What's going on?
Despite the recent rise in commodity prices, the world’s second largest mining company, Rio Tinto, announced that it plans to cut overall costs (tweet this) and scale back long-term building projects – all with the aim of boosting the company’s profits.
What does this mean?
Rio Tinto relies on selling commodities, like iron ore and aluminum, for the majority of its revenue (and it sells a lot into China). While the company has benefitted from a large surge in commodity prices in 2016, it is still choosing to tighten its belt in the years to come. Rio plans to spend substantially less money on building and buying mines, and instead will use the savings to support payments back to shareholders (a.k.a dividends) and to directly buying its own stock (which gives the remaining shareholders a proportionally higher ownership in the company).
Why should I care?
For markets: Rio Tinto is turning itself into a leaner machine, partly to protect itself from another decline in commodity prices.
While prices for iron and coal have skyrocketed in the second half of 2016, it’s against a backdrop of a big fall between 2012 and early 2016. Rio’s announcement on Thursday suggests it doesn’t want to bet big on the rebound in commodity prices continuing. Instead, it will focus on getting more bang for its buck from its mines – increasing the efficiency of the ones it already owns rather than buying new ones (which it would do if it wanted to make a big bet on commodity prices going higher).
The bigger picture: China’s commitment to lightening its environmental footprint is one potentially important factor influencing commodity prices in the future.
China has been forcing its coal industry to cut back on its production in order to protect the environment. That has helped to push up the price of coal this year, as it has limited its supply. However, over the longer term, if China implements initiatives aimed at cutting its consumption of fossil fuels, it would mean relatively less demand for commodities over the long-term – and (eventually) will be negative for commodity prices.