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Record output by BHP masks pain felt by next tier peers

Wednesday, 17 Jul 2013 | 9:58 PM ET
Peter Hendrie | Photographer's Choice | Getty Images

BHP Billiton's bullish iron ore production figures on Wednesday suggest the mining sector is shrugging off any worries about a slowdown in China and declining commodity prices, but analysts warn that the next tier of iron ore producers could get stung.

The world's biggest miner posted a 17 percent rise in output for to April to June quarter, bringing annual output to a record high of 187 million metric tons for the fiscal year. The news came a day after the world's second largest miner Rio Tinto said iron ore output rose a robust 7 percent in the same quarter from the year before.

The upbeat figures come even as China reported this week slower growth for the second straight quarter. The economy expanded 7.5 percent in the second quarter from the previous year, down from 7.7 percent pace logged in the first quarter.

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Slowing economic growth in China is a concern for the mining industry, given that the country is the largest consumer of the steel making raw material. In June China's imports of iron ore fell 9.1 percent month on month to 62.30 million tons, Reuters reported, the lowest in four months and compounding worries about falling demand for iron ore.

According to analysts, while mining giants BHP and Rio are well equipped to counter headwinds in the market, the next tier of players in the mining sector, along with smaller producers, are less equipped to weather an industry slowdown.

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"If demand weakens, your costs are high, your margins are smaller and your efficiency is lower... what happens is you are the company that becomes unprofitable fast," said Ric Spooner, chief market analyst at Sydney-based CMC Markets Asia Pacific.

"I can easily see some of these smaller players moving into a loss situation and cutting production or closing mines," he added.

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BHP Billiton's future under new CEO
Vincent Pisani, Resource Research Analyst at Shaw Stockbroking says that incoming CEO Tom Mackenzie is more focused on ground-field expansion and that's good for BHP.

Evan Lucas, market strategist at IG Markets, singled out Fortescue Metals Group (FMG) and Atlas Iron are examples of miners more exposed the rising headwinds in the iron ore market.

"FMG derives over 98 percent of its revenue from China. That kind of exposure leaves it wide open to Chinese concerns. [If there is] any sign that China's thirst for iron ore slows dramatically, it will see a pinch," said Lucas.

"Atlas Iron is also seeing production issues and is also fairly highly leveraged," he added.

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According to Warren Gilman, chairman and CEO of Hong-Kong based CEF Holdings, the big players are boosting output in the coming years and expecting China to absorb the supply. And if the Chinese economy continues to slow, it's the smaller players that will get caught out.

"All the big boys, whether it's Vale, BHP and Rio are going full guns in terms of iron ore production and that's part of the problem. There's this huge wave of supply that's coming on in 2014, 2015 and 2016 that we are all relying on China to absorb it," he said.

"Where it becomes difficult is for the next tier of producers, the Fortescues and the Atlas Irons. Their margins are going to get squeezed as the price of iron ore comes down due to that wall of supply," he added.

Analysts broadly expect prices of iron ore to come under further pressure over the next few years due to slowing demand and rising supply. Iron ore traded at around $130 per ton on Wednesday and CMC's Spooner sees iron prices falling to around $80-100 over the next two years.

ByCNBC's Katie Holliday: Follow her on Twitter @hollidaykatie