Morning, everybody. Welcome to our 2018 interim results. If I could ask you to put your phones onto silent. Just briefly, health and safety, the best fire exit is back through the door you came, just to the right, then you turn left onto Throgmorton Street for the muster point. There is no alarm set, no test alarm set for this morning, but you'll be told if we need to evacuate. With that, I will hand over to J.S. Thank you.
Thank you, John. Good morning all, welcome to our results presentation. Our strategy is working. It's delivering. Rio Tinto has once again delivered strong results with superior shareholder returns. We have real momentum, I'm absolutely delighted to report that we continue to deliver on our promises. We maximize cash generation through our value over volume approach, delivering $9.2 billion of EBITDA, with an EBITDA margin of 43%. We strengthened our portfolio with $5 billion of announced divestment. We invested $1.4 billion in high-return growth. We generated around $300 million of free cash flow through our mine-to-market productivity. Most importantly, we've announced superior cash returns of $7.2 billion, including an interim dividend of $2.2, a $1 billion top-up to our current buyback programs, the return of $4 billion to our shareholders from disposal proceeds. The precise timing and form to be announced shortly.
We are proud of those results, rest assured, we will not become complacent. Our aim is simple: to continue to deliver superior returns over the short, medium, and long term. Now, I will take you through the highlights. In the first half, we continued to deliver robust financial performance, to allocate capital with discipline, to position the company for the long term. Let me take each of these in turn. We delivered net cash from operating activities of $5.2 billion and free cash flow of $2.9 billion. The conditions were broadly positive. Our cash generation is underpinned by strong operational performance and results, our new mine-to-market activities, divestments to strengthen our portfolio. Our success in these areas drove a strong cash flow, which was a great effort during a period of increasing inflationary pressure. Turning to capital allocation.
As I mentioned today, we announced a record interim dividend, a top-up to our existing buyback programs. We also continue to improve our world-class portfolio, announcing divestments for a total of $5 billion in the first half of this year. Overnight, we closed the sale of our remaining Queensland coal assets for around $4 billion. The post-tax proceeds from our divestment will be returned to our shareholders. Our strong balance sheet, with a net debt of $5 billion, positions us well for the future, we can deal with ongoing economic volatility, invest in high-value growth, retain the optionality around smart M&A. In other words, we have the flexibility to maximize performance, take advantage of any new opportunities that may arise. This year, we have also progressed our growth options. The Silvergrass iron ore mine is ramping up successfully.
Three weeks ago, AutoHaul completed its first loaded run, unlocking capacity and flexibility in our world-class iron ore business. Amrun is on track to ramp up in the first half of 2019, and Oyu Tolgoi underground is progressing well. Let me turn to safety. Safety is our number one priority at Rio Tinto. It has been a challenging start of the year. A colleague died in April while working on the demolition of a furnace at Sorel-Tracy in Canada. I joined the team on the ground after the tragedy, and we are doing all we can to support the family and our colleagues. In July, a team member was fatally attacked while on security duty at our Richards Bay Minerals site in South Africa. We are fully cooperating with the local police.
These are absolutely unacceptable and sad events. We are working very hard to learn from them. Our ambition remains the same. We want all of our colleagues to return home safely at the end of each and every day. Turning to our product groups. Overall, they performed well. Our iron ore business achieved a strong first half performance with an EBITDA margin of 67%. The pressure from inflation was felt most in our aluminum business so far. Despite this, the [whole group] achieved an EBITDA margin of 35%. Copper and diamonds achieved an EBITDA of $1.4 billion, up 77% on the same period last year. They also increased EBITDA margin from 40%-45%. Despite operational challenges, energy and minerals achieve a 36% EBITDA margin. During the first half, we continued to sell non-core assets, announcing $5 billion of divestments, achieving prices well above market expectations.
We also signed a heads of agreement for the sale of our entire Grasberg interest for $3.5 billion. The parties are now working towards signing definitive agreements in the second half of this year. Our long-term success depends on having a portfolio of high-quality assets which achieve higher returns. When we think about shaping our portfolio, we focus on the best assets in commodities with sound long-term fundamentals. We will continue to optimize our portfolio and look to divest those assets that do not fit our strategy, further driving sector-leading return on capital employed. Before I cover the outlook for the industry and Rio Tinto's future plan, let me hand over to Chris, who will take you through the detailed financials. Chris?
Thanks, J.S. These are another strong set of results. Let's have a look at the numbers in more detail, starting with the commodities. In iron ore, benchmark 62% prices declined by 9% versus last year. This was driven by slightly lower demand, stronger than usual first half seaborne supply, and some destocking of inventory at the ports, mostly in the second quarter. Lower iron ore prices were offset by higher prices across the rest of the group. We saw increased demand for our seaborne bauxite and reasonable pricing over the period. The LME price for aluminum improved with an increase of 18%, reflecting strong demand and disruption in the sector, including the impact of tariffs in the U.S. We've also continued to increase the proportion of value-added products from 57%-58%. These carry an average premium of about $222 per ton.
Copper prices in the first half of 2018 were 20% higher than the first half of 2017, primarily as a result of strong demand from both China and the rest of the world. Chinese environmental policies also curtailed the importation of scrap, which created increased demand for concentrate and cathode. Copper prices sold off in the last month or so as markets became concerned by the noise around potential trade wars. For the first time, we're showing a waterfall slide for underlying EBITDA rather than underlying earnings. We think that underlying EBITDA is a better proxy for the cash performance of the group, which is something that we prefer to focus on. This metric has remained fairly flat compared to the same period last year, despite some of the headwinds that J.S. has already mentioned.
As I've just discussed, pricing has been broadly positive across the commodities, with higher pricing in most of our products, more than offsetting slightly lower iron ore prices. Overall, there was an improvement of $600 million compared to the first half of last year. Price improvements during the period could have been about $200 million higher for the group, but for the impact of legacy alumina contracts. These contracts are for the supply of just over 2 million tons of alumina per year, and they're linked to the primary metal LME price, are entered into first up in 2003. We're likely to see the same impact in the second half, should prices stay high. The impact of unfavorable exchange rates, energy costs, and measured inflation have had a combined negative $400 million impact in this period. This brings us to flexed underlying EBITDA of $9.2 billion.
In the first half of the year, increased productivity across the system, assisted by better weather, allowed higher iron ore shipments. Our copper division saw operations return to normal at Escondida at the same time as we mined higher grades at Kennecott and improved the plant performance at OT. The strong performance of these divisions was offset by lower production in some of our aluminum operations. Overall, volume and mix generated $900 million of additional underlying EBITDA. During the period, we've seen input costs in both our aluminum and TiO2 businesses negatively impacted by about $300 million. Other cash costs have had a negative impact of $200 million. This includes additional exploration and evaluation activity, as well as spend in Information Systems and Technology, and further investment to support the group's mine-to-market productivity program.
These were partially offset by improvement in the iron ore cost base, further enhancing our productivity gains. One-offs during the period have had a $400 million negative impact to underlying EBITDA. Included in this number are the costs associated with the 2-month strike at IOC, disruptions at our titanium business, and a power interruption at our Aluminium Dunkerque in France. One-off costs were offset by the absence of the strike at Escondida last year and the inclusion of restructuring costs this year, which were previously taken below the line. Overall, we've delivered underlying EBITDA of $9.2 billion, which represents a margin of 43% across the company. The cost inflation that we're starting to see come through the industry makes our mine-to-market productivity program even more important in protecting our margins and maintaining our competitive position. We started to see cost increases in 2017, initially in the Aluminium Group.
As you can see here, the index price of caustic, coke, and pitch remain well above the first half of 2017. As a bellwether for input costs, average oil prices rose approximately 28% to $68 a barrel during the first half. We'll continue to fight against rising inflation across the business and I'll now discuss how our productivity program has assisted in offsetting some of these increases and allowed us to keep our EBITDA margin broadly in line with the first half of 2017. By the end of 2017, we'd delivered $400 million of additional free cash flow from our productivity program. To successfully deliver on our targeted $5 billion of cumulative additional free cash flow by 2021, we must ensure that all these benefits are sustained and embedded.
In the first half of this year, we delivered total productivity improvements of $500 million, which included carrying forward the embedded savings made last year. Cost headwinds in the first half reduced this year's achievement by $200 million. This brings the total cumulative contribution for the past 18 months to $700 million. The numbers shown on this slide are different from those in the variance waterfall, as these are cumulative post-tax cash impacts. We continue to target total productivity gains of $1.1 billion for 2017 and 2018 combined. Across the business, we're focusing on maximizing cash by improving both our operational and commercial outcomes. Since 2017, or the last two years, the last 18 months, we've announced a total of $7.7 billion of divestments, including $5 billion pre-tax in 2018. This includes the sale of our European aluminium smelters, Aluminium Dunkerque, along with our coking coal assets in Australia.
Additionally, we've also signed a heads of agreement for the sale of our interest in Grasberg to Inalum, Indonesia State Mining Company. This is an important step forward, but there are still a number of conditions required, and at this stage, there's no certainty of a transaction. The sale of Winchester South completed during the first half, and cash of $150 million was received. There's a further $50 million in about 12 months' time to come from that process. Today, we've announced the completion of the Kestrel and Hail Creek transactions for $3.95 billion pre-tax. We expect the remainder of these divestments to complete in the second half. I'll talk more about the intended use of those proceeds a little bit later. Disciplined capital allocation is at the core of everything we do.
Having spent sustaining CapEx to ensure the integrity of the business, our next call on cash is our dividends to shareholders. We then have an iterative cycle of managing the balance sheet, pursuing value-accretive growth options, including M&A, and considering further returns. Our aim is to ensure that we're able to invest in value-accretive growth through the cycle, maintain that strong balance sheet, and continue to pay superior returns to our shareholders. Let's have a quick look at how this has worked out over the last 12 months. This data combines the second half of last year with the first six months of this year. Over that period, we spent $2.3 billion on sustaining CapEx and $2.8 billion on our growth projects. Over 50% of all cash received during the past 12 months was returned to shareholders.
This included dividends of $5.2 billion, comprising the then record interim payment in September of 2017 and the record final dividend paid in April of 2018. $3.3 billion of share buybacks were also completed over this period. These cash returns represent just under half of all the combined returns from our entire peer group. If I get back now to the data for this half, capital spend was $2.4 billion, 34% higher than the same period last year. Of this, $1 billion related to sustaining our current operations, and $1.4 billion was spent on our compelling growth options. The Amrun project in North Queensland is on track for commissioning in the first half of 2019. During the first half of this year, we have transported the stacker and reclaimer to site and have almost completed the assembly of the ship loader.
At Oyu Tolgoi, contractor numbers have almost reached their peak, during the first half, the shaft 5 ventilation system was completed, and that's now operational. In iron ore, AutoHaul is progressing well, with around 65% of all train kilometers now completed in autonomous mode. Two key AutoHaul milestones were met in the first half, with final regulatory approval received in May. A few weeks ago, we ran our first loaded, fully autonomous journey. We remain on track, pardon the pun, to have full implementation of AutoHaul by the end of this year. There was a bit of a joke in there, but never mind. We'll work back around to that. Group CapEx guidance of $5.5 billion in 2018 and around $6 billion in 2019 remains unchanged. For 2020, we're raising our guidance to around $6.5 billion.
This half billion increase partly reflects the timing of spending and additional capital required for some of the replacement production in the Pilbara and increased CapEx expected in that year on the Oyu Tolgoi Power Station. In each of these years, the expectation is that sustaining capital will be between $2 billion and $2.5 billion. In 2018 and 2019, we'll continue to spend CapEx at Amrun. At OT, we're spending around $1 billion in each year to develop the underground mine. From 2019, we'll also start spending CapEx on the power station. In the iron ore business, we'll need to spend around $3 billion on sustaining CapEx over the next three years. We'll also spend about $2.7 billion on replacement mines over the same period. Starting in 2019, we expect to see spend coming through for the Koodaideri mine.
The increase that we're seeing in the Pilbara replacement mine spend is due to a combination of increased capital costs from revised scope for some of the projects and the fact we're bringing forward some of our 2021 spend into 2020. The feasibility study for Koodaideri is ongoing, yesterday, the board approved $150 million of early works funding for this project. One of the advantages of a strong balance sheet is the ability to invest in the business through the cycle and to drive future returns. At the end of 2017, we reduced our net debt to $3.8 billion, a 60% reduction from the end of the previous year. In February, we flagged some cash outflows. These included a final tax payment of $1.2 billion for the Australian tax group for the full year of 2017, which was paid in June of this year.
Adding the tax payment back creates adjusted net debt of about $5 billion at the end of last year. The net debt remains relatively unchanged at $5.2 billion. This is after returning $4.7 billion of cash to shareholders during the first half. That $4.7 billion includes the payment of the final 2017 dividend in April of $3.2 billion, and ongoing share buybacks in Rio Tinto plc of $1.5 billion. Gross debt has again been reduced. A reduction of $2.1 billion, this included a repurchase of $1.9 billion of bonds. There was a net interest paid of $100 million arising from the repurchase of these bonds. From January 1, 2019, there are changes to accounting standards, including the treatment of leasing arrangements. These changes will require that the present value of operating leases are brought onto the balance sheet and included in the net debt.
The exact outcome is still to be determined. To give you a sense of quantum, undiscounted operating lease commitments disclosed in our annual report for the end of 2017 were $1.8 billion. We'll further update our guidance on any impacts from these changes at the year-end presentation. We believe that having a strong balance sheet is a major competitive advantage and is essential in a cyclical business. It provides us with what I like to talk about as the three Rs. Some of you may have heard this before, robustness, returns, and readiness. Robustness against volatility in the commodity markets in which we operate, but also in the global macro and geopolitical space. Returns. A strong balance sheet provides an ability to make returns through the cycle. The third R is a readiness to take advantage of opportunities as and when they arise.
Our strong balance sheet has enabled us to continue to invest in value-accretive growth and to make sector-leading returns to our shareholders. As I've already mentioned, during the first half of this year, we returned $4.7 billion to shareholders. We've today announced a further $3.2 billion of interim returns. This is made up of a record interim dividend of $1.27 per share or $2.2 billion, which will be paid in September. In line with last year, the dividend represents 50% of year-to-date underlying earnings. We've also allocated an additional $1 billion toward our existing share buyback program in Rio Tinto plc. $1.5 billion of share buybacks were completed in the first half from our existing program of $2.9 billion. Since the period end, we've completed a further $200 million.
This means that from today, we'll be buying back $2.2 billion between now and the end of February 2019, which is equal to just over $300 million per month. During the first half, we've announced $5 billion of divestments from our coking coal assets and European aluminium smelters. We've now received $4.1 billion pre-tax proceeds from the disposal of our coking coal assets, Hail Creek and Valeria, Kestrel, and Winchester South. The bulk of this was actually received overnight. Pretty close timing. On these proceeds, we expect a tax liability of approximately $1 billion. We expect to receive the remainder of the proceeds from the other sales later in the year. Yesterday, the boards approved that the post-tax proceeds of $4 billion will be returned to shareholders. The decision on the form and timing will be made in the coming months.
We have a strong track record demonstrating our clear commitment to delivering superior returns. Whether running operations, committing capital expenditure, evaluating disposals or acquisitions, we've remained disciplined and focused on the value of every dollar. With that, I'll hand back to J.S.
Thank you, Chris. Let me now share some thoughts on the macro environment. The mining industry has two key drivers: GDP growth and global trade. The GDP outlook remains solid, with positive growth indicators in most geographies. Global trade is potentially a concern. Focusing on China, the biggest market for the mining industry, we remain optimistic about the medium to long term. As expected, growth is slowing, but only modestly, and was still at 6.7% in Q2. The government is introducing measures to support domestic demand and increase liquidity, including fiscal stimulus, which should underpin growth. China's policy changes have had a significant and enduring impact on several industries, including the mining sector. Supply side reforms and pollution controls have resulted in capacity reductions, which are unprecedented. This is particularly the case in steelmaking.
The outcome of which is higher capacity utilization and improved profitability. The change in industry structure has also led to a shift in iron ore demand, which in turn has given rise to a significant premium for higher quality product. That is absolutely good news for Rio Tinto. In aluminum, the impact of new policy changes will take more time. We do believe there will be a slowdown in capacity growth over the medium term and the rebalancing of supply over time where demand continues to be strong. It is not all plain sailing. We are concerned about the return of inflation, which is impacting the entire industry, putting margins under pressure. Resource nationalism is not a new feature of the mining industry, but there is no doubt that many stakeholders want a greater share of the wealth created by minerals development.
There is also an increasing emphasis on how we operate and our impact on the world around us. This is why we believe our license to operate is a make or break for the industry. Now turning to trade. Ongoing threats to global trade is potentially a concern. History shows fair trade and open markets are the best driver of growth and prosperity. We believe this will continue to be the case in the future. In these uncertain times, resilience is absolutely key. That's why we are so focused on four key drivers. One, driving performance. Our productivity drive will generate $1.5 billion of additional free cash flow per annum from 2021. Two, actively shaping our portfolio, highlighted by our announcement this morning. Three, growing in a very focused way. Our current organic pipeline will deliver an average of 2% per annum over the next five years.
Last but not least, item number four, maintaining a strong balance sheet. This is how we will continue to deliver superior returns for our shareholders in the short, medium, and long term. Turning to growth. Our current growth projects are progressing well. On the broader growth outlook, we continue to evaluate exciting medium to long-term opportunities across the entire portfolio. These include Resolution Copper in the U.S., the Jadar lithium project in Serbia, and potential expansions of our aluminum and bauxite businesses. Our world-class assets in the Pilbara have significant potential for optimization and future capacity development. Yesterday, the board approved around $150 million, $146 million it is actually, Chris, for early works and studies at the Koodaideri mine. This will be our first fully autonomous mine. We also have an extensive pipeline of additional replacement and growth options in the Pilbara.
Oyu Tolgoi and Resolution are two of the largest copper projects in the industry. Long life, low cost, and close to our customers in China and in the U.S.A. Our Canadian aluminum smelters are in the first quartile. Long term, as demand grows, we will strengthen these assets through continued productivity gains and potentially brownfield expansions. These measures are already the greenest in the industry. The new technology joint venture between Rio Tinto, Alcoa and Apple to create carbon-free smelting will mean an even more attractive product for our consumers and a further reduction in operating costs. Across all communities, our projects sit at the bottom of the cost curve, which means they are well-placed to deliver tier 1 free cash flows.
It won't surprise you to hear these opportunities will be looked at through our value over volume lens and only move forward if they offer the most attractive returns. Of course, we will keep a watching brief on M&A. Just to remind everybody, our strategy is clear and simple. We will maintain our strong performance by executing our four P strategy with excellence, which has underpinned our recent outperformance in some key areas. It's about portfolio, performance, people, partners. Portfolio is about world-class assets. Performance is about operating and commercial excellence. People is about developing industry-leading capabilities. Partners is about long-term relationships with our customers, suppliers, investors, governments, and communities. Before I wrap up, let me say a few words about the man next to me. Well, he's on the other side, but he's over there.
As you all know, this is Chris's last results presentation before he retires in September. I could not let today pass without thanking Chris for his outstanding contribution to Rio Tinto, both as a board member since 2011 and as CFO since 2013. He played a key role in strengthening the organization following a challenging period and has given me both great support and wise counsel. As well as his sense of humor, capital allocation discipline has been his signature, and I'm here to tell you it will remain his legacy. Thank you, Chris, for all your hard work, and we wish you all the best. I would also like to welcome Jakob, our new CFO. He's in the back of the room, last row. You can't hide, Jakob.
He comes to us with extensive experience in senior financial roles across Europe, Latin America, and Asia, within and outside the resource sector. Jakob is with us here in London today. I look forward to sharing the platform with you at our end-of-year results in February. In closing, every decision we make at Rio Tinto will prioritize value over volume. We have real momentum and plans to keep pushing for even better performance. We will continue to deliver on our promises as we have done in the first half, with our strong EBITDA and cash performance, with a strengthened portfolio, with a strong balance sheet providing options for growth, and most importantly, with a strong commitment to deliver superior cash return to our shareholders.
We do face challenges as any business in the 21st century does, but we have the right strategy, the right assets, the right team, and a real focus on value. For us, it is all about delivering on our promises, day in and day out. On this note, I will open the Q&A session. Where is David? We start with the room here and then Come on, Jason. Yeah, we need the mic, otherwise people will not hear.
It's Jason Fairclough, Bank of America Merrill Lynch.
The mic is working or not?
Yep.
It is working, yeah. You have a question for Chris, I think, yeah?
No. You mentioned the quality premiums being paid in iron ore right now. Could you talk a little bit about how the organization thinks about the sustainability of those premiums?
Yes.
To what extent is that informing your view on bringing forward CapEx in iron ore to sustain that quality?
All right. You asked me the same question last year.
No.
Well, one of your colleagues did. We believe that the shift between high grade and low grade in iron ore in China is becoming more and more structural. All right? We had the opportunity to meet with Xiao Yaqing, the Chairman of SASAC, a few months ago, and there is no doubt that the restructuring of the steel industry is here to stay, that the push for environmental better performance is there as well, and therefore they will continue to reduce capacity. That doesn't mean they will reduce production, and you saw the latest stats on the production. Steel production is still increasing in China, and therefore, for them to continue to produce with a reduced capacity, you need higher grades. We believe that the spread, the difference, the discount, the premium, call it whatever you want, between high grade and low grade is here to stay.
That's the first point. The second point is we are delivering to China the reference product, the Pilbara Blend. All right? Despite everything you can hear about trade and so on and so forth, today, we don't have any issue in placing our Pilbara Blend in the marketplace in China. Quite the opposite. People would ask for more of it. We do this optimization on an annual basis. What should be the right production, the type of production we should have in the Pilbara, and so on and so forth. We go through this cycle. The next conversation will be in September to see how we position. Remember, the Pilbara is about 16 mines, 1,700 km, four ports. It's a big system.
What we have been focusing for last two years, and we'll continue to work on it, and we are working on it, is to continue to increase the flexibility of the system, and it takes a lot of time. All right? AutoHaul and the announcement a few weeks ago is helping us in that domain. What we want, the vision which we are implementing is we want to have a capable system that we can flex up and down to meet our customer in a better way. That's what we're doing. We are progressing along this journey. Now, in terms of CapEx is the value of a volume question, which is always the same question, is to say, if you bring CapEx forward, you need to make sure you have a return on your CapEx.
Keeping in mind that if you have too much volume in the marketplace at any point in time, you could have an impact on prices. The metrics have not changed. $10 of price is worth $2 billion of free cash flow after tax for Rio Tinto. We do this optimization every year, and at this point in time, we are comfortable with the guidance of 330 to 340 for this year. We'll provide a new guidance at the end of this year, and then we have updated our guidance in terms of CapEx for the next three years, where you see some slightly higher replacement CapEx for iron ore. I can't tell you much more than that. I can give you only the principles on how we look at it. At the end of the day, for us, it's really about value.
It's really about how can we maximize the free cash flow yield of our system in the Pilbara. Keep in mind, for the medium to long term, we need to have a capable system, highly flexible. We want to be in control of the system. I believe that what we have achieved this year, what the team has achieved this year, is moving in the right direction. That's okay, Jason?
Morning, it's Menno at Morgan Stanley. Just two questions. One for Chris, then maybe one for you. Judging by the reaction of the shares this morning, considering that the company's returning $5 billion, which is clearly 5% of the market cap, it suggests that maybe some people are worried that Rio Tinto is losing out on some profitable growth options. What would be your reaction to that statement? Do you think that's right, or do you think you're capturing everything that's out there? Secondly, Chris, on the cost, slightly boring, but central cost stepped up quite significantly to $560 million this half. Is that the run rate we need to think of going forward?
If I turn that into your waterfall, the $200 million headwinds post-tax cash flow in the mine-to-market program, is that a run rate for the second half, or is it going to accelerate given the statements made on inflation?
Go for the cost side, maybe we'll share-
I'll do the cost run first. We've got the addressing the Mine-to-market, the input headwinds. They're persisting, but they're probably easing a little bit in terms of the second half. Where we've seen that most pronounced was in the aluminium business. If you look across to some of our competitors in aluminium, you'll see the same sort of story coming through there. With regard to the central cost, there's a series of things going on that are sort of placing the company in position to go forward. We've been working on the operating model, and there's commensurate spend with that. We've had a program, what we call Fix the Basics, in the IS&T and some of the shared service areas, which are limited timeframe spend.
Even the second half will be slightly slower than the first half was, but it's within this year type event. That you've got that. If I give you a bit of a breakdown on that, though, it's like that operating model and restructuring stuff is about $80 million. There's some work going into the further establishment of the commercial center in Singapore and the IS&T fixes. Combined, and the majority of this is in the IS&T side, it's about $75 million. We've got a higher charge going through central for insurance and pension costs. The insurance is something that we're taking through the central rather than within the product groups at the moment. That's a change this year that's slightly different, but that's about $40 million in there. That's the $200 million, give or take, in that central cost.
The run rate in the second half will be lower than that going forward.
Going back to the share question. The shares have been trading for a few hours, to state the obvious. I understand it is the middle of summer. There are very few volumes and so on and so forth. We've been around for 146 years. You don't expect us to run the company just to optimize the share price for the next five minutes. You agree with that?
Totally agree.
Thank you very much. All right. I'm not sure I'm going to draw too many conclusions on back of the share price. What we have delivered today is exactly what we deliver against our commitment, which is to deliver superior value for our shareholders. I hope you agree that $7.2 billion of returns is pretty good. That comes on top of the nearly $10 billion of last year and so on and so forth. We are clear about our commitment to deliver to our shareholders, and I truly believe we're delivering against our commitment. Am I going to read too much about the share price over a few hours? No, I'm not going to read too much about this one, to be honest. All right. Shall we take one question from the phone, and then I'll come back to the floor.
Ladies and gentlemen, if you would like to ask a question over the telephone at this time, please press star 1 on your telephone keypad. If you find that your question has already been answered, you may remove yourself from the queue by pressing star 2. We will now take our first question from Paul Young from Goldman Sachs. Please go ahead. Your line is open.
Hi, J.S. Hi, Chris. J.S., two questions for you, actually. The first one's on the bauxite market. I noticed a statement in the results about there being significant uncertainties around the direction of the bauxite market. That appears to be new. You had a decent increase in realized price during the half, but based on what you're seeing in Guinea and Guinea supply, has this changed your view on long run fundamentals and pricing? Second question, J.S., I know your Oyu Tolgoi underground development seems to be progressing very well. But I'm interested in the exact CapEx requirements for the power plant and the benefits of actually on the cost side, and also your view on the current government study around this implementation of the investment agreement. Thanks, J.S.
Okay, no worries. I'll share some of it with Chris. On the bauxite, what we are highlighting is there are more and more bauxite moving from Guinea back to China. It's still early days, and the old question, what we are highlighting here, as you said, there is a lot of volatility. We don't know going forward if the bauxite market will be priced on the cost plus or on commercial terms between Guinea and China. That's the only thing we are highlighting. Let's be clear, is we have no doubt that the investment in Amrun that should come on stream next year is a very good investment for us. It will be a world-class asset. As I said, high level of uncertainty. The statement I'm going to make is true across all commodities of Rio Tinto.
Our philosophy is the following at the end of the day. Is there are things you can control, there are things you cannot control. Let's focus on the controllable. Today what is important is to focus on having the right cost structure, the right quality of product, the right relationship with the customers. Whatever market conditions we are in, whatever volatility in the marketplace, then we will continue to be profitable, we'll continue to generate a lot of cash, and we'll be able to do two things. One is to continue to invest for the long term, which is very important in the mining business. The second point is to reward our shareholders with superior returns. I think what we have experienced or what we have disclosed today is a good example of it. That's where we are on the bauxite.
I know you've to go, yes, you want to pick up the power stuff, Chris?
Happy to.
Yeah. Go for it. I'll deal with the government after.
Okay. Paul, the OT power plant is in the pre-feasibility stage, currently there's a range of cost between $1.0 and $1.5 basically. There's a lot of conversation going on with the government as we speak about the various options available to us for that development. If I give you a simple example, if the degree to which it meets European standards or local standards or other global standards can have a difference on the capital cost. That's something that's got to be negotiated on the way through here. Once we get down to a stage where we've got a permitted, proven path forward, that's when we'll come back and revise any cost estimates.
What we've got in our CapEx guidance, and part of that increase in the 2020 year, is actually an expectation that we previously had about $250 million in that year. We think there'll be slightly higher spending in that year of 2020. That's part of that half a billion dollars of the increase in that guidance we've given you this morning about CapEx. It's still very much a live conversation, and it's really still quite fluid. Once we've got something firm in that, we'll come back.
Right. The other question is around the agreements in Mongolia. We have been very clear about the sanctity of these agreements. No matter what they are, the IA, the [Osha], the UDP, and so on and so forth. Discussions are on the way with the government. There are multiple work streams. Some of it have been triggered by the cabinet, the government, some of them have been initiated by the parliament, discussions are underway. There has been a slowdown in terms of discussion during the summer because it's Naadam, which is a big summer festival, they stop for a few weeks. The discussion will restart soon. They are restarting as we speak. We have been very clear about the sanctity of the agreement.
I can tell you is, remember, we are not alone on this one because we have on the back of the $4.4 billion of project finance that we put in place a few years ago, we got the World Bank, we've got all the main banks, all interest. It doesn't matter if you sit on the government side or on the Rio Tinto side or the Turquoise Hill side, our interest is to unlock the value of this absolutely world-class deposit that will be producing copper and gold for the next 100 years. The benefits we're already providing to Mongolia are significant. 14,000 people working on site, nine out of 10 being Mongolian nationals. If you look at the integrated supply chain that we have, around 40,000 people today. Remember, there are only 3 million people in Mongolia, just to put it in reference.
40,000 people across the supply chain. We've placed $1.5 billion of local procurement last year and so on and so forth. Our interest, our joint interest, is to unlock this value, and that's what we're working on it. Now, my personal experience over the last five years is lots of emotion, lots of drama, lots of things in the press. At the end of the day, common sense prevails. If I even step further, Rio has been around for 135 years, 136 years, and that's what our job is about, is to operate in challenging jurisdiction, to find a way to do it, and to unlock value for short, medium, and long term. All in all, Paul, discussion on the way. I'm sure there will be further announcement, including potentially a power station in the second half of this year.
If I can take another question from the phone and then I'll come back.
Thank you for coming.
David? There's none somewhere.
We will now take our next question from Hayden Bairstow from Macquarie. Please go ahead, your line is open.
Thanks, J.S. It's just a couple from me, one probably for Chris, I guess. On just the cash flow versus EBITDA, it seems to have been in a bit of a decline in the last few years despite revenue EBITDA being pretty flat. Just wondering if there's anything in that or is it just tax payments and other sort of variability in the business. J.S., just a question on the tariffs out of Canada into the U.S., just how that's impacting the business. Are the premiums adjusting enough to cover that or is that becoming a bigger issue for you? Thanks.
Yeah. I'll pick up the question on the tariffs and aluminum. Just to set the scene is, the bulk of the aluminum, or should I say aluminum, produced in Canada is sold in the U.S., and we are supplying one-third of all the aluminum consumed in the U.S. All right? We're clearly watching this whole trade situation or potentially trade situation between the U.S. and Canada very carefully, hence, how many? Four trips, five trips to the U.S.A. and Canada this year. Today, we don't have any problem whatsoever. Remember, you need to look at it through the lens of a consumer in the U.S. If you are a consumer in the U.S., you want to have access to a low-cost, reliable source of aluminum. You could argue some of them want to have a green access to source to be have access to a green aluminum as well.
The best aluminum we can think of is coming from most smelters in Canada. They are not in the first quarter of a cost curve, they are on the first side of a cost curve. They are hydro-based. On top of it, when you think of the joint venture we signed with Alcoa and Apple to develop the inert anode technology, we are a few years away from having a purely green product there. At the end of the day, from a consumer standpoint in the U.S., I've got no doubt because the supply chain is so integrated between the U.S. and Canada, that common sense will prevail. Back to your question about the premium and the duties and so on and so forth. The way the pricing formula works is we don't have any material impact for us at this point in time.
You saw it in the margins that were presented in the presentation today. The impact that we had in aluminum, which started last year and Chris did refer a few times in his speech, is about inflation, which has nothing to do. From a purely trade standpoint today, the whole situation in relation to NAFTA between the U.S. and Canada had no material impact on our business at all. Do you want to pick up the other one?
On the cash flow, I think probably it's always a bit hard to sort of talk about where people are versus their expectations because we can't get inside the head of everybody's expectation. What we have observed, I guess there's slightly higher CapEx. There's increase in working capital, trade working capital. About half of that is good, because it's higher prices and so on in receivables and the like. Probably the biggest single difference that some people have fully understood what we were saying at the full year and some haven't, is the timing of that tax payment of $1.2 billion to the Australian jurisdiction that actually pertained to 2017. It's a good outcome for us because we had hung onto the cash for an extra six months in our own balance sheet.
The net debt at the end of last year, if you recall the presentation, we talked about $3.8 and we pro formed it for that tax payment was in the numbers. That would have taken us to $5 billion at the end of last year. If you go to this year, we're $5.2. I think all up we've got a strong bias on cash generation. I think we still need some more detailed attention on the working capital to make sure our guys don't relax on that.
Yeah.
Some of it's good because it's price related in our favor. Our number of average working days has gone up a couple of days. That's work that we've got to get the businesses focused on.
We go back to the room. One in the front, then I come back to you, Paul.
Hi. Dominic O'Kane, JP Morgan. Just three quick questions. On aluminum costs, just maybe push a bit further on to H1 versus H1 2017 performance. You saw a roughly 30% increase in unit cost driven by raw materials. How should we think about second half this year? Do you think there's capacity to keep that flat at best? Do you think we should be thinking about further raw material cost increases in primary metal? On Grasberg, obviously reported $3.5 billion potential exit. Should we expect any tax payable on that amount in CGT? Then final question, diamonds. Did about $100 million of EBITDA in diamonds in H1, roughly $50 million of free cash flow. Does that remain a core division?
All right. I'll deal with the Grasberg one. We've signed a head of agreement, as you know. The one thing I said in the speech is the three teams, because there are three parties, are working very hard to come to a conclusion documentation. The target is still to sign before and get the cash before the end of this year. As you know, a transaction, until you sign and until you get the cash on the balance sheet, you don't have a deal. Okay, let's be absolutely clear. Back to what happened during the night, I know there are a few people in the back row here who were slightly concerned that we won't get the cash on time. We're working hard to get it. On the taxes, discussion underway.
Seen from today, we don't see a material tax payment on the back of it. Those discussions are taking place with the relevant tax authorities. We'll clarify the situation closer to the closing transaction. Diamonds today we have two mines. Do we like diamond as industry? The answer is yes. You know Dominic what I'm going to say is, if people think that copper is difficult, we always use copper as a baseline. Between the time you have a nice rock and the time you got cash flow is only 25 years on average. In diamonds, it's only 30 years. It is a very attractive industry, but it is very difficult to find world-class asset in that space, right? Are we spending money or resources in the context of exploration diamonds? The answer is yes.
You see it in the QRs and so on and so forth. We have an extensive program of exploration in that space. In that sense, to answer your question in very direct ways, diamond is important for us. Now we need to acknowledge that we have only two mines today, and they are on their last leg. We can see the closure coming and the work, a big chunk of work is taking place as we speak to make sure that when the time is right and when we have to close those mine, we will do it the right way. Yes, we like diamonds. Yes, we're spending money and resources in the exploration space. We're going to have to be patient, but trust me, I'm putting our friend from exploration under massive pressure to move fast in that space, and I will continue to do it.
As we say, I would love, absolutely love to find a new big diamonds mine, to be honest. I may have to wait for 30 years. Whoever is standing here in 29 years may have a good piece of news. Not for me to tell, right? Lynch.
I like costs.
I think you can do it.
Yeah. Well, the key, the year-over-year increased about $200 million. Your question was really about going forward. I really can't give you any better guidance than probably maintain the same sort of basis into the second half. They seem like they're stabilizing and leveling off, but time will tell. It's primarily the inputs of caustic pitch and coke. They're the main inputs into that mix, and you'll see that across our peer group variously as well with those same items coming through. The carbon material is also a factor for us in the TiO2 business, the RTFT business. With the furnace activity there. I don't think I can give you much better than that really.
I'm going to build on what Chris said. Let's be clear, inflation is hitting all commodities and all players across the industry. I'm going to use one matrix. We did check, was it a week ago, 10 days ago? In Australia today, if you go to advisor sites where you look for jobs and so on and so forth, you've got 40% more posting for jobs in the mining business than a year ago. I slightly smile when people are saying, "Oh, inflation is not going to impact us," and so on and so forth. If you got 40% more requirements for job in Australia, guess what will happen? All right. Our position is very simple on this one is we acknowledge the point.
We did highlight this concern, this risk around inflation November, December last year. We have taken actions. Our approach is to acknowledge the challenge and try to take as many actions as we can in order to mitigate the potential issue. I think what you saw in the result this morning, the fact that we were able to deliver 43% EBITDA margin on the back of our mine-to-market productivity program is a good example of it. We acknowledge the challenge, and we get on with it. Mine-to-market, it will be absolutely essential in the coming years because inflation is coming back. If you look on the CapEx front, all majors in Australia have announced in the last few weeks major capital program in WA. Once again, what's going to happen?
Inflation is coming, therefore, it's even more important for us not only to apply mine-to-market to our existing asset, but to apply our mine-to-market approach to the capital space as well. That is actually what we're doing. If I go to the back. Come on, Paul. Yeah.
Thanks very much. Paul Gait, Bernstein. A couple quick questions. You alluded to supply-side reforms in China in terms of steel capacity, but we've also seen that in terms of the iron ore, domestic iron ore production in China has come down quite markedly year-on-year. Just wondering if you could give us some thoughts about what you're seeing there. Second of all, in terms of the Pilbara Blend, and of course Koodaideri feeding into that, but how long can you actually maintain the quality of the Pilbara Blend in sort of roughly today's specifications given the reserve base that we've got or rather you've got? Then finally, in terms of Grasberg, terms of agreement at the minute, are you still involved in that discussion process or does this essentially now represent Rio Tinto sort of taking a step back from those discussions? Thanks very much.
Yeah, on the Grasberg piece is pretty simple. We're still involved in the discussion because, Paul, at the end of the day, Rio, we have to sign the SPA with the government of Indonesia, and only Rio Tinto will sign it, okay? I'm not going to delegate anybody to sign it on our behalf. Do you agree with that?
Yes.
Good. We are involved on this one, and as I said, the three teams are working hard, and the sooner we can sign, the better it is. On the iron ore in China. We have 200 people in Shanghai, and we have a big team in China, and part of their job is to find out about it. If you go back a few years ago, our understanding was the local domestic production of iron ore was around 400 million tons. They dropped to, at some stage, 225 million tons. We believe in the first six months of this year, post-winter cut, we're back. There is some uncertainty, but if I had to pick a range between 235 million tons and 245 million tons, maybe slightly below 250 million tons if you want to be on the toppish side.
Interesting enough, our understanding is primarily a lot of it is underground and not open pit because of pollution, environment concerns, and so on and so forth. There is, compared to the question asked one year ago, two years ago, we have full confidence that the iron ore production, the domestic iron ore production will continue to reduce, because it's high cost, but more importantly, the environmental concerns are very significant, hence my comments about open pit versus underground. That's the best view that we have today. Once again, we acknowledge that there is a risk around this one, and therefore, back to my previous point is we need to work on what we can control.
Today, what is important in the iron ore business or the aluminum business or the copper business, making sure we've got the right cost structure, and you saw the cost structure now I know which is pretty good. I know some people had some concern, and you saw that hard work to get to this point. Having the right quality of product, and I'll come back to your second question, and having the right relationship with the customers, and so on and so forth. All in all, if you got those parameters right, then you will have a strong market share, you will generate a lot of cash, and as I said earlier, be able to continue to invest in the long term and be able to reward your shareholders as per our commitment.
On the question of Pilbara and the ability for us to maintain the Pilbara Blend. If you think about in the next 5 to 10 years, because we have a long-term plan for obvious reasons. You got a resource of more than 100 years. If you look at the short term, 5 to 10 years- I know people smile when I say that. Do we have a concern about our ability to maintain the Pilbara Blend ? The answer is no. Okay? On a regular basis, we do this long-term mining plan that we're going through this process at this point in time, but for the next 10 years, we don't have a concern whatsoever. As we said many times, and you know better than anybody else, is 10 years in mining business is pretty short-term, right? Can I go back to the front? Front row.
We will now take our next question from Clarke Wilkins.
Mine is also-
Please go ahead. Your line is open.
[audio distortion]. Just one on price.
Hi, Jacques.
Internally and from shareholders to deliver more than just 2% volume growth over the next five years. Are you seeing, related to that, more opportunities on the M&A side? Are the right assets at the right price, or is it still effectively a no-go? Secondly, maybe with Pilbara iron ore unit costs. Doing a good job first half of this year. As we look forward with AutoHaul, with the volume increase, is the potential for unit costs to go down on a two-year view despite inflation, or is best case, stay where we are?
All right.
You pick up the iron ore? I'll pick up. The growth, well, we're going to start the roadshow in a few hours for obvious reasons. On the back of the conversation, the last round of conversation was the time of the Bank of America Merrill Lynch. I should get a discount for that next year, Jason. Conference in Miami and the subsequent investor roadshows we have in New York and so on. No, we're not under pressure in terms of growth today. Yes, there are some questions about where you're going to go in the long term and so on and so forth. We fully acknowledge that in the mining business, you need to grow because depletion is a reality, and therefore, if you don't grow, you can have a problem. Today, we are not under pressure from that perspective. Okay?
What is important for us is to develop a pipeline of attractive growth options. Right? Today, when I look at what we are delivering, we deliver Silvergrass, we're talking about Koodaideri now, we have Amrun around the corner, which should come in line pretty soon. We've got Oyu Tolgoi. We never stop investing, including at the bottom of cycle. For us, it's about delivering high-quality growth. Some people have a mantra of being big. The mantra of Rio is to be focused and to be profitable and to deliver superior return for our shareholders. Right?
It's better to be very focused, making sure you deliver your project on time with the right quality, the right safety performance, and so on and so forth, than just growing for the sake of it, and then not having your A-team working on it, and then ending up with lots of overruns and so on and so forth, which, if you look at the last 10, 15 years industry, has been a feature of the industry. I would rather grow below GDP, if I'm honest, but it has to be high-quality growth, and making sure we deliver it on time, and as I said, on budget. That's where we are. M&A, you know what I'm going to say. Everybody knows which asset I would love to have in the portfolio, but we're not going to do anything stupid. Absolutely not. We'll keep the watching brief.
If there were to be what we describe as smart M&A, where you have synergies because you've got a logistic advantage or you've got technology advantage or whatever, yes, we will look at it, but you need to have the right level of synergy to justify any kind of premium. Do we have teams looking at all kind of options? The answer is yes. We've been very transparent on this one. We have a watching brief on M&A, but today, at this point in time, there's nothing that really excite us. We have to be patient. You know mine's better than anybody else, I guess. That sometimes in mining business, you have to wait for 20 years for the right asset to come at the right price, and so on and so forth. Having said that, I repeat what I said last year.
The last trough was not deep enough, long enough for the premium asset to be released. All of us had lots of expectation that it was coming, but unfortunately or fortunately, depending on how you want to look at it, the market recovered. Some people had some near-death experience, let's put it this way, and the assets were not released to the market. We'll be very patient. History shows that the bulk of the M&A don't create value anyway. You need to be very selective, very focused. History shows that the best growth option at the end of day are your organic growth options. We're pushing hard on the organic growth option, and we keep a watching brief on the M&A. Do you pick up the iron ore and the inflation issue, Chris?
Yeah. Iron ore is not immune from the threat of inflation. What our challenge is to offset that. That's where we'll be targeting with the productivity agenda. Obviously, things like the oil price are showing pretty healthy sort of increases over the course of last year. We will be entering more below water table-type mining as well. We're going to add longer haul distances. We do have some challenges coming our way, which it's important that we get the productivity agenda in full run there. Where we need to attack our costs is on the first line of entry into the business. The volume absorption is one thing, but the first spend is really where you want to attack it. The guys have done a great job over the last 6 to 12 months in easing that rail bottleneck.
We've now got a position where the rail is more tuned to the port capacity. We've got a bit of flexibility in the system there that wasn't there up until about, well, early in this half. I think, we don't give you guidance about the cost, as you well know. I think there are a series of factors there. There's a good challenge there, and the team, Chris and the team are more than up for the challenge, that threat of inflation is there and it will be there, and it's going to be a constant. Once we get the early works on Koodaideri. That's an encouraging thing. Once we get that in play, assuming that that comes through the normal approval processes and the like, that's going to be a very exciting mine.
I'd love to be around when it's.
You can come back, Chris.
Yeah. Well, I hope I'm still around as a shareholder.
We welcome all shareholders.
It's pretty much going to be a fully automated mine, and you'll have on display in one side quite a lot of the functionality that we've been working on for the last decade.
All right. John is telling me we have time for two questions. We'll take one from the call, and then we'll come back to the room. One from the conf call. David?
We will now take our next question from Mr. Clarke Wilkins from Citi. Please go ahead. Your line is open.
Hi, J.S. A question on bulk side, also on iron ore. On your comments earlier about the uncertainties around that market. When you look at your volumes, you've got increasing volume coming from Amrun as well as from Guinea. Is it primarily a price risk or is it also a volume risk? Are there any offtake volume for those projects? It's very much shorter-term sales contracts. Depending on what happens to the market, is there a volume risk there? In regards to iron ore, the comments around grade discounts being more structural.
We've obviously seen recently impurity penalties rising quite significantly, given your comments around China domestic supply continuing to fall, is there a chance or is there a potential that the impurity penalties in the market are also going to be more structural? Is bringing forward CAPEX a potential way to adjust the quality of that Pilbara Blend?
Two very good questions. On the bulk side, the key question for us is mainly about Amrun. Remember that half of the additional capacity of Amrun is replacement capacity, the other half is regrowth. Do we have any concern today in our ability to place the growth element of Amrun when it comes online? The answer is absolutely no. We don't have concerns from that perspective. On the iron ore pricing is, without getting into the detail too much, the impurities are already priced. If you look at the pricing formula, it's not only about the Fe content. There are adjustments for alumina, phos, and so on and so forth. The pricing exists already there to adjust for those impurities.
Your question is absolutely spot on, our experience is because of the pressure from SASAC and the government in China in relation to environment, the management of the burden of the blast furnaces is becoming more and more important. Last time I went there, I met with some of the engineers or some of the people at our customer site, I can tell you I've never seen, and I've been traveling to China for many, many years in the context of steel. Remember, I used to work in the steel business before joining Rio Tinto. I've never seen our customer knowing how well to manage their burden, how well to run the performance of their blast furnaces, and so on and so forth. It is absolutely clear that our customers in China are becoming closer to the customer we have in Japan.
Very aware of how you optimize your blast furnaces, I'm sure that the question about impurities, the phos, for example, and alumina, will become something which can be a feature. The point is, the pricing already accounts for those adjustments, and so on and so forth. That's where we are. One last question in the room, we have to take the other question during the coffee break. Go for it.
Morning. Liam Fitzpatrick from Deutsche Bank. I'll keep it to one. Just on the Canadian-
One for Chris. Come on. That's his last set of results. I don't know what the question is going to be, Chris, you have to pick it up mate.
Over to Chris. On the Canadian aluminum expansions, you've been flagging them for a while. If the market does tighten, can you give us a sense on timing? Could we see these approved early next year, or are these much more long-dated options?
We are a few years. I'll pick it up, this one, because you won't be there, that's for sure. Maybe as a shareholder you'll be there, but we are a few years away. Okay? For us to take a decision to build a new smelter in Canada, okay, we need to be absolutely convinced that the structural change in China are there. Okay? I've got no doubt that in medium and long-term, China is moving in the right direction. China will become more and more balanced. Until we get to this point, we do the work, we do the study, we're ready. We will become option ready, option rich, option ready. We are still a few years away before taking a decision to add capacity in the aluminum space. That's one aspect.
Having said that, we are looking at option, like we've done forever, to expand the capacity of our aluminum smelter on the back of brownfield, on the back of creeping, because that is productivity and so on and so forth. Before we take a decision to build a brand-new half a million ton smelter in Canada, we're still a few years away. I invite you to open the smelter, Chris, when it happens.
That'll be good.
On this note, we're going to have to stop. Thanks for coming. I know you love your numbers and so on and so forth. The only two numbers you should remember is $7.2 billion of return to our shareholders and $2.2 of dividend, which is the highest in the 146 years. Oh, that's three numbers. History of the group. Thanks a lot. We'll talk soon. Thank you very much.