Outlook for metals and minerals - Investor seminar

    LONDON, UK, Nov. 26 /PRNewswire-FirstCall/ - The following paper from
 Rio Tinto chief economist Vivek Tulpule has been issued today to coincide
 with the Rio Tinto Investor seminar.
 
 

     Executive summary
 
     - Commodity markets are entering a fifth straight year of growth with
       mineral and metal prices at levels well above their long term average
       and in many cases above levels at the start of this year.
     - Firm global economic activity led by China is expected to support
       strong increases in demand for most metals and minerals over 2008 and
       2009.
     - With low stocks and a likely continuation of supply side difficulties,
       most commodity prices are expected to remain well above their long run
       trend over the short and medium term.
     - It is too early to suggest that the current price cycle has peaked
       across the range of commodities.
     - While the central case is positive, we are mindful of the short term
       risks associated with the predicted slowdown in the US economy.
         - But, it is important to recognise that the United States is now
           significantly less important in world commodity demand than it was
           just five years ago.
         - Additionally our analysis suggests that even a sharp slowing in the
           US economy would have only a small impact on Chinese and Indian
           economic growth and consequent demand for commodities.
     - Viewed from a longer run perspective recent history and the IMF's
       forecasts suggest that we are currently going through a period of
       global growth not seen since the period of fast growth and
       reconstruction in OECD economies following World War 2.
     - Specifically, there has been a structural shift favouring rapid growth
       in developing countries with large populations such as China and India.
       Growth in these economies will be resource intensive as they
       industrialise and urbanise.
     - The implications for commodity markets are nothing short of profound.
       Projections for iron ore, aluminium and copper suggest that demand
       could double and even triple over the next 25 years.
     - In time production can be expected to expand to meet faster growth in
       demand at more sustainable prices. But that pricing environment is
       expected to be significantly stronger than would be implied by
       historical trends.
         - It is expected that prices of many minerals and metals will remain
           elevated above trend for longer than has been the case in the past
           because of constraints on the speed with which production capacity
           can be expanded over the next few years.
         - Also most prices are expected to assume significantly higher
           average levels over the very long run than has been the case
           historically due to structural increases in industry costs.
     - We present case studies relating to markets for aluminium, copper and
       iron ore - three commodities that are expected to be drivers of the
       industrialisation and urbanisation process in developing countries.
 
      Iron ore
 
     - Substantial growth is expected in the demand for iron ore reflecting
       expected strong growth in steel demand related to the processes of
       ongoing industrialisation and urbanisation in the developing world.
     - Reflecting the current tight market spot prices have risen sharply over
       the last few months with Indian ores currently selling in China at
       around $190/tonne double their price at the beginning of 2007.
       Australian and Brazilian ores are selling at a substantial discount to
       this spot rate given current freight rates.
     - A substantial amount of high cost production will be required to meet
       growing demand over the long term. This strongly suggests the
       possibility of higher long run prices & higher margins for traditional
       lower cost producers.
 
      Aluminium
 
     - Prices are currently in the range of $2450-2550/t - levels supported by
       industry cost structures.
     - Aluminium consumption has grown the fastest of all non-ferrous metals
       over the last 5 years and is forecast to grow rapidly over the next
       20 years.
     - There has been enormous recent growth in Chinese consumption and
       production but aluminium has benefited from increasing intensity in
       many other regions including the OECD.
     - Constraints on China's domestic bauxite production suggest that the
       country's massive investment in aluminium capacity will remain reliant
       on imported bauxite. This combined with China's high power cost
       environment mean that Chinese aluminium capacity will continue to be
       high cost on a global scale.
     - Additionally, Chinese production will also be disadvantaged by a
       stronger currency as the RMB edges toward fair value over time.
     - The implied increase in the marginal cost of production for alumina and
       aluminium means that their prices are unlikely to revert to the lower
       levels implied by historical trends
 
      Copper
     - Reflecting the tight market situation, copper prices are currently in
       the range of $6400/t-$7000/t - about three times higher than their
       average level through the 1990s and well above levels achieved in the
       early part of this decade.
     - Prices could remain near current levels as long as production growth
       continues to under-perform against the underlying demand trend creating
       a need to ration supplies.
     - Strong Chinese demand growth is expected next year and on the supply
       side the likelihood of ongoing disruptions and possible constraints on
       the availability of sulphuric acid affecting SxEw operations are
       issues.
     - The importance of investment funds in exchange traded commodity markets
       means that large price movements could take place on the back of
       commodity specific speculative shifts or broader shifts in investor
       sentiment - well in advance of any fundamental change in physical
       markets.
     - Looking to the long run, strong demand growth prospects are based on
       the expected resource intensive development of economies such as China
       and associated investment in power distribution networks and other
       infrastructure.
     - On balance, we believe that, as for many other commodities, there has
       been a structural shift in copper costs supporting the expectation of
       significantly higher long run prices than would be implied by
       historical trends.
 
     A fundamental shift toward fast and resource intensive growth
     As 2007 draws to a close, resource markets are entering a fifth
 straight year of cyclical strength with virtually all minerals and metals
 prices at levels significantly above their long run historical trends and
 in many cases above start of year levels.
 
     Looking forward, global GDP growth is expected to be firm in 2008 and
 2009 with rapid growth in China and other developing countries expected to
 reduce any drag from slower growth in OECD countries. Such conditions
 should create a basis for continued strong underlying commodity demand over
 the medium term. At the same time, growth in production for a number of
 commodities is expected to remain relatively constrained. In this context,
 it is entirely possible that some commodity prices may not have reached
 their cyclical peaks as yet.
 
     Indeed, illustrating the significance of current commodity market
 developments in a historical context, if as expected, most prices remain
 well above trend over 2008 and 2009 then prices will have been above trend
 for 6 years. This would be a 3-in-100 year event for many commodities.
 
     Viewed in a broader setting, the current strength in most resource
 markets can be seen as the result of a fundamental shift in economic forces
 that is leading to rapid growth in developing economies with large
 populations. For example, recent history and the International Monetary
 Fund's projections for future growth would suggest that we are currently
 going through a period of global growth not seen since the period of rapid
 economic development and reconstruction that followed the Second World War.
 
     China and India provide the most significant recent examples of the
 current growth phenomenon but they are not alone. For instance, many
 countries in the Middle East and ASEAN are also on fast growth paths. In
 such economies growth tends to be resource intensive. In particular, the
 processes of urbanization and infrastructure development that accompany
 early-mid stage productivity growth and industrial development require
 increasing utilisation of resources such as steel (and therefore raw
 materials such as iron ore), aluminium, copper and energy. At a global
 level such a resource intensive development pattern is expected to persist
 for at least another two decades leading to sustained strong global demand
 growth for many commodities.
 
     Prices are determined by both demand and supply and by its nature
 minerals and metals production can be difficult to accelerate. But
 accelerating production in cyclically high markets can also be very
 profitable causing a 'rush' to meet demand. The current 'rush' has
 manifested itself in a number of forms including: increasing construction
 costs and project delays; higher levels of disruption as existing
 production systems are stretched; higher average production costs due to
 labour and other input cost increases; and higher industry marginal costs
 as increasingly expensive production is drawn in to meet demand.
 
     In time, it is expected that sufficient commodity supply growth will be
 induced to cause prices to revert down toward more sustainable long-run
 levels. But the demand and supply phenomena just described suggest that it
 will most likely take longer for commodity prices to return to long-run
 levels than would have been the case if historical reversion rates had
 applied. At the same time long-run prices and in some instances margins are
 expected to be significantly higher than would be implied by historical
 trends.
 
     Medium term expectations are for strong global GDP growth
 
     Against a backdrop of record high oil prices, a rapidly slowing US
 housing market and a credit crunch precipitated by the US sub-prime
 mortgage crisis, the IMF is nevertheless projecting global GDP growth in
 2008 of about 4.8 per cent (in PPP terms)(1). This projection accounts for
 slowing growth in advanced economies but relatively fast growth in the
 developing world. In 2009 a recovery in activity in advanced economies and
 continued strong growth in developing economies are projected to generate
 global growth of around 5 per cent(1). Viewed in a historical context such
 growth rates are high and therefore provide a positive setting for
 underlying commodity demand in the medium term.
 
     China's GDP has continued to surge, growing at 11.5 per cent (y-o-y) in
 the first three quarters of 2007. In this period industrial production grew
 by about 18 per cent, nominal fixed asset investment grew by about 26 per
 cent and the trade surplus soared to about US$200bn. At the same time
 inflationary pressures, mainly related to food and energy prices, have been
 increasing with consumer and producer price inflation in October at 6.5 per
 cent and 3.2 per cent respectively. In this setting the government has
 introduced measures to restrain liquidity. But even with this tightening,
 GDP is expected to grow rapidly at between 10 per cent and 11 per cent in
 2008 and around 10 per cent in 2009 based on strong domestic demand and a
 strong but moderating contribution from net trade(2).
 
     The US economy is expected to grow at around 2 per cent in 2008 as
 residential construction continues to fall and private consumption growth
 slows. On the other hand, a weaker dollar is expected to generate an
 improved contribution to GDP from trade. In 2009 residential construction
 is expected to start growing again and the positive effects of recently
 lowered interest rates on investment and disposable incomes should lead to
 a recovery in economic activity; GDP growth in the range of 2.5 per cent to
 3 per cent is expected in that year(3).
 
     Japan's growth has been volatile during 2007. It grew strongly by 0.7
 per cent (q-o-q) during Q1, declined by 0.4 per cent in Q2 and then beat
 analysts' expectations to grow by 0.6 per cent in Q3(4). The contraction in
 Q2 was partly attributable to reduced residential construction resulting
 from the implementation of a stricter building code. In 2008 and 2009
 steady growth in consumer demand and a rebound in residential construction
 are expected to offset slower net exports to see overall GDP grow at around
 2 per cent(5).
 
     The Indian economy grew by more than 9 per cent in each of the first
 two quarters of 2007 and growth of between 8 per cent and 9 per cent is
 expected in 2008 and 2009(6). Capacity constraints in many parts of the
 economy are creating inflationary pressures and in response the Central
 Bank has tightened monetary policy. While this reduced inflation it
 probably also contributed to reduced industrial production growth during
 the second half of this year.
 
     Expected limited global economic risk from a further US slowdown
 
     ----------------------------------------------------------------
 
     Markets have been nervous about the impact of slowing US growth on
 commodity markets and speculation about this has had negative effects on
 exchange traded prices. But in terms of commodity demand generally, the
 importance of the United States has declined substantially relative to that
 of China since 2000 and in the specific case of seaborne iron ore, the US
 is a negligible market participant. In that context, the key issue for the
 health of commodity markets over the medium term is the magnitude of any
 negative spillover effect from a slowing US economy on economic activity in
 the rest of the world and China in particular.
 
     One macroeconomic linkage is clear. With slower US private consumption
 and a weaker currency, US demand for exports from other regions can be
 expected to decline and its own exports to increase. In terms of GDP
 accounting, this would reduce the net contribution of the United States to
 aggregate demand in the rest of the world. But it is easy to exaggerate the
 potential flow on effects of this possibility on global economic activity
 including in Asia.
 
     For example, modelling suggests that a sharp reduction in US
 consumption and residential investment during 2008 to levels consistent
 with a US recession and a weaker US exchange rate would be expected to
 reduce Chinese growth by less than a percentage point. This would still
 leave scope for Chinese growth at levels approaching 10 per cent. For
 India, the impact of any further slowdown in the US would be expected to be
 smaller because of India's more limited exposure to world trade.
 
     The modelling captures the likelihood that, governments and central
 banks in countries affected by any US slow down could boost economic
 activity through monetary and fiscal responses. Some commentators have
 noted that such economic pump priming would favour construction and
 infrastructure development, which in turn is likely to be a positive for
 commodity demand.
 
     Moreover shifts in trade flows and policy responses are only part of
 the picture. A focus on these aspects alone ignores any shift in financial
 flows favouring countries with better investment prospects. For example
 modeling based on a framework that focuses on international financial
 dynamics suggests that the flow on effects of any slowing in US growth
 could be reduced substantially as financial resources shift away from the
 United States toward other locations including developing Asia.
 
     Some commodity specific examples further illustrate the point. Chinese
 consumption of steel is believed to be affected only marginally by
 fluctuations in external demand as China's steel industry is overwhelmingly
 focused on meeting needs from the domestic construction sector.
 
     Even in the case of copper, consumption is mostly driven by domestic
 construction and infrastructure development which together account for the
 majority of China's copper consumption. Exposure to external conditions
 arises from China's position as a major global supplier of household
 appliances containing copper components. China has also grown its exports
 of semi-fabricated products and copper tubes in recent years, although it
 remains a net importer of semis.
 
     It is difficult to put a precise figure on the amount of copper
 embodied in Chinese trade to the United States. But even if 20 per cent of
 total Chinese copper consumption were related to exports and given that the
 United States generally accounts for around 20 per cent of China's total
 merchandise exports, the direct exposure of China's total copper demand
 growth to any slowing in US economic activity would be very limited.
 
     Currencies
 
     Since the start of this year the US dollar has weakened appreciably
 against most other currencies. Recent falls in the greenback have been
 driven by perceptions of increased riskiness in US asset returns in the
 wake of the sub-prime mortgage crisis; and expectations that the US Federal
 Reserve may cut interest rates to address growth concerns while other
 central banks may raise rates to combat inflationary pressures.
 
     The currencies of many commodity exporting countries have also been
 affected by upgrades to market expectations about future commodity prices
 and M&A activity. The Australian dollar has gained about 13 per cent
 against the US dollar since the start of the year. The Chilean Peso has
 gained about 5 per cent, the Brazilian Real has gained about 16 per cent
 and the Canadian dollar has appreciated by about 19 per cent(7). Such
 exchange rate shifts have increased average US dollar production costs for
 many commodities. But at the same time, US dollar weakness provides support
 to prices of commodities that are denominated in US dollars but with large
 non-US consumption and cost bases.
 
     Over time, market based exchange rates are likely to fluctuate on
 ever-shifting speculation about relative interest rate policies and ongoing
 concerns about risk and structural imbalances and commodity prices in the
 case of large commodity exporters. In the case of managed currencies,
 policy and economic pressures on governments or the emergence of
 unsustainable foreign exchange flows will have the greatest influence on
 outcomes. Future rates of appreciation in the Chinese RMB are of special
 importance for commodity markets.
 
 

     Chinese RMB expected to continue to strengthen providing a basis for
     --------------------------------------------------------------------
     higher long run prices
     ----------------------
     A range of empirical analyses and the evidence of burgeoning trade
 surpluses and foreign exchange reserves suggest that the RMB is
 significantly undervalued. The extent of possible undervaluation is shown
 in the following chart based on research commissioned by Rio Tinto. The
 straight line labeled 'Fair Value' shows a statistically determined
 relationship between real exchange rates and per capita incomes. This
 empirical analysis backs the theoretical argument (known as the Balassa
 Samuelson effect) that as developing countries become richer their real
 exchange rates can be expected to strengthen relative to those of the
 richest countries. The Chinese real exchange rate has been and remains
 below the estimated fair value line suggesting substantial scope for
 ongoing revaluation.
 
     The Chinese authorities have progressively allowed the currency to
 appreciate in nominal terms against the US dollar. Pressure on the RMB to
 strengthen further is expected to continue, both to address political
 frictions associated with the trade surplus and constraints on monetary
 policy associated with a managed currency.
 
     Importantly this process of revaluation has been increasing the US
 dollar costs incurred by trade exposed industries including metals and
 minerals producers. In aluminium and iron ore Chinese producers are already
 among the highest cost producers in the industry and therefore any currency
 appreciation would tend to increase marginal industry costs for those
 commodities over time. In turn, this cost increase provides a basis for
 higher global prices.
 
 

     Long run economic developments and implications for commodity markets
 
     Long Run Growth and Development Entering a New Elevated Phase
     -------------------------------------------------------------
     It is important to reiterate that the IMF's growth projections for 2008
 and 2009 are high when viewed in a historical context. This results from an
 expected structural shift (rather than cyclical move) in global economic
 activity based on the ongoing economic emergence of China and other
 developing economies such as India. Indeed, the expected shift would take
 world growth to levels not seen since the period of rapid growth and
 reconstruction in OECD countries just after the Second World War. The
 longer term implications of this shift for commodity markets are
 potentially profound.
 
     Our revised analysis of longer run Chinese growth prospects suggests
 that GDP growth can be expected to average levels approaching 9 per cent
 per annum in the period to 2015 providing a sustained basis for strong
 commodity demand growth. In a similar vein, a recent study carried out by
 the Development Research Centre under China's State Council concluded that
 China's industrialization stage will last into the 2020's with potential
 GDP growth rate at around 10 per cent in the period to 2015 and 8 per cent
 from 2015 to 2020. A study by Australian National University academics,
 Garnaut and Song, suggests that China is reaching a 'turning point' in its
 growth creating potential for highly resource intensive growth in excess of
 10 per cent over the next two decades.
 
     Indian growth has lagged behind China's despite both countries having
 had similar per capita incomes in 1980. In more recent years Indian growth
 has accelerated and importantly it has become less variable. Studies by Rio
 Tinto suggest that India has the potential to grow at a sustained rate of
 around 10 per cent for at least a decade if key economic reforms are
 undertaken. Studies by banking research groups produce similar results with
 long run growth potential estimated to be in the 8 per cent-10 per cent
 range(8). Most of this research points out that continued reforms that free
 up the ability of Indian industry to respond to price signals remain
 crucial both to allow more rapid allocation of resources to their most
 profitable uses and reduce inflationary risks. In India's case it is
 arguable that the turning point favouring highly resource intensive growth,
 identified for China by Garnaut and Song, is still to be reached.
 
     Commodity demand expected to grow strongly
 
     ------------------------------------------
 
     The shift toward faster and more resource intensive global growth led
 by developing countries has led to strong rises in commodity demand over
 recent years. But per capita consumption remains relatively low in those
 countries suggesting scope for strong growth well into the future. For
 example, while China accounted for 60-90 per cent of the increase in global
 demand for steel, aluminium and copper between 2000 and 2006 its per capita
 consumption of those metals remains well below that of many OECD
 countries(9). For example in 2006 Chinese per capita steel consumption was
 about 60 per cent of that in the OECD average while its per capita copper
 and aluminium consumption was at around one-third of OECD levels. The
 implication is that Chinese demand for these commodities - and associated
 raw material inputs - has substantial scope to continue to grow rapidly for
 some time. Indian per capita consumption is a fraction even of China's
 consumption, suggesting scope for rapid sustained demand growth over the
 longer run.
 
     Empirical analysis based on historical patterns of commodity
 consumption and differences in commodity consumption between countries
 shows a relationship between per capita incomes and commodity consumption -
 typically known as 'commodity S-curves'. The S-curves suggest that as
 incomes grow per capita consumption of commodities increases. At first
 growth is more rapid as economies industrialise, build urban environments
 and commercial infrastructure and then growth slows for rich countries as
 consumption per head approaches saturation. Such S-curves are shown for a
 range of commodities in the graph below.
 
     The analysis shows that per capita consumption of aluminium, copper and
 steel making raw materials tend to pick up at a relatively early stage of
 industrial development. For aluminium the empirical analysis also suggests
 that demand in developed countries has not yet achieved saturation implying
 scope for more broadly based future per capita global consumption growth.
 For commodities such as iron ore and coking coal it is important to
 recognise that the S curves are for total consumption and not for
 consumption of seaborne material. So, for countries in which domestic
 production of raw materials is constrained, growth prospects for imports of
 seaborne materials may be greater than for demand in aggregate.
 
     The chart shows that the largest proportion of the world's population
 has low average per capita rates of commodity consumption consistent with
 relatively low incomes. As per capita incomes grow larger numbers of people
 will consume increasing commodity volumes and aggregate global consumption
 of commodities can be expected to rise at a fast rate. For example, based
 on the S-curve analysis and assuming a plausible positive scenario for
 global growth over the next 2 to 3 decades, the seaborne iron ore market
 could triple in size relative to today's level.
 
     Of course the analysis does not suggest that demand will increase at a
 steady rate over time. Macroeconomic cyclicality along with stocking and
 destocking patterns can be expected to play major roles in determining
 demand outcomes for different commodities in any given year. For example,
 in China's case with virtually all sectors of the economy growing rapidly,
 there is a chance that developments in some parts of the economy could move
 out of phase with developments in other parts. This suggests a possibility
 that at times economic imbalances could emerge, generating cycles of strong
 growth and capacity building followed by periods of slower growth, catch up
 and consolidation. The implication is that Chinese growth and associated
 commodity demand growth can be expected to have a cyclical pattern over
 time.
 
     Supplies are stretched and capacity expansions have been delayed
 
     ----------------------------------------------------------------
 
     The supply side of the mining industry continues to face challenges in
 its response to fast demand growth. These challenges have been exacerbated
 by a prolonged period of underinvestment throughout the sector due to slow
 demand and low prices during the 1990's and into the early 2000's. As a
 result, the industry entered the current cycle with reduced capabilities at
 all stages of project development, from exploration through to construction
 and operations. In this setting, the industry has become increasingly
 stretched in its attempt to meet stronger demand and in many cases there is
 little slack in the system to compensate for disruptions such as those
 related to events of nature and downtime for maintenance.
 
     There are few signs that constraints faced by the supply side are
 easing in the short term - as indicated for example by shipping freight
 rates which have reached new record levels in recent months. Operating and
 capital costs have continued to rise in 2007 and supply has once again
 underperformed significantly especially in the copper market.
 
     Some of the supply challenges are medium term in nature. These are
 typically related to: increased demand for materials and equipment, leading
 to higher input costs and longer lead times; and bottlenecks in supporting
 infrastructure (ports, rail and shipping).
 
     Other constraints will take much longer to address. First, the industry
 is moving increasingly toward the development of resources that in the past
 were either considered to be too complex or low-grade or in regions with
 high country risks and poor infrastructure. This is presenting challenges
 to mining companies not only because new skills and technologies are
 required to develop those resources, but also because of the increased
 capital intensity and delivery risks associated with many such projects.
 Second, the industry and its suppliers and contractors are facing acute
 shortages in the labour market - especially in relation to skilled
 professionals such as experienced mining engineers with project management
 experience - leading to increased project costs and delays.
 
     Importantly the mining industry is not alone in the struggle to access
 material and human resources. The upstream and downstream oil sector as
 well as the chemical industry have also stepped up their capital spending
 plans in recent years and are competing for similar parts and equipment,
 construction workers and the services of EPCM contractors. The competitive
 environment for such inputs has led to capital cost escalation for mining
 projects and longer lead times to deliver new capacity. As a result, the
 commodity prices required to induce development of future resources are
 likely to face upward pressure.
 
     Natural resources constraints facing the mining industry extend to its
 access to supporting resources such as energy and water. In this context,
 environmental considerations in the development of new projects present a
 key set of long-term resource related challenges. Additionally, it is
 becoming apparent that regulatory approvals are becoming an increasingly
 significant barrier to rapid supply expansion. Such constraints are likely
 to persist and perhaps become more significant over the longer term.
 
     Commodity case studies
 
     We present case studies relating to markets for aluminium, copper and
 iron ore - three commodities that are expected to be drivers of the
 industrialisation and urbanisation process in developing countries.
 
     Iron ore
 
     --------
 
     Current pressures in the iron ore market are intense as reflected by
 spot prices, which have increased sharply over the last several months.
 Spot Indian ores are currently selling in China at now at around
 $190/tonne, double their price at the start of the year. After taking into
 account current freight rates, Australian fine ores sold at benchmark
 prices (of around $50/tonne) trade at a substantial discount to these spot
 prices. Brazilian ores, which have significantly higher transportation
 costs to the growing Asian market, sell at a lower but still significant
 discount(10).
 
     On the demand side, steel production has grown rapidly leading to
 strong growth in iron ore trade. Chinese crude steel production has
 continued to rise by over 18 per cent y-o-y despite the levying of export
 taxes(11). While these taxes and the weaker US economy have discouraged
 exports, this has been more than offset by renewed strength in domestic
 demand. Evidence of this is suggested by domestic Chinese steel prices
 which reached a new high in mid-October.
 
     Strong demand for iron ore is not limited to China, however. Annual
 Japanese crude steel output this year is expected to hit a new record level
 for the first time in 33 years and the German Steel Federation has recently
 raised its forecast of domestic steel production for this year. While North
 American steel producers have cut back output this has little impact on the
 seaborne iron ore market as nearly all domestic production relies on either
 domestic ores or scrap.
 
     Increases in demand for iron ore have continued to outpace the ability
 of low cost producers to add additional supply. Over the first three
 quarters of the year Chinese iron ore imports rose by 15 per cent(12) -
 less than the rise in steel production This means that in high-grade
 equivalent terms the amount of Chinese iron ore production required to meet
 domestic demand is expected to be around 350 million tonnes this year. Much
 of this is produced at a relatively high cost. Chinese costs (in US dollar
 terms) have also been affected by a strengthening RMB and this pressure is
 expected to persist while the RMB remains undervalued. At the same time, as
 well as having to mine lower grade ores, there is an increasing reliance on
 new more remote and therefore more expensive supply from the far north
 eastern parts of China. Costs of Indian ores have also increased due to new
 taxes and a progressively strengthening rupee. There has only been limited
 progress on the major infrastructure investments required in India to make
 its exports more competitive and at the same time exports compete against
 strongly rising domestic demand for ores. Most importantly the escalation
 in freight rates has substantially increased the cost of landing ore in
 Asian markets from all destinations. The overall implication is that
 current high prices have, in all probability, been supported by a rising
 and steepening industry marginal cost structure.
 
     Over the longer run, continued strong growth in demand for steel in
 developing countries and developed parts of the Middle East is expected to
 result in substantial growth in seaborne iron ore trade over the next two
 decades. Given the large volumes of high cost production currently in
 operation and expectations for continued demand growth, any reversion of
 prices to lower long run levels can be expected to take place over an
 extended period. Additionally it is expected that a substantial amount of
 high cost production from China and India will continue to be required to
 meet growing demand over the long term. This strongly suggests the
 possibility of higher long run prices and margins for the traditional lower
 cost producers.
 
     Aluminium
 
     ----------
 
     Spot aluminium prices have moderated by about 10 per cent since the
 middle of 2007 and are currently moving in the range of
 $2450/t-$2550/t(13). Prices at around these levels are supported by
 production costs at the highest cost smelters. Forward prices have
 increased in relation to spot prices reflecting a market expectation that
 production with high marginal costs could be required to meet demand for
 primary metal over the medium term.
 
     Aluminium has experienced the fastest consumption growth of all
 non-ferrous metals over the past five years and it is forecast to continue
 to enjoy one of the most rapid growth profiles over the next two of
 decades. CRU projects consumption to grow by more than 140 per cent over
 the period to 2030(14). One reason for the recent growth is that China's
 economic development is highly aluminium intensive. But at the same time
 there have been worldwide gains in intensity of use and favorable
 substitution across a wide range of applications.
 
     The strong and sustained growth in aluminium demand is starting to
 stretch the resource base that has been the foundation of the development
 of the aluminium industry - large-scale good-quality bauxite deposits and
 competitively priced stranded energy.
 
     In the case of bauxite the escalation in demand for aluminium is being
 met increasingly from high cost and low-scale bauxite deposits in China and
 opportunistic mining operations in Indonesia. Such sources of supply are
 unlikely to provide a long term solution for the industry's rapidly growing
 bauxite needs and have already led to stronger prices for traded ore. This
 implies that significant investment in new large scale bauxite mines are
 likely to be required if the industry is to meet demand projections.
 
     Meanwhile, high energy prices combined with a greater integration
 between regional energy markets through the development of LNG and
 gas-to-liquids projects could increase the costs of power available to
 greenfield smelters around the world. Together with a likely growing trend
 towards the introduction of pricing mechanisms or tax regimes for carbon
 emissions, sustainable stranded hydropower sources have become more
 valuable. This in turn may increase the value of existing aluminium
 capacity linked to such power sources.
 
     In the context of growing demand and constrained supply, the long run
 pricing environment for the industry will be heavily influenced by the
 evolution of costs. Turning first to alumina, refineries relying on
 imported bauxite supplies, such as in Europe and the US Gulf coast, have
 traditionally occupied the top-end of the alumina cost curve. High energy
 prices and rising delivered bauxite costs have increased the competitive
 disadvantage of these refineries over the past five years. The Chinese
 industry is currently adding significant non-integrated alumina capacity
 drawing on its capital cost advantage. These refineries are rapidly joining
 US and European alumina refineries toward the top of the cost curve. The
 resulting increase in the marginal cost of production means that alumina
 prices are unlikely to revert to the lower levels implied by long run
 historical trends even if some higher cost integrated capacity is
 eventually replaced by lower cost production.
 
     As with alumina, in the case of aluminium new Chinese smelters are
 fundamentally changing the shape of the industry cost curve. The rapid
 increase in Chinese smelting capacity since the start of this decade
 reflects the moderate barriers to entry in building smelters in China due
 to low capital costs and short build times. However, this new capacity has
 come in at the top-end of the operating cost curve mainly reflecting
 relatively high power costs. Consequently, the industry aluminium cost
 curve has shifted up since 2003 and become steeper. This has provided a new
 significantly higher base for prices.
 
     A key point to note is that the gradual appreciation of the Chinese
 currency should also translate into higher US dollar production costs for
 Chinese smelters - all other things being equal. To illustrate this point,
 the effect of a further 10 per cent appreciation of the Chinese RMB on the
 aluminium cost curve is shown on the chart above. With Chinese smelters
 predominantly in the third and fourth quartiles, the top end of the curve
 would shift up in such a scenario creating an even higher basis for
 aluminium prices and higher margins for smelters in the lower cost
 quartiles.
 
     Copper
 
     ------
 
     Copper stocks have been at critically low levels since a surge in
 consumption in 2004 depleted available inventories. From that point, stocks
 have been constrained by supply's inability to match a stronger underlying
 demand growth trend related mainly to Chinese growth. Reflecting the tight
 market situation, copper prices are currently moving in the range of
 $6400/t-$7000/t(15) or about three times higher than their average level
 through the 1990s and well above levels achieved in the early part of this
 decade.
 
     Unlike for iron ore and aluminium, the scope for opportunistic and
 high-cost sources of supplies to help bridge supply shortages has been
 limited for copper. Current prices are therefore significantly above
 marginal costs of supply. Short term copper prices are instead supported by
 the need to induce those with the least 'willingness to pay' for copper to
 reduce their consumption. In this context most of the switch away from
 copper has so far occurred in the plumbing sector to the advantage of
 plastics. This means that prices could remain near current levels as long
 as production growth continues to under-perform against the underlying
 demand trend creating a need to ration supplies.
 
     In terms of demand, most analysts are projecting flat copper
 consumption outside of China in 2007. But within China copper consumption
 growth is projected to grow by 15 per cent this year. Calculations of
 apparent demand are pointing to growth well in excess of that number,
 although this is thought to reflect the reversal of a destocking phase in
 China during 2006. Overall global demand is expected to record its
 strongest growth since 2004, rising this year by about 3.5-4.0 per
 cent(16). Looking forward, even with a projection of high underlying
 average demand growth in China, demand for material can be expected to
 fluctuate unpredictably over periods of months on stocking and destocking
 cycles generating price volatility.
 
     On the supply side copper miners have faced many of the challenges and
 bottlenecks discussed earlier. Strikes and unforeseen disruptions from
 weather related events and accidents have also affected the performance of
 existing copper mines. It is estimated by Brook Hunt that actual global
 mine output over the past three years has underperformed market
 expectations by a cumulative 2.5 to 3 million tonnes of copper. This is
 equivalent to annual losses of 4 per cent to 6 per cent which compare with
 losses in normal years closer to 2 per cent.
 
     The medium term outlook for copper will be highly dependent on whether
 disruptions continue to run at high levels. Third quarter production
 reports from copper mining companies suggest that this remains an ongoing
 issue. In addition recent reports have pointed to potential shortages of
 sulphuric acid which could constrain SxEw operations in the short term.
 This source of supply has accounted for a high proportion of primary
 production growth over the past two years.
 
     The influence of investment funds activity could also be a factor
 affecting medium term prices in the copper market. In particular, some
 analysts are suggesting that additional demand associated with long only
 funds means that stocks levels associated with a market in equilibrium will
 need to be higher than in the past. In any case, the likely continued
 importance of investment funds in exchange traded commodity markets means
 that large price movements could take place on the back of commodity
 specific speculative shifts or broader shifts in investor sentiment - well
 in advance of any fundamental change in physical markets.
 
     Looking to the long run, CRU projects that copper demand will more than
 double over the next 25 years. Growth prospects are based on the expected
 resource intensive development of economies such as China and the
 associated investment in power distribution networks and other
 infrastructure. Additionally, in a high-energy price and carbon conscious
 world copper can be expected to benefit from any global drive for increased
 energy efficiencies and any shift towards the development of local
 distribution networks around sources of renewable energy.
 
     Ultimately, the industry should be able to surmount bottlenecks in
 equipment and supplies. However, some of the supply challenges are likely
 to be of a longer-term nature. These include declining ore grades, an
 increasing shift towards underground operations and the need for the
 industry to access and develop deposits in countries with higher risk
 profiles such as the DRC. Meanwhile upward pressure on capital costs for
 copper projects is likely to remain. This suggests that future long run
 prices and margins may be sustainable at levels well above long run
 historical averages without encouraging excess capacity.
 
     Historically copper prices have tended to trend towards the industry's
 marginal cash cost of production. But reflecting the cointegrated nature of
 costs and prices, cash costs have continued to move up driven by higher
 labour rates and bonuses, increased royalty payments, and stronger prices
 for supplies, services and energy. Exchange rate changes have also been
 significant in key copper mining regions, exacerbating the upward pressure
 on cost. Overall, cost increases have been felt more strongly at the margin
 and we estimate 9th decile costs to be back near or even above levels last
 seen at the start of the previous decade. While some of the recent cost
 pressures are likely to subside in the longer term, we believe that, as for
 many other commodities, a structural shift in the copper cost curve has
 occurred supporting an expectation of significantly higher long run prices
 than would be implied by historical trends.
 
     Conclusion - faster long run average demand growth, extended medium
 term
 
     price elevation and higher long run prices
 
     Continued firm global economic activity led by rapid resource intensive
 growth in China is expected to support strong increases in demand for most
 metals and minerals over 2008 and 2009. At the same time with low stocks
 and a likely continuation of supply side difficulties, most commodity
 prices can be expected to average well above their long run trend over this
 period. It is too early to suggest that the price cycle has peaked across
 the range of commodities.
 
     While the central case is positive, it is important to remain mindful
 of macro-economic risks especially relating to US housing and credit
 markets. However it is also important not to exaggerate these risks as our
 modelling suggests that they may not have a significant impact on the
 developing economies that have been the growth engines of commodity demand.
 It is also important to keep in mind that price movements from month to
 month will be influenced by stocking and destocking and investment funds'
 activities that may be only indirectly related to economic growth.
 
     Over the longer run strong resource intensive growth from China, India
 and other developing countries should continue to provide momentum to
 commodity demand. Indeed, recent history and the IMF's projections for
 future growth would suggest that we are currently going through a period of
 global growth not seen since the period of fast growth and reconstruction
 in OECD economies following the Second World War. The implications for
 commodity markets are profound.
 
     In time production can be expected to expand to meet faster growth in
 demand at more sustainable prices. However, it is expected that prices of
 many minerals and metals will remain elevated above trend for longer than
 has been the case in the past because of constraints on the speed with
 which production capacity can be expanded over the next few years. Also
 most prices are likely to assume higher levels than has been the case
 historically due to structural increases in industry marginal costs.
 
 

     Sources:
 
     (1)  IMF World Economic Outlook, October 2007
     (2)  Global Insight, Interim China forecasts, November 2007
     (3)  Global Insight, Interim USA forecasts, November 2007
     (4)  Cabinet Office, Government of Japan for historical quarterly GDP
          growth estimates, Development of real GDP, November 2007
     (5)  Global Insight, Interim Japan forecasts, November 2007
     (6)  Global Insight, Interim India forecasts, November 2007
     (7)  Data downloaded from Ecowin database, November 2007
     (8)  Lehman Brothers, India: Everything to play for, October 2007;
          Goldman Sachs, India's Rising Growth Potential, January 2007
     (9)  References to steel from IISI, World Steel in Figures,
          September 2007; for references to aluminium CRU The Long Term
          Outlook for Aluminium, 2007 Edition; for references to copper CRU
          Copper Quarterly, October 2007
     (10) CCCMC and Rio Tinto analysis (Indian exports), Mysteel, CUSTEEL and
          Rio Tinto analysis (domestic concentrate), benchmark prices and
          Clarksonspot freight rates (Australia and Brazil).
     (11) IISI Media Release, November 2007
     (12) CRU Steelmaking raw materials Monitor, November 2007
     (13) LME data downloaded from Ecowin database, November 2007
     (14) CRU The Long Term Outlook for Aluminium, 2007 Edition
     (15) LME data downloaded from Ecowin database, November 2007
     (16) CRU Copper Quarterly, October 2007
 
 
     About Rio Tinto
     Rio Tinto is a leading international mining group headquartered in the
 UK, combining Rio Tinto plc, a London listed company, and Rio Tinto
 Limited, which is listed on the Australian Securities Exchange.
 
     Rio Tinto's business is finding, mining, and processing mineral
 resources. Major products are aluminium, copper, diamonds, energy (coal and
 uranium), gold, industrial minerals (borax, titanium dioxide, salt, talc)
 and iron ore. Activities span the world but are strongly represented in
 Australia and North America with significant businesses in South America,
 Asia, Europe and southern Africa.
 
     Forward looking statements
 
     This article includes "forward-looking statements". All statements
 other than statements of historical facts included in this article,
 including, without limitation, any regarding Rio Tinto's financial
 position, business strategy, plans and objectives of management for future
 operations (including development plans and objectives relating to Rio
 Tinto's products), are forward-looking statements. Such forward-looking
 statements involve known and unknown risks, uncertainties and other factors
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 results, performance or achievements expressed or implied by such
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 regarding Rio Tinto's present and future business strategies and the
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 or achievements to differ materially from those in the forward-looking
 statements include, among others, levels of demand and market prices, the
 ability to produce and transport products profitably, the impact of foreign
 currency exchange rates on market prices and operating costs, operational
 problems, political uncertainty and economic conditions in relevant areas
 of the world, the actions of competitors, activities by governmental
 authorities such as changes in taxation or regulation and such other risk
 factors identified in Rio Tinto's most recent Annual Report on Form 20-F
 filed with the United States Securities and Exchange Commission (the "SEC")
 or Form 6-Ks furnished to the SEC. Forward-looking statements should,
 therefore, be construed in light of such risk factors and undue reliance
 should not be placed on forward-looking statements. These forward-looking
 statements speak only as of the date of this article. Rio Tinto expressly
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 Services Authority and the Listing Rules of the Australian Securities
 Exchange) to release publicly any updates or revisions to any
 forward-looking statement contained herein to reflect any change in Rio
 Tinto's expectations with regard thereto or any change in events,
 conditions or circumstances on which any such statement is based.
 
     Nothing in this article should be interpreted to mean that future
 earnings per share of Rio Tinto plc or Rio Tinto Limited will necessarily
 match or exceed its historical published earnings per share.
 
     Subject to the requirements of the Takeover Code, none of Rio Tinto,
 any of its officers or any person named in this article with their consent
 or any person involved in the preparation of this article makes any
 representation or warranty (either express or implied) or gives any
 assurance that the implied values, anticipated results, performance or
 achievements expressed or implied in forward-looking statements contained
 in this article will be achieved.
 
 
 

SOURCE Rio Tinto Group