Alan Chirgwin, VP, Iron Ore Marketing
Singapore Iron Ore Week
14 May 2015

Good morning,

First of all, I would like to thank CUSTEEL and the Singapore Exchange, supported by International Enterprise Singapore, for their organisation of this Singapore Iron Ore Forum and for giving me the opportunity to speak here today.

Second, I do want to point out the disclaimer to you and remind you that it is important in relation to today’s presentation.

It’s my pleasure to speak to you today on three main themes:

• First, I will share with you our views on the iron ore market, both short and longer term;
• Second, I will update you on our production plans and productivity focus in Western Australia; and
• Third, I will reflect on the ongoing evolution of an iron ore marketplace into one that is more transparent and more efficient, and more sustainable as a result.

In line with our expectations, the delicate and long-term rebalancing of growth is underway in China. We do also expect volatility as this transition takes place.

Following strong growth over the last decade, China apparent steel demand growth has slowed and turned negative in 2014, with the latest statistics also indicating that apparent steel demand has fallen 6 per cent year over year in Q1 CY15, due to destocking, the softening in the property sector, and a slow-down in manufacturing.

On the other hand, to stabilise the decelerating economy, we have seen the Chinese Government ease its monetary policies and issue various supportive measures for housing and manufacturing sectors, which will be supportive of steel end-user demand in the latter part of this year. For example,

• The cuts to the Required Reserve Rate (RRR) for banks and to interest rates means some easing of access to credit for steel traders and end-users, and lifted market sentiment recently.
• The Government (NDRC) has accelerated the approval of infrastructure projects to stabilise investment since this year.
• Housing sales and prices started to stabilise after the Spring Festival, and some cities (e.g. Shenzhen) saw housing prices rebound, as interest rate cuts and housing supportive policies (e.g. lower mortgage requirement and transaction tax) started to take effect. And finally, for example,
• Whilst overall housing inventories remain high, they have stabilised since beginning of the year and are anticipated to start to decline as developers continue to focus on destocking, with recovery in investment to follow and take place later this year.

More broadly, we see strong potential for increasing steel demand outside of China.

Steel production growth in other emerging economies is outpacing China – a trend that will continue in the long term. A number of those emerging economies are in Asia.

They have significant potential for growth in steel intensity per capita, although clearly the pattern of growth will vary by country.

And China steel exports are expanding accordingly and have offset the domestic demand growth moderation somewhat with annualised net exports remaining strong.

China has been a steel net exporter since 2005, and in the 2014 calendar year, China Steel exports increased strongly.

Accordingly, we see China steel exports as an ongoing significant part of China’s steel production with Chinese steel makers continuing to adapt to the demands of overseas market, maintain their cost competitiveness in the global market, and continue to actively upgrade their technologies and product mix.

Moreover, China’s “one road one belt” strategy is set to boost infrastructure investment in developing countries in Asia and Africa, which will continue to support steel exports to those regions.

If we turn to the longer term picture, whilst China’s steel production growth is moderating as the economy increasingly transits from fixed asset investment in favour of domestic consumption, it has not yet peaked.

Let me take you through some of the context around that view, based on an assessment of China’s steel stock per capita. Steel stock is basically the total amount of steel present in a country, tied up in all of its buildings, infrastructure, machines, cars etc. Developed economies, represented in the graph by the US in this instance, typically hold over 10 metric tonnes of steel stock in use per capita. China’s steel stock per capita currently represents just half of the US equivalent. This is reflected by the fact that:

• Urbanisation was 54 per cent in 2014, compared to around 90 per cent in developed countries.
• Floor space in China was 34 square metres per capita, compared to 40 to 60 square metres in the developed countries. The US is 65 square metres comparable floor space per capita.
• Car penetration in China is just 100 units per thousand persons, compared to 300 to 700 units in the developed countries. The US has 749 light duty vehicles per 1000 persons.

If we then look forward and add in our China steel forecast, we see China’s steel stock per person gradually moving towards the level of developed economies and catching up by around 2030.

As the economy is still far from being mature and given that graduating into the ranks of high-income countries is a clear priority for the Chinese population and the China Government, we believe that China will not fall into the Middle Income Trap and that the economy will keep growing at a sustainable level that implies more is required from its steel industry.

Accordingly, we forecast Chinese steel production growth to continue into the next decade and peak at around 1 to 1.1 billion tonnes in the mid-2020s and plateau through to 2030.

Also keep in mind, even if one assumes a more conservative assumption that China’s steel stocks will remain lower than in developed countries, rising steel exports will also contribute to the upside of China’s steel production.

The second part of the market outlook story is around iron ore supply. 

Over the past few years, we have seen large miners ramping up production, in Australia and Brazil, increasing approximately 40 per cent between 2010 and 2014. Some of the green-field projects initiated in the past few years are still in their ramp up phase or for those projects initiated most recently still under construction.

BHP Billiton has maintained its share of iron ore exports through a disciplined program of investment. We approved our last major investment at Western Australia Iron Ore in 2011 and since then we have focused on productivity which has delivered volume growth above beyond the original capital investment estimate by:

• Improving capacity utilisation e.g. driving more volume through existing infrastructure;
• Reducing external expenditure through lower demand, better rates and insourcing services; and
• By driving efficiencies and optimising functional support to enable people productivity.

I will speak further on this subject in the next section on our production plans.

Notably, the supply side has proven to be price sensitive.

The displacement coming from an inflow of low cost seaborne supply initially impacted the highest-cost producers, namely Chinese private mines. Back in 2011, according to China’s Shanghai Metals Markets (SMM) surveys, Chinese private mines were operating at a nearly full capacity rate of approximately 90 per cent. The displayed chart shows the nearly perfect correlation between iron ore price and China’s private mines operating rates.

The correlated trend has accelerated over the past 18 months as supply growth outweighed demand growth.

The displacement of the private Chinese mines is mostly due to economic factors, although the more stringent environment measures taken by the Chinese government also contributed to some closures.

The latest preliminary survey indicates that private mines in China are operating at around a lowly 30 per cent. Clearly, as the ratio of private mines declines in terms of total production, the ratio of production coming from SOEs increases. Although some SOEs have also shut their operations very recently, China’s volume of production will become stickier in the future and therefore we are approaching a more stable long term level of Chinese production.

The inflow of low cost seaborne supply, has, as mentioned previously, primarily impacted Chinese private mines.

However, as the iron price declined throughout 2014, exports from so-called non-mainstream countries also reduced across the board, but primarily from Indonesia, Malaysia, Mexico and the CIS. According to official customs data, combined exports from Southeast Asia, Mexico and the CIS dropped by approximately 30Mt in 2014 versus 2013 (160Mt vs 190Mt). Main reason was economics but also due to the fact that mills increasingly preferred to buy ore of higher quality that is not offered by all seaborne exporters.

Further, in the last part of 2014 and in 2015 year to date, we have seen high cost producers in West Africa, Canada, Northern Europe and even Brazil and Australia forced to reduce or suspend production due to not being economically viable at prices that are trending towards a more sustainable level long-term.

For example, in 2014 we estimate that approximately 40Mt of production from Australia, Brazil, Canada, Northern Europe and West Africa exited the market. In Q1 2015, we estimate that there has been a further tonnage reduction of approximately 15Mt to date.

Finally, whilst many of the smaller miners have also been able to respond to the lower price environment by cutting costs over the past six months or so, it’s reasonable to assume that the low hanging fruit has been collected and that cost deflation benefits arising from lower freight, oil and a stronger US$ are now fully priced in. At the end, shareholding structure, balance sheet strength, cost competitiveness and quality will be key to the long term sustainability of their ongoing iron ore supply.   

Looking forward, the year 2014 marks a key turning point for the iron ore market. Whilst China’s demand for iron ore will continue to grow, albeit at more moderate rates, driven by urbanisation and industrialisation, it is estimated that supply growth will outpace demand growth over the next few years.

In doing so, the additional, lower cost, seaborne production will displace higher cost supply and result in the lowering and flattening of the cost curve, as we have been witnessing since 2014.

This is where our competitive advantage comes to the fore as we retain a favourable cost position, underpinned by the quality of our resource base and the success of our productivity agenda, which I will speak more to now

Since 2007, BHP Billiton has increased its production by approximately 2.5 times and our production guidance for FY15 is 250Mt vs 225Mt in FY14. Beyond this, we estimate that production of 270Mt can be achieved without the need for additional fixed plant investment.

We anticipated supply growth would exceed demand growth, and have stated this on numerous occasions, over the past number of years, including at this Forum on each occasion.

The last time the BHP Billiton Board approved major capital was in March 2011 when US$7.4 billion was approved to deliver capacity in excess of 220Mtpa, on a 100 per cent basis. This project included development of the then new Jimblebar mine (initial capacity of 35Mtpa) and rail links, two new berths in the Port Hedland inner harbour and port blending facilities and rail yards.

Since then we made the very significant decision in 2012 to defer the proposed Outer Harbour development (removing 110Mtpa); subsequently another decision was made to defer development of a further two additional berths (removing approximately 70Mtpa) and earlier his year we announced deferment of the Inner Harbour debottlenecking project that would have delivered a further 20Mtpa of throughput capacity at a low capital cost.  

It was as a direct result of the view of global market conditions that, since 2012, BHP Billiton has focussed only on safely and sustainably growing production while reducing costs through optimising existing infrastructure. Improved productivity has resulted in the unit cost of production falling by 29 per cent from US$28.80/wmt in the half-year ended 31 December 2013 to US$20.35/wmt in the half year ended 31 December 2014. Today, unit costs are below US$20/t and we expect for FY16 unit costs of US$16/t.

In summary, what we are doing is continuing to work productivity hard and that allows us to get more through the existing infrastructure that we manage, but without some of the investments that we’ve now postponed at the Port Hedland Inner Harbour, it means we’re going to get to a system capacity beyond 270Mtpa probably less expensively, but also at a slower rate beyond the end of FY17.

In the changing environment, we obviously cooperate closely with our customers on their changing iron ore supply requirements. And as growth rates moderate and the emphasis shifts to productivity and quality, our partnership with China and our customers becomes more critical.

Accordingly, over the past year our Chinese customers have increasingly favoured iron ores of high quality with low variability and which come with a high confidence of reliable supply.

There are two key drivers for this behaviour

China is following the global trend towards larger blast furnaces:

• Currently, less than 20 per cent of China’s BFs have a capacity exceeding 3,000 cubic meters. It compares to about 80 per cent in Japan. As furnaces grow bigger, they also require a stable burden and consistency in raw materials quality to fully maximise the benefits of the larger size. Further, higher quality materials also increase the life of assets, increasing the return on the capital invested.

High quality raw materials lower emissions:

• In line with more stringent environmental regulations, higher quality materials will contribute to lower emissions. Low gangue level reduces fuel rates and sulphur emissions. Low levels of trace elements minimise waste and hazardous emissions.

Therefore, our support of our China customers will become ever more critical as our products offer the quality and the reliability so critically required by the large, modern furnaces that will come to dominate a China steel industry so focused on productivity.     

An excellent example of BHP Billiton’s high performance ore products is our Newman Blend Lump (NBLL).

• With the increasing focus on the environment in China, NBLL is an obvious choice to reduce SOX emissions
• Unlike iron ore fines and or concentrate that must be sintered or pelletized prior to use in the blast furnace, Newman Blended lump can be charged directly to the blast furnace without any further processing
• This not only avoids capital and operating costs associated with sintering and pelletizing, but also reduces SOX and other emissions such as dioxin, NOX and heavy metals
• Furthermore, overtime the costs associated with the removal of these will increase as legislation forces mills to move up the environmental maturity curve, thereby requiring removal of ever more pollutants from the waste gas with the associated increase in complexity and  processing costs

Hence, we see BHP Billiton’s NBLL as the direct charge choice of the future:

NBLL Unique Selling Proposition:

• NBLL is the highest Iron content Lump from the Pilbara which increase furnace productivity and reduces hot metal production cost
• With Low gangue and high reducibility which decreases Blast Furnace fuel rate

The changes faced by the industry are not only related to supply and demand. Over the past few years we have seen the emergence and successful development of physical transaction platforms as part of the evolution of the iron ore market. 

Such an evolution only comes about when key stakeholders are regularly and openly engaging on the industry challenges and opportunities, with a view to finding sustainable, mutually beneficial solutions; and the introduction of the physical transaction platforms in China and Singapore with Joint venture ownership by steel mills, traders and producers are a tremendous example of that

The Platforms have been widely accepted by the industry as an alternative, transparent and efficient channel to buy and sell spot iron ore.  As a result, the overall platform spot transaction volume has jumped by 424 per cent to approximately 62Mt in CY14 compared to less than 15Mt in CY12.

Moreover, more steel mills, mining companies and trading companies are joining platform as active participants.  The registered membership for globalORE and COREX, as an example, has increased by 58 per cent and 38 per cent respectively from the end of CY12 to end of CY14.

In addition to enabling greater spot liquidity and therefore transparency, platform transactions can also greatly boost productivity, by reducing time and effort to source and negotiate spot cargoes and minimize administrative work related to contract management. 

A spot purchase via physical transaction platform can be completed in seconds with pre-matched counter-parties. Moreover, there is no need to sign additional contracts for every spot deal concluded through platform with the same supplier, as the bilateral agreement on standard terms is signed only once.

This compares to the traditional way of spot iron ore purchase where it may take 2-7 working days to finalize one spot transaction. Clearly, this offers a very efficient way to access and to take advantage of the spot market.

The Platforms such as GlobalOre and CBMX have enabled substantially greater transparency in the spot market and, in turn, more robust and reliable indices, as is evident in this graph.  

And the trend is encouraging…. For Q1 CY15, platform trades accounted for around 59 per cent of all reported spot trades, compared to around 49 per cent for CY14.

We continue to sell around 15 per cent to 20 per cent of our total sales of iron ore on a spot basis so as to contribute to a liquid and transparent spot market, and to report spot iron ore transaction information to Price Reporting Agencies so as to enable reliable price index formation.

We see this is a responsibility of ALL participants in the industry.

Summary:

• China is facing short term headwinds but we remain positive in terms of long term upside potential
• Low cost seaborne supply entering the market is not only displacing high cost Chinese production but also high cost seaborne supply. While volatility is likely to persist in the short term, it will recede as the cost curve continues to flatten
• Our resource position is a distinct competitive advantage, enabling sustained delivery of a high quality product, at low cost, from our existing mining hubs over the long term
• Our productivity agenda continues through capacity utilisation, driving more volume through existing infrastructure; reducing external expenditure; and driving efficiencies and optimising functional support to drive people productivity; and
• BHP Billiton remains strongly committed to initiatives aiming at making the market more transparent, liquid and efficient.

For more information, view the Presentation.