can as efficiently as you can. That's the name of the game," he said. "All these tonnes are going somewhere. If you're not going to produce it, someone else will do it in your place."

Mr Ritchie was in charge of Rio's business in China in the years leading up to his departure, and while confident in the country's economic growth story, he cautions its steel industry faces a period of adjustment.

"I think what China will do will be the same as what Japan did, in that you've got to get more economies of scale in the steel industry. There's going to have to be less state-owned enterprises that are involved; there are going to have to be some amalgamations and some real work done to make them more efficient."