Rio Tinto Continues Restructuring Of Coal Portfolio In Subdued Coal Pricing Environment

Rio Tinto ( RIO ) recently announced that it has reached an agreement to sell Rio Tinto Coal Mozambique, which comprises the Benga coal mine and other projects in the Tete province of Mozambique, to International Coal Ventures Private Limited (ICVL) for $50 million. (( Rio Tinto agrees sale of coal assets in Mozambique , Rio Tinto Press Release)) The transaction is subject to regulatory approvals and is expected to close in the third quarter of 2014.

The sale of these coal assets is a part of Rio's disciplined approach to capital allocation in a subdued pricing environment for coal.

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Challenges in Mozambique

The Mozambique coal assets were acquired by Rio as a part of its acquisition of Riversdale Mining Limited in 2011, for a total consideration of $4.17 billion. However, the company reported a post-tax impairment charge of $2.86 billion in 2012 due to challenges in development of infrastructure in Mozambique to support its coal assets and a downward revision of estimates of recoverable coking coal volumes. Rio recognized another impairment charge of $470 million on these assets in 2013, bringing the total impairments relating to Rio Tinto Coal Mozambique to $3.3 billion.

In addition to the challenges pertaining to infrastructure constraints, the company has also dealt with instances of civil unrest and ongoing political tensions. (( Rio Tinto's 2013 20-F , SEC)) These problems have been compounded by challenging market conditions for coal.

Coal Prices

Metallurgical coal is a major input in steelmaking. Thus, demand for metallurgical coal is indirectly influenced by the demand for steel. China is the largest consumer of metallurgical coal in the world. There has been weak demand for the commodity by the Chinese steelmaking industry, along with subdued demand from other major consumers such as Japan and the EU. Flagging demand for metallurgical coal from China in the wake of an economic slowdown earlier on in the year, put downward pressure on coal prices. According to data from China's National Bureau of Statistics, growth in investment, factory output and retail sales slowed to multi-year lows in the first two months of the year. A Chinese government crackdown on polluting steel plants has forced many of them to shut down. In addition, the tightening of credit by Chinese banks to steel mills that are not performing well has negatively impacted their prospects. Furthermore, the Chinese leadership has proposed structural reforms of the economy, shifting the emphasis from investment and export driven growth to services and consumption led growth. Such a transformation of the Chinese economy may negatively impact Chinese demand for steel in the long term. Chinese steel demand growth is expected to slow to 3% and 2.7% in 2014 and 2015, from 6.1% in 2013. Weak demand for steel has indirectly resulted in weak demand for metallurgical coal. Weak demand coupled with an oversupply situation due to expansion in production by major coal mining companies has resulted in plummeting coal prices. Prevailing metallurgical coal stand at around $120 per ton. These are way off their 2011 peak levels of $330 per ton.

Weak demand from major consumers of thermal coal, China and India, has put downward pressure on thermal coal prices. In addition, Chinese efforts to shift towards natural gas for energy generation may also affect demand going forward. A supply glut due to a increase in production by major coal mining companies has kept prices subdued. ((Coking coal prices set for modest gains, thermal still marooned, Reuters))

Restructuring the Coal Portfolio

In view of the prevailing pricing environment for coal, the sale of its Mozambique coal assets is the latest step in Rio's efforts to restructure its coal portfolio. Earlier in the year, the company announced the completion of the sale of its 50.1% interest in the Clermont Mine for $1.015 billion. In addition the company has invested capital in projects that would generate long term value. For example, along with the announcement to divest its stake in the Clermont mine, Rio Tinto also announced the completion of the $2 billion Kestrel Mine extension project in 2013. This extension will add 20 years to the life of the Kestrel coal mine. ((Rio Tinto's 2013 20-F, SEC))

The restructuring of its coal portfolio is a part of Rio's disciplined approach to capital allocation. As a part of its Q2 2014 earnings release, the company lowered its capital expenditure guidance for 2014 by $2 billion to $9 billion. The company intends to maintain capital expenditure at $8 billion for the medium term starting in 2015. This approach to disciplined capital allocation will help Rio Tinto operate competitively in a subdued commodity pricing environment.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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