Why miners may want to rethink high output

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The world's top three iron-ore producers continue to consistently churn out record volumes of output, worsening an already dire supply glut, but investors are now wondering just how long that strategy can last.

On Wednesday, BHP Billiton—the world's largest miner by market capitalization—reported a 7 percent annual rise in September quarter output to 61 million tons, adding to a 6 percent gain in the June quarter, and maintaining its full-year guidance of 247 million tons.

Report cards over the past week confirms other miners are also in high-output mode.

Rio Tinto reported a 12 percent annual rise in third-quarter production to 86 million tons, building on a 9 percent gain in the previous quarter. The world's second largest miner also announced it was on track to meet a full-year target of 340 million tons. Meanwhile, Brazilian giant Vale logged a record performance, with output up 2.9 percent on year to 88.2 million tons and more increases to come.

A low cost of production has been the secret to miners' profitability despite iron ore prices crashing to $52 a ton from nearly $200 four years ago. Rio Tinto's unit cash production cost at its Pilbara operation fell to $16.20 a ton during the first half of this year, from $20.40 per ton during the same period last year, while Vale plans to reduce its current unit cost from $15.80 per ton to less than $13 by 2018, according to the companies.

Read MoreDoes Rio's iron ore boost signal a turn for commodities?

But if miners continue ramping up production at high levels, it could become counterproductive.

"So far, miners have been able to withstand commodity price declines but if they keep pushing prices down, and testing the low cost producer-price relationship, margins and cash flow will eventually decline and they'll get to a point where they can't escape by cutting costs further," explained David Lennox, resources analyst at market research firm Fat Prophets.

If prices fall below the average variable cost of production, companies may be better off shuttering factories in the short-term.

BHP Billiton has more room to cut costs
BHP Billiton has more room to cut costs

The past two years have seen heavyweight names like BHP and Rio engage in aggressive asset sales and spin offs to bolster balance sheets but there's a limit as to much they can rely on those options, he said.

"How often can they do that in the future? It's not a sustainable strategy....For now, they are still very much in low-cost territory but if they continue to expand, it will start to bite."

A key reason why big miners remain successful is because of their efforts to focus is on producing what they have, instead of spending on exploration, noted Evan Lucas, IG's market strategist.

Read MoreGlencore may spark a Lehman moment for miners

"But there is indeed a finite limit to that. In U.S. dollar terms per ton, there's only so much more they can cut out."

Don't despair yet

However, tailwinds from cheaper currencies could delay that limit from happening anytime soon, Lucas pointed out.

Seeing as most miners have costs priced in local currencies, the Australian dollar and Brazilian real's 17 and 60 percent decline against the greenback in the past year are major benefits to BHP, Rio and Vale.

"The Aussie dollar has been abnormally priced in the past three years given that the greenback has been pushed down by lower interest rates, so the currency is now at fair value and will be able to sustain these levels for longer," Lucas explained.

Moreover, miners are still betting on reasonably strong Chinese demand, pointed out Gavin Wendt, founding director and senior resource analyst at MineLife.

Expectations are widespread for Beijing to unleash more fiscal stimulus, which is likely to boost infrastructure and ramp up commodity demand. China data released earlier this month showed that while the value of iron ore imports fell, the volume of imports actually climbed.

"Everything miners are selling is still being consumed as we can see from strong sales numbers so for the time being, their strong margins can last," Wendt said.