Rio Tinto on China's economy, iron ore
Rio Tinto chief executive Jean-Sébastien Jacques speaks to the FT's Neil Hume about the Chinese economy and its steel industry, and the outlook for the iron ore price.
Filmed by Steve Ager. Produced by Vanessa Kortekaas. Edited by Paolo Pascual.
Rio Tinto is one of the world's biggest mining companies. It's also a huge supplier of the steel making ingredient, iron ore. That makes it perfectly placed to talk about what's happening in China. I'm joined by Jean-Sebastien Jacques who is the chief executive of Rio. Jean, you've just come back from China, I think. Can you give us your impressions about the economy, industry there? The steel industry, SOE reform?
Yes. So I've been in China twice in the last four weeks. If you ask me, am I concerned about the health of the Chinese economy, the answer is no. I'm very confident about 2017. The government is taking a lot of actions. And we shouldn't forget that they have their leadership conference in Q4, and I'm very, very, very confident that they will do whatever it takes in order to make sure that they meet their target ahead of this conference. So am I concerned about 2017? "No" is the answer.
OK. And are there any themes or real trends that are coming across? SOE reform? Environmental regulations? Is there anything there that you picked up?
Yeah, absolutely. So we had the opportunity in the last nine months to meet twice the chair, Chairman Xiao, the chairman of SASAC. He's the gentleman who is in charge of all the non-financial SOEs. So it's only 45 to 48 trillion RNB. So if you think that Rio is big, I think this guy is really big.
So we had a pretty open conversation-- and we've known these gentlemen for a long, long time-- about the SOE restructuring. There is no doubt that they are restructuring the SOEs because of environment and pollution. And I think the restructuring of the steel business is well underway, but that could be a good opportunity for us.
Let me give you the rationale. We had a firsthand experience three weeks ago, when I did visit some of our customers in Shanghai, where we could see with our own eyes where people are shutting down small blast furnaces and moving the production to larger US blast furnaces. But in order for them to maintain the level of output, what they need is better quality-- better quality of iron ore, for example. And that's where the opportunity sits for us.
And does that explain why the price has held up so well?
I think there are four key drivers in price formation of iron ore. So let me take you through those four. The first one is the health of the Chinese economy, and I said no real concern at this point in time. And we shouldn't forget that this whole discussion about five versus six versus seven is slightly simplistic. And it doesn't really matter, because even 5% of a large number remains a big demand, from that perspective, OK? So we should acknowledge the size, the scale of the Chinese economy today is very, very significant.
First driver is the Chinese economy. Am I concerned? The answer is no. The second one is the one we just discussed, which is around the restructuring of the steel business. Restructuring of the steel business doesn't mean that the output would come down-- first point. Second point is, it could mean-- and it's meaning, as we speak-- the demand for higher quality raw material, starting with iron ore. So no real issue.
The third driver is really about additional capacity that is put online by some of the majors, either in Australia or in Brazil. I believe its well documented. Everybody's expecting around 100 million tonnes of additional capacity in the coming two years. I think it's fully priced.
The fourth driver, which is a key source of uncertainty and potentially volatility in the marketplace, is domestic iron ore production in China. A few years ago, three years ago, they did produce slightly more than 400 million tonnes. At this point in time, our best estimate is around 270 million tonnes. It's still winter in China, as we are having this conversation, and it's very difficult to forecast what may happen as and when the summer months come. Are they going to restart some of this production or not? Depending on this decision, it could have an impact on the prices for iron ore.
OK, one final question from me. I mean, if the iron ore price does hold at these levels for the rest of the year, Rio Tinto is going to be generating a fantastic amount of cash. I mean, you could even end the year with a net cash position. What will you do with that money? Can we expect shareholders to receive some of that? Will you kick it back to them?
So let's be clear. The first priority for the team is to make sure that we have lots of cash on balance sheet-- the first point. The second point is, we have been very clear about our capital allocation framework. You'll remember, we did change our shareholder return last year, in January. The way we look at it is, we have a very clear view on the capital that we will have to spend in the next five years and we have given the guidance. And we did reconfirm the guidance recently- $5 billion this year, $5 and 1/2 the year after, and so on and so forth. That's one aspect. We already have a very strong gearing. We have the best balance sheet across the industry. However, we would like to slightly improve it.
And then the rest is for discussion with the board in February, next year, to shareholder return. We have committed clearly to provide superior cash return for our shareholders. And if you go back to what we did six weeks ago, we've all resolved for 2016-- it was a good illustration of it-- $3.6 billion of return to our shareholders through dividend and a share buyback.
Jean-Sebastien Jacques, thank you very much.
Thank you, Neil.