Morning, everyone. Hello? Great. It's 10 so we'll get going. Thank you very much for coming along to our half year results.
If you could put your phones on silent, please. There is no alarm set for this morning. If the alarm does go, the best fire exit is the one just back through the door where you've just come. Deutsche Bank don't have muster points anymore. They run at dispersal.
So if the alarm does go, you go out and leave. Okay. With that, I will hand over to
J. S. Thank you.
All right.
Thank you, John, and good morning, everyone. I'm delighted, together with Jacob and the team. So we've got Chris, we've got Simon, Arnold, Steve, Bolt, there are, I mean, the longest today, to welcome you to our 2019 half year results. It has been a very strong financial performance. We have delivered an EBITDA margin of 47%, the highest in the last 10 years, and the return on capital employed of 23%, in line with the best in class industrial blue chip companies.
We have delivered free cash flow of $4,700,000,000 up 65% compared to the same period last year. We have maintained a very disciplined approach to capital allocation. We have paid $7,800,000,000 of cash return to our shareholders so far in 2019, delivering on our commitments. And we have just announced we will return a further $3,500,000,000 in dividends. As a result, our shareholders will receive $12,000,000,000 in cash returns in 2019.
We have invested $2,400,000,000 in our asset, a similar level to last year. And we have one of the strongest balance sheet in the sector with a net debt at $4,900,000,000 which highlight the financial strength of Rio Tinto. So our financial performance was very strong, thanks to a robust iron ore pricing environment. However, I want to acknowledge upfront, we have experienced operational challenges this year, including fully optimizing our iron ore system. This is not good enough, and we are taking clear actions.
I will take you through this. I will also cover our plans for Yutogoy and update you on other growth options. As I've already mentioned, a number of the team are here today with me, and they'll be happy to take additional questions you may have after the presentation. Now let me turn to one of our operational highlights of this half, safety. As I've said it before, safety is our number one priority.
There is nothing more important. In 2019, we have had no fatalities. Our AFR has improved. Our severity rate has reduced and there has been a reduction in process safety incidents. But we are not complacent.
We continue our focus on major hazard risk management, interrogating our tailings and water storage management in even more detail. After the tragic incident in Brazil, we continue to look at everything we do. And as you know, in February, we disclosed our global tailings and water storage facilities and our controls and approach to managing them. We provided even further information in June. We are working with the ICMM and our peers in this space to develop an intentional standard on tailings storage facilities.
Our aim is to continue to improve our safety performance, which is a core part of our approach to sustainability. Sustainability is an absolutely vital part of doing business in the 21st century. It is not a new initiative, but central to the way we run our business. Key to our approach to sustainability is profitability. We are not if we are not profitable, we cannot contribute positively to the world around us in the long term.
We have 3 key areas of focus: 1st, running a safe, responsible and profitable company secondly, collaborating to enable long term economic benefits third, pioneering materials for human progress. We progressed on all three of these in the first half. I've already covered safety, so let's take a look at a few more of the performance highlights. In February, we published our first climate change report aligned to the TCFD framework, which outlines our key areas of focus. To number 1, supply essential metals and minerals for the transition to a low carbon economy.
2, is reduce our own carbon footprint 3, identify and assess physical risk exposures 4, partner and advocate for policies that advance climate goals. In the first half, we made further progress to reduce our Scope 1 and Scope 2 emissions. Let me give you an example. We closed our coal fired power plant at Kennecott and switched operation to renewable electricity purchased from the grid. We are currently investing in various climate related initiatives around the group from our partnership with customers like Apple and Elesys to produce carbon free aluminum to our partnerships with Chinyere University to the World Bank and a few others.
We are also working hard on our post-twenty 20 emission reduction targets. These targets will be well thought through, and you will hear more on this next year. We are also committed to transparency. We have shown that this is not only in the area of tax paid but also in the disclosure of some contracts with governments. We finished number 2 in the corporate human rights benchmark of global companies only behind Adidas.
And we are proud of our innovative partnerships. For example, our collaboration in WA to create qualification in automation. We do not claim to have all the answers on sustainability. It is a complex area. We do though understand and mitigate against our material risk, and you will see us do more in this area.
And now on this point, we'll now return to you, Jakob, on the financials.
Thank you, J. S. Ladies and gentlemen, good morning. As JES has already told you, we have today disclosed a set of strong financials. When you look at the profit and loss and cash flow statement from top to bottom, you'll see that all underlying comparisons from the first half of this year to the first half of last year have improved.
Our top line has improved by 3%. However, if you exclude the coal businesses that we divested last year, the underlying growth is 7%. We saw double digit improvement in EBITDA, and we saw an even stronger improvement in cash from operations and free cash flow due to a high cash conversion in the first half. Following our project update on Neur Talgoi announced on the 16th July, we have impaired the asset value with a net income impact of 0 point $8,000,000,000 We have taken a cautious approach, which captures the average of a range of potential outcomes. This oil tolkoy impairment represents the main variance between IFRS net earnings of 4,100,000,000 and underlying earnings of CHF 4,900,000,000 J.
S. Will provide a further update on Oyu Tolgoi later. Because of strong earnings and a strong cash conversion, the Board was able to both increase the interim dividend to $3,500,000,000 while we continued to strengthen our balance sheet as demonstrated by the reduction in pro form a net debt. Now let me step back before diving into the details of our results. The value creation expressed in terms of profitability and growth is strong for BIUTENTO.
Our profitability continues to improve and reached the highest level of recent record in the first half. We saw our return on capital employed reach 23% and this is based on underlying net earnings after tax. Despite being in a very capital intensive business, our road share is not only the highest amongst our industry majors, but as J. S. Said, at the top end amongst industrial companies in general.
We are also a growing company. Over the last three and a half years, our growth have been a CAC of 2.5%. The first half of twenty nineteen was affected by weather and operational issues at the Pilbara. We expect though to return to production growth in the second half of the year, of course, always driven by our value over volume mantra. China's economic growth has been strong in the first half supported by fiscal stimulus while the rest of the world has experienced a weakening growth.
In aggregate, this impact on our portfolio has in fact been positive with strong iron ore demand somewhat offset by weaker demand for aluminum and copper. The iron ore business has faced rather unusual conditions. We saw strong growth in steel production in the first half. At the same time, we had a very high level of iron ore supply disruptions, starting from the tragic incident in Brazil in January and carrying on with exceptional weather conditions. And we have furthermore experienced operational issues, which J.
S. Will cover later in the presentation. As a result, the iron ore price increased significantly throughout the first half. Aluminum demand growth moderated to only around 1% impacted by, in particular, the transportation sector. On supply, as we anticipated restructuring in the Chinese aluminum industry has been modest today.
And in January, we saw the sanctions on russar lifted, meaning that more supply came to market. As a result, there has been a decline in price during the first half compared to both the first and the second half of twenty eighteen. The Midwest premium though has stayed stable to the tune of $400,000,000 sorry, dollars 400 per tonne. Now moving on to copper. The slowing economy world economy has impacted market sentiment and demand growth.
Combined with limited disruption in supply, this has resulted in an 11% deterioration in the copper price compared to the same period last year. Our underlying EBITDA in the first half of 'eighteen was SEK 8,600,000,000 when you exclude the coal business that we still had last year. Higher prices were driven by the iron ore and favorable exchange rates, particularly by the weaker Australian dollar. Overall, the lower EBITDA compared with the flexed EBITDA for the same period last year is entirely due to weather conditions or weather disruptions in the Q1. When we last presented to you here, we set out a target for this year to reach a run rate productivity improvement of $1,000,000,000 Given the revised guidance production guidance in iron ore, that will not be achieved.
The weather in the Pilbara removed around $200,000,000 from our productivity initiative. And as a result, we have seen a run rate reduced from SEK 400,000,000 at last year to $200,000,000 in the first half of twenty nineteen. However, more importantly, the planned improvements in productivity primarily in iron ore was not achieved and hence we are updating the full year guidance. As a group, we are though confident that we will improve from here in the second half of the year. Our updated target run rate is $500,000,000 for 2019.
We recognize the operational issues we have experienced in the Pilbara and addressing them will rigor. However, looking forward, we anticipate generating between $1,000,000,000 $1,500,000,000 of additional free cash flow by 2021. This new range is subject to an increase in iron ore volumes, which will be dictated by market conditions, of course, and a reversal in raw materials cost, primarily in our aluminum business. Now let me move to the results of each of the product groups. As previously mentioned, we've seen a significant hike in the price of iron ore.
This has progressively developed throughout the half year. On average, the improvement in the realized price was 35%, whereas prices towards the end of the period are materially higher. Shipments in the first half fell short of our expectations. We had expected higher shipments compared to previous year and instead we saw an 8% fall. The shortfall against last year can be explained by weather impacts at a fire at Cape Lambert A and the operational issues which J.
S. Will cover later. The overall operating cost measured in U. S. Dollars is at the same level as last year.
Hence, the lower volume is entirely driving the 9% increase in unit costs. As a result of lower production guidance and additional total material moved, we have also updated our operating cost guidance from $13 to $14 per tonnes to $14 to $15 per tonnes. The financial metrics are very strong, and we saw improvements in revenue, EBITDA and cash flow. And it is important to note that we have increased our investments in sustaining CapEx to improve the future reliability of our world class assets. Our integrated aluminum business has faced a challenging price environment that kicked in, in the second half of last year and has further deteriorated in the first half of this year.
You'll see the achieved aluminum price is down 15% and the alumina price is down 17%. We saw a slight increase in bauxite production as the Ameren ramp up exceeded the negative weather impact. Our integrated aluminum business is like the rest of the industry experiencing right now a tough environment. Our financial metrics demonstrate this difficult environment and we ended up with a return on capital employed of only 4% in the first half. Fortunately, we are well placed to weather the storm.
We have the highest margin in the industry, and it looks like we have only extended that position in the first half of this year. We also try to take advantage of this by doing everything we can to improve efficiency and reduce cost. You will see that our unit costs have gone down by 5% and we had a 1% production creep in the first half. Nonetheless, profitability is not at all at the level where we wanted to be and hence we are therefore also very disciplined in our usage of capital protecting the free cash flow from aluminum. Copper and diamonds as a product group faced lower prices in the first half, but demonstrated stable performance against a strong prior year.
The continued productivity improvements at Kennecott were particularly highlight. We saw a significant reduction in unit cost, mainly due to higher productions of byproducts, which we do not expect will continue into the second half. Copper production was down 5% and at the lower end of our guidance. This was due to lower grades from where we are currently mining in the pit rather than a performance issue. Overall, the financial metrics are fairly stable.
It was a good first half last year and it was a good first half this year. We see stable margins and a small variance in the financial statements. Return on capital employed of 6% includes significant development CapEx of not yet producing assets and significant expense costs for developing our growth options of resolutions and WiNO. Finally, Energy and Minerals experienced a strong recovery after a year of disruptions in 2018. Production is up significantly.
At RTIT, 2 rebuilt furnaces were restarted in the first half. The third will start in the second half of this year. Also IOC was impacted last year by a strike. The financial metrics have improved significantly with revenue up by a third and EBITDA more than doubled. Energy and Minerals obviously benefited from the high prices enjoyed for iron ore pellets, but also from higher titanium prices.
Return on capital employed continued to improve ending at 15% for the first half. Overall, it's a profitable and highly cash generative business. We continue to explore opportunities to further grow our business. In the first half, we approved $500,000,000 for further investments in the Salty South project in South Africa. During the first half of the year, we have continued with a disciplined approach to capital investments.
In total, we invested $2,400,000,000 similar to what we invested in the first half of last year. What you will see though is that we have invested more in sustaining CapEx so that we are taking best possible care of our existing assets and ensuring the future sustainability and reliability of our operations. Investments in growth projects was somewhat lower than anticipated, mainly because of completion of Ameren and less ramping up of our spending in Neur Talcoy than expected. Overall, the picture remains the same. We are in a phase of ramping up our investments from SEK 5,400,000,000 last year, and we expect around SEK 6,000,000,000 this year and around SEK 6,500,000,000 next year.
We know we are going to spend the money, but there will always be some uncertainty over the exact phasing and some of this year's investments may tick over into next year. The strong cash generation and disciplined approach to capital means that we are able to further strengthen our balance sheet. Adjusting our reported net debt for future commitments regarding share buybacks, the return on disposal proceeds, tax lags combined with the new IFRS 16 rules changes shows a very consistent pattern of deleverage, taking the pro form a net debt from $8,000,000,000 at the beginning of the year to $5,600,000,000 at the end of June. We are very comfortable with this level of net debt. It provides optionality and the ability to provide superior cash returns to our shareholders.
As previously announced, we have paid out $7,800,000,000 in the first half. On top of this, we have $700,000,000 of our ongoing share buyback program still to be completed between now and the end of February. Today, based on our first half results, the Board has approved an interim dividend of $2,500,000,000 which again represents 50% of underlying earnings. We have also approved a special dividend of $1,000,000,000 That brings the overall payout ratio to 70% and takes our total cash return paid in 2019 to approximately $12,000,000,000 In summary, we have today disclosed a set of strong financial results. We are a very profitable company and our profitability is increasing.
This enables us to make significant investment in further improving our world class assets and pay superior returns to our shareholders. However, we fully acknowledge that we have had operational issues in the first half and we're working hard to address those. Before closing, I'm delighted to announce that we will be hosting a Capital Markets Day here in London on October 31. I look forward to seeing as many of you as possible on that date. On that note, let me hand back to you, J.
S. Thank you.
Thank you, Jakob. Now let's focus on the macro outlook and the fundamentals of our industry. Overall, they remain positive. As you know, there are 2 key drivers for the mining business, GDP growth and trade. On the first, economic growth is relatively stable.
Despite consumer confidence being at record highs, the U. S. Economy is showing signs of slowing, and we saw it last night. And we see trade tensions starting to weigh on industrial indicators. Now in China, our main market, as expected, growth is slowing, But we're still strong at 6.3% for the 1st 6 months of 2019.
I mean, this year, I spent quite a lot of time in China. And on one of my visits, I mean, I attended the CEO Council of Global Business Leaders where I heard directly from the Chinese Premier that the government is focused on targeted stimulus measures to support domestic growth. And we see evidence that these policy shifts are working. For example, regional light rail projects, urban renewal programs and increased infrastructure investment are ramping up. On the second driver, trade.
Volatility and risk remain. And while we see this reflected in sentiment, we have not yet seen total volumes of global trade meaningfully impacted. This is why I remain the optimist in the room, and I'm still hopeful that common sense will prevail. Now of course, the real question is, what do these macro conditions mean for those of us in the commodity business? Let me share some thoughts on iron ore on aluminum and copper.
We continue to see a positive outlook for iron ore on the back of strong demand and supply disruptions globally. There have been record levels of steel production in China at the run rate above 1,000,000,000 tonnes per annum over the past few months. Seamless measures I mentioned have encouraged property and infrastructure investment, which has largely flowed through into consumption. At the same time, supply has been weak. In 2018, for the first time this century, we saw no growth in iron ore seaborne supply.
It remained almost flat at 1,600,000,000 tonne. The industry has experienced a material level of disruption, equating to around for the full year in 2019, around 100,000,000 tonnes, which compares to around 40,000,000 tonne in 2018. There are multiple reasons, including the tragic events in Brazil, operational and weather issues in Australia and significant weather impacts in Northern Brazil. These combined factors have seen a lowering of port stocks in China with around 26,000,000 tonnes drawn down in the first half. As we have been saying for some time, the opportunity for supply side response from Chinese domestic mines is less now than in the past, driven by several factors, including permitting environmental regulations, driving transition to underground mining and small artisanal miners have stopped producing some time ago.
So all in all, we see the outlook for iron ore remaining positive. As we are on the topic of iron ore, let me share what we are doing to fully optimize our PBR system, to maintain product quality and the reliability of our supply chain, particularly the Priba blend, our flagship iron ore product in China. The value of the PYRABLEN for our customers is clear. Its very consistent chemistry provides a baseload of burden management in their blast furnaces and sinter plants. This is reflected in the price it commands.
This blend combines all from a network of mines, including Town Price, Hopdowns, West Angeles, the Brockman Hub. And from 2021, Kodalyri will be a major contributor. Of course, as we clear, the Pilbara plant is not the only product. Overall, our annual system comprises, as you know, 4 ports, 16 minutees, 1700 kilometers of rail and around 400 trucks, the big trucks, of which around 150 are autonomous today. As you would expect, the focus for us is to run the system first and foremost safely and then to maximize profitability by providing the quality product our customers want, but not at the expense of short-, medium- and long term sustainability.
So let me first talk about the mines and then the rail. We have been ramping up all parts of the Pilbara system for several years, including Port and Roll. In a context where we deferred capital on Silver Grass and Cudallari for a number of years, it was the right decision to preserve capital, but it did require us to run our existing mines harder. As we disclosed in June, we are experiencing operational issues, particularly at our Greater Brockman Hub. We have fallen behind in mine development and waste movement.
This resulted in us producing a higher proportion of lower grade ore and restricted our ability to access the right ore at the right time to produce a pitroblend. This is a sequencing issue that happened for several reasons, including a challenging transition to autonomous trucks at Brookman 4 and more broadly, some pockets of inadequate equipment and workforce retention. None of this is acceptable full stop. So we have made 2 major decisions to protect our Priba brand. 1, we have reduced plant production in 2019 and changed our production guidance to between 320,000,000 and 330,000,000 tonne.
2, we are increasing our planned total material movement across the Pilbara mines by a few percentage points. To do this, we have brought in extra equipment and contractors. We'll spend around $80,000,000 in 2019 on this activity. The work is well underway, and further investment will be required in 2020 to increase the resilience, the health of the system. We will not stop until we have fully optimized our system.
As you know, our other main focus is the pillar in the pillar is rail. It's worth remembering that our 1700 rail system in pillar is one of the most utilized heavy roll rail networks in the world. To further optimize our Epilroa system, we continue to invest in the maintenance of our rail network to ensure reliability and sustainability of these critical assets. This includes a major shift towards the end of Q3, which we advised you of last month. This will be an ongoing feature of our rail maintenance program.
In this context, subject to market condition, we will continue to optimize our business from here with 3 principles in mind: 1, the quality of our product and relationship with our customers 2, EBITDA margins and last, strengthen the health of our asset base, underpinned by the right level of cost and sustained CapEx. We will provide annual 2020 guidance at our upcoming Capital Market Day in Q4. Moving to aluminum. There is no doubt that the current aluminum market is changing with 3 key factors impacting on the market right now. 1, we sold inventories that we have built during the U.
S. Sanctions are still flowing into the market as we are having this concession. 2, the global auto sector is currently at a cyclical low and a slow restructuring in China. However, stocks inventories continue to decline. As we look ahead, the long run fundamental for aluminum remained positive with demand driven by return to train growth on automotive, light weighting and electrification and on the other side, on the supply side, governed by restructuring China as well as market forces.
On Doctor Copper, macro conditions and market sentiment continue to impact the price, as demonstrated by investment flows into copper future. On the physical side, despite low mine disruption in the first half of around 3% compared with the recent historical average of just over 5%. We expect mine supply to contract by around 1% in 2019. And we expect the market will remain relatively balanced in the short to medium term. Longer term, copper fundamentals remain strong, driven by the adoption of electrical vehicles, the electrification of industry and the growing share of renewables in the energy mix.
On the supply side, ongoing resource depletion will require considerable investment in new and replacement supply in the long term. Moving to growth. We have a strong pipeline of future growth options in iron ore, in copper and in minerals to name but a few. Starting with iron ore, we are investing in new projects in Epiira, including Cudadiere, our most technologically advanced mine to date and Rodd River sustaining mines. At Kudailleiri, engineering and construction is progressing to plan.
And we are starting to study on cudaille d'Aurey Phase 2. At the Rob Rever joint ventures, we have West Angeles and BESAS B, C and H, certain projects underway. All are progressing well, except in BESAS H, where there are some delays with environmental approvals. We are working with both the state and federal governments to resolve it as quickly as we can. Of course, our investments are not limited to iron ore.
In the first half, we have also approved an investment in Zolty South at RBM. The project offers an attractive return with an IR of 24% and is expected to come into production in late 2021. This investment of around $463,000,000 Rio Tinto share of $343,000,000 will be fully self funded from RBM's cash flows. We are working on the framework agreement with the provincial governments and communities, and we have all the permitting and approvals to proceed. Expect to start investment in that project in the coming weeks.
On the copper side, our project in the U. S. Resolution is progressing well, and we expect the environmental impact assessment to be finalized in the coming week. And of course, we are also progressing our copper project Vinu in WA, which I will touch on shortly. Now let me give you an update on the Utegoi in Mongolia.
Oti or Utegoi is one of the best undeveloped copper resources in the world and has been in operation since 2013. It is one of the safest and most productive mines we have. The underground project is where the bulk of the value lies. It is also one of the most technically complex underground mine construction in the world in one of the most remote location. The project has 3 main components: the aboveground infrastructure, the shaft and belowground infrastructure and the mine development.
As you can see, substantial progress has been made in all three areas over the last 3 years. We have installed most of the aboveground infrastructure, the control center, the overland conveyor, the 5,500 percent camp and the batch plant. And we are well underway with the large equipment on the ground such as the production and ventilation shaft, the large low crusher and facilities for workforce. We have also done a significant amount of underground mine development. As we have progressed, we have experienced tougher than expected geotech conditions, which are impacting on a number of fronts and have resulted in slower than expected mine footprint advancement, slower conveyor to surface progression and the growth in the overall quantum of work.
As we drill underground, we identify weaker rock in the western side of Panel 0, which could cause stability issues and has meant we need to consider mine design options as we progress. The schedule and cost ranges we have disclosed to develop the underground project are driven by 4 key factors: mid access drive requirement and location, lateral development productivity, location of our ore handling facilities and panel boundaries transitions. It is also important to note that none of the options under consideration will impact the existing already built underground infrastructure. It is all about what is ahead of us. The team is doing the work to define the best way forward and to minimize the impact.
The mine design work will continue to early next year, and the definitive estimate will be completed in the second half of twenty twenty. We have significant experience in block caving within the group, and we are working with the best people in the industry on the productivity improvement program with the aim to accelerate the delivery of sustainable production. We are also looking at ways to improve the assumptions made and to optimize the scope of work. Above all, the key considerations are the following one. Number 1, safety, followed by value and sustainability.
We continue to believe OT is a highly attractive and valuable resource. While the underground is a technically challenging project, unlocking the value of this Tier 1 resource will underpin our copper business for decades to come, and we are totally focused on doing so. We need to get this right, and we are working with all OT shareholders to find the best way forward. Moving on to Vinu. As we announced earlier in the year, an intensive drilling program is underway.
Results are encouraging with data now in from a further 42 drill holes. They show wide intersection of mineralization close to the surface. The primary studies have begun, including environmental baseline studies, geotech and meteorological test work. And we are progressing quickly with around 200 people and 11 drill rigs on-site. Work will continue throughout 2019, and we will then be in a position to provide a further update.
Vinu is a great example of the value of our exploration program. By the way, we have invested $138,000,000 in the first half on 8 committees in 18 countries.
So in summary,
once again, we have delivered a strong financial performance. Our EBITDA margin and return on capital employed was the best in the last 10 years. Our cash performance and conversion was strong. Our balance sheet is strong. We have world class assets, but we have room for improvement.
We have the right plan to address the challenges we face, and our priorities are clear. We will keep the focus on safety, drive EBITDA margin and free cash flow, protect the quality of our products and strengthen the relationship with our customers, focus on our performance in the Pilbara and deliver our growth plans, including work at Oyu Tolgoi. We will do this while maintaining our capital allocation discipline and balance sheet strength. Our consistent track record over the last 3.5 years speaks for itself, with $32,000,000,000 return form of cash to our shareholders, including $12,000,000,000 to be paid in 2019. For us, it's all about creating superior returns for our shareholders in the short, in the medium and in the long term.
And then at this point, why don't we open the Q and A. I want to wait for the year.
Thanks very much. Paul Gail from Bernstein. I just wondered if you could sort of elaborate a bit more on OT. And in particular, I mean, if you had the benefit of hindsight, what sort of
That's a good question.
What technical work could you have undertaken ahead of time that would have identified the issues that you're now sort of dealing with?
Yes.
And the sort of learnings for that when we then sort of think about something like resolution and potentially other blockades. And then sort of carrying on from that theme. And then I'm just also thinking about the impairment you've made sort of on the asset. Using an 8.3% sort of cost of capital, given the discussions that have been going on in sort of Mongolia with the government, how should one sort of think about that? Is that and I suppose what I'm thinking about is, if that's 8.3%, how should what's the discount rate for the Pilbara, right?
And then finally, TRQ have already stated that they're going to run out of cash by the end of 2020. So clearly, some kind of recapitalization needs to take place there. And again, how does how are you thinking about that recapitalization and your sort of participation in our team from the state you've got
now? Thanks very much. Yes. So thank you, Paul. I think I'll deal with the last one.
It's an easy one. The funding of Tercosil is a question for the Board of Tercosil. So let them do the work and then we are our shareholder of Turk Ozil and we'll discuss with them when the time is right. So I think this one was an easy one to deal with. The first one, I'll let Jacob to deal with the discount rate and the impairment.
But I think the first one is very important. We should add what is the level of drilling we have done and we could have done. So as you want technical answer, I know, I'm going to ask Steve who's there, who's going to tell us what drilling we have done. I know don't try to make it too complicated, Steve. If we can go back to the slide as well, if you know the slide where you got the footprint and so on?
Go for it. Explain the level of drilling we've done from the surface and then what we could see, what we couldn't see and then the drilling that we're doing now and so on and so forth, that would be great.
Thank you, Jess, and thanks for the question. So of course, in terms of defining the resource at OT, that drilling was done from the surface, a lot of drill holes, 2 to 2.5 kilometers deep and vertical to subvertical drilling. So obviously, what we do there is get a very good definition of the ore body, so resource grade. But what happens is that that in essence disproportionately will identify more of the horizontal structures because you're drilling vertically down through them. It wasn't until we got underground that we can really start to see the vertical structures in more detail.
We can see some of them, but not in detail. As soon as we got underground, as soon as we had access to shaft 1, we started drilling out horizontal holes. They're really the key ones in terms of understanding the infrastructure that you need to put in ahead of you. That drilling was done from the south to the north. And it wasn't therefore until we were able to drift up or develop up to the side of Panel 0 as we can see here and start drilling across it, We actually see the more north south running fault systems.
So in essence, you have to be on the ground, you have to get to off to the side of the ore body, you have to be able to drill across pretty much at right angles to be able to illuminate all of the structures in 3 d. And it was at that point that what we could see were faults on that southwest corner of Panel 0. That's where we are planning, as Jay has said, to build critical infrastructure, things that we call mid access drives or handling systems or passes. And obviously, in those pieces of more broken ground, we either need to work out where to move them to or how to protect them as we move forward. And that's the basis for the mine design underway.
So I think the important point is this is typical for our blockhead, okay? There is nothing new there. And we said in the past is until you get into the ore body, that's where you can refine your design in that sense. So that's what we're going through. And let's be clear, at this point in time, we are looking at multiple options, okay.
So some of the questions, as I mentioned, at multiple options, okay. So some of the questions, as I mentioned, where we're going to put the mid access drive, the RAN link, you can shift it, do you need to have a mid access drive, can you have it and so on, so forth. There are lots of questions and we're looking at multiple options and we believe we will land on something early next year and then we need to give time to the team of Steve to go through all the mechanics of doing the cost and so on and so forth in order to get the definitive estimate. So there was so much drilling we could do from the surface. And we're doing the last batch of drilling as we speak and still drilling as we are having this concession, and we are refining the model to make sure we really understand the stability.
And remember, the model is 1 meter by 1 meter block, okay, as we are having there in order to make sure we understand. And then what is important is, I thought Steve was going to say, it's a 4 d model. Time is of the essence here. So not only you've got the 3 dimensions, but the model is run forward. So as and when we run the cave, then we can see how the stress is going to move into the system and so on and so forth.
So it's a 4 d model. So as you can imagine, you've got 1,000,000 of sales and people have to run those model in order to see what is the situation on day 1, 1 month, 1 year, 10 years and so on and so forth. So it's complicated. It's block cave. We just have to go through the process.
Is there any concern about the ore body per se in terms of copper content and gold content? The answer is no from what we can see today. But what we need to get right, and as I said, safety is the priority number 1 on this one, is to make sure we have something which is stable and sustainable. We're going through this process, multiple options being looked at. We should have a better answer we should have an answer in early next year and then the team will do the costing and we'll come back to the market with a definitive estimate.
That's what we are going through. No different from I mean, you know that as much as I do, some of the other blockades globally. So that's where we are. But I thought it was important to bring Steve today just to give you a better sense of what we could have seen. And your question is absolutely bang on money, is what could we have seen from the surface.
And there was so much you could do and so on and so forth. On the discount rate, an easy one for you, Jacob.
Thank you. So look, with the project update on the 16th July, we also wrote that that was kind of a trigger for our full impairment assessment. And what you do there, you have to kind of separate out. We have a very systematic approach to discount rate because actually all project specific risks you build in with contingencies in your projections. We gave some updates on ranges to cost and schedule, and we have basically weighted a number of multiple development options together.
And then all the cash flow is being discounted. And you quoted a number. And just first thing, because just so that people don't misunderstand that, that number is in real terms. So you have to add the inflation to it. That's important.
So it is, of course, a higher number. Our and actually, you can read it in the accounts because we have a smaller impairments in Nizal as well. Our WACC is to the tune of 6.9%. When it comes to gold business, we have a lower WACC and therefore the weighted WACC would be for the Oryotalka is 6.3% and we add a 2% country risk on it. We have carefully reviewed that, looked at a number of external measures for that, and I think it's an entirely appropriate risking in.
So that's how we have done it. And that's consistent with how we're doing impairment tests than any assets across the world.
So maybe Paul, I can build on this one and ask Arnaud was in charge of copper, in charge of what you told me. I mean he's been involved now for a few years and dealing with the government and so on and so forth. So I know you want to give us an update on the discussion of the government and how you see the sovereign risk from that perspective because we've been in this project since a long time, and discussion with the government has been a feature from day 1 and will be a feature for a long time. Arnaud, do you want to give us an update on this one?
Thanks, Jess. It feels good to be in London actually for a change. So we are in ongoing discussions with the government, as you know. We've agreed 1.5 years ago on working together on some 4 critical opportunities that are addressing the needs of the government and that are looking at how together we can work together within our existing agreements to create more value for all shareholders in Mongolia. So, the 1st working group is dedicated to power.
And as you know, last year, we made an announcement where we agreed with the government's framework, legal framework to be able to build a power station at Tavan Tolgoi on the coal deposit. And so we're working with the government to progress that project and to honor the commitments that we made in the investment agreement about sourcing 100% of our power within Mongolia from coal. The second working group is on the tax. We had a tax audit a year and a half ago that found that the government thinks that we should have paid more tax. And so we're working with the government to resolve this issue.
And we're working in a very collaborative way. The 3rd working group is on interest rates. Within our investment agreements, there is a provision to review the interest rate every 7 years. And so we are in discussion with them on this. And the 4th working group is dedicated to increasing our support for the development of the economy.
If you look at and particularly the local economy. If you look at the big picture, Uyutolgoi is a major contributor to the Mongolian economy already now with the open cut mine. In the future, what we are working with Steve's team in building the underground project is going to make through your Torgoi amongst the 3rd or 4th biggest copper mine in the world. And so this is going to be a huge booster of benefits to shareholders. And we are currently with around 17 1,000 employees, the biggest employer private employer in Mongolia.
90% of our employees are from Mongolia. We've invested around $9,000,000,000 in country. We've paid around $2,400,000,000 of tax or so since the beginning of the project. So, the economic benefits to Mongolia is already very tangible. And we are continuing to work with the government to look at how we can even further increase the benefits within our existing
looking for David, you take question from the front row after. So Dominic first and then
Hello. I'm Donica Kane, JPMorgan. Two quick questions. Just on the CapEx guidance. So your 2019 CapEx guidance hasn't changed, but you're guiding to higher sustaining CapEx.
Yes.
So could you just help us understand what the change is in terms of gross CapEx allocation? And when we look at the 2020, 2021 numbers, which are going to run unchanged, is there anything in there for the OT CapEx revisions, I. E. Should we expect when you announce at the end of next year upside risk to those 2020 numbers?
All right. So Dominik, I'll pick up this one very quickly. There is no change in the CapEx guidance. And we had already in the past guided that over time, we will increase our sustained CapEx. So there is nothing new from that perspective, right?
There is no change whatsoever. We're coming out of a long period of high investment, as you know, and we have the sweet spot where we don't have to spend a lot of money to maintain our assets. But we said that 6 months ago, a year ago, I think we've guided this one for some time that we will increase the sustaining CapEx going forward. And as we would increase as well the replacement CapEx, particularly in iron ore going forward because as and when you move 1,000,000 tonnes every day, then at some point in time, we need to open new mines. Hence, for example, decisions we made on could I vary $2,600,000,000 So there is no change on this one.
The second part of your question on the CapEx, I know you're talking, there will be no increase per se because what you're going to have to do is it will take more time to build the mine and so on and so forth. So that's why there is a link in our range between the timetable, the timing and the CapEx per se. But are they going to be spend more money in the short term? The answer is no for that.
Sorry, second question. That's Arthur. There was 2 questions.
No, that was 2 questions. I was 2 questions.
And I think back in May, you indicated that $6,000,000,000 was the level of net debt that you were comfortable with.
We said $5,000,000,000 to $7,000,000 But okay.
So as we look forward, is that the type of net debt number we should be thinking about Rio is comfortable with in terms of capital headroom and implications for future shareholder returns.
No worries. Yes, look, I'm very happy. I'm going to disappoint you a little bit because we're really not setting a target debt. I was describing the capital framework last I presented here in March. And we are very happy with a strong balance sheet.
But ideally, we want to be able to act a little bit countercyclical. And that means that net debt can go up and down right now where we have very strong results. We are comfortable with seeing very low levels of debt. So I don't think you should take that as the parameters. The key parameters is that we are have a discipline opposed to capital investments independent of the cash flow we are generating and focusing on providing a superior return to the shareholders.
Thank you, Jakob. I think Dominik is there is no absolute formulaic solution to your question. I think what we'll do is to be on the point of the ACR business, we will look at it on a regular basis on the back of 2 or 3 items. One is how we see the outlook in terms of commodities. That's very well important.
What is the capital program that we have ahead of us and therefore what is the risk profile and what is the level we want to have on the net debt. But you know that if you step back, the liquidity story of RIIO is pretty simple. It's about the resilience of a business case, the resilience of value proposition under any kind of market environment, okay? And it's a combination of a few things. I'm sure you've heard the 4 piece before.
The quality of the portfolio with Work Life like the Arnaud, which delivered 72% EBITDA margin in the first half. It's about the strength of our balance sheet and we fully accept that we are conservative or some people would accuse us of being conservative that maybe we could return more cash or return to shareholders on the back of the strength of our balance sheet. But we look at through the cycle. And at the end of the day, it's a cyclical business. It's a capital intensive business.
And therefore, we believe it's a belief. People may have the strategies from that perspective. There is a belief that having a strong balance sheet at the end of the day is the best insurance policy you can have. And if you go back to your models in the last 10, 15 years, I think the proof point is there. Why don't we take a question from the call, David?
Come back to the room.
Thank you. And your first question comes from the line of Lyndon Fagan. Your line is open.
Thanks very much. Look, the first question was just to try and break down some of the iron ore performance. Just wondering if you could perhaps share the root cause of some of these issues. Just listening to your commentary, you've linked the waste stripping to deferrals of Silver Grass and Cadilliary. And I guess I just wanted to try and understand this a bit more.
Are you saying that those assets would have provided better access to higher grade ore and therefore that got deferred and that's what's causing some of the issues or I just don't quite understand how we got into this position. And then the next question is just to share perhaps if you could share annualizing 9% growth in China in June. Just wondering, looking into 2020, whether you expect further growth in Chinese steel production on an annual basis? Thanks.
Chris, you want to have a crack at the first question?
Yes. Thanks, Linda. Chris Alsbury, thanks for your question. Just firstly, I think what J. S.
Was describing about the deferral of Coditry, that was a good decision, still is a good decision. But what it meant was we do have to run our existing mines, our brownfield mines harder. If I then dive into more specifically the issue that arose at Brockman Hub. Brockman is a very large part of our system. It's about 100,000,000 tonnes coming out of the Brockman Hub.
And more specifically, if I get to the root cause of the downgrade that we made, that was associated with Brockman 4, which is 40,000,000 tons of the 100,000,000 tons. And to be very specific, it was simply around conversion of IHS. There was a convergence of events. We had some poor fleet performance. We bought in a backup fleet while we were converting some trucks.
That backup fleet didn't perform to expectations. And secondly, at the time, there was a lot of labor turnover. The market has tightened labor market has tightened in Western Australia. So we actually had literally some trucks stand because we can have the people. So none of that's acceptable and we're going to fix it.
Already started fixing it. And as Jay said, we've bought in extra equipment to do it. And then secondly, looking further ahead, we'll continue to invest to ensure that we've got a robust and reliable system right across the Pilbara.
Thank you, Chris. I mean, let's be clear is we knew the plan will stretch. We knew that because of all the reason mentioned by Chris that we had to run the mine hard. And if you look at the slide here, it's a blend, okay. And we attract because it brings so much value to our customers, it attracts a premium.
But it's complicated to get there. And we were running at a very high level, right? Now as we said, it's not acceptable. We're throwing the resources to deal with it and so on and so forth, right? But we had a choice.
We had a choice. And the choice we made with Chris and with Simon, Simon Chart was dealing with the customer, was very simple. We made the choice to protect the quality of our blend. We made this choice. It is absolutely essential.
And I will link it to the next part of the question about the market demand and so on and so forth. We made the choice to protect the plant, not to damage, not to lessen the quality of the product. That could have been an option. We took the decision to protect the quality of our product and to protect the relationship we have with our customers. And as a result, we took 2 major decisions, as I said, is one is to reduce the production of the PYRABLEN and the second one is to throw resources to fix the problem and so on and so forth.
But that was a very important decision. And that was the comfort. I mean, I was with Simon in Korea at that point in time when we had this comfort with Chris and a few others. The decision was in the current environment, when you look at forward, when you look at the market conditions and look at the market demand from our customers, either in mainly in China in the context, the need to provide high quality product, the need to build a strong relationship with our customer, we took this fundamental decision to protect the quality of our product. And therefore, we did reduce the guidance and so on.
I have got no doubt because when we took the decision, I was in Korea on my way to China. So I was getting the 11 p. M. Flight from Seoul to Beijing. I met with CISA, the key association, the following morning and Mean Metals and a few others.
I've got no doubt in my mind that was the right decision. We didn't want to pass on the program to our customers because that is not sustainable, all right? So that's the first part of it. I mean, Simon, you want to know about China and the demand, how optimistic you are?
I have to stand up here. I'm shorter than my colleague. I know. So we can't feel good today.
Or you will hear me.
Look, thanks for the question and morning all. Clearly, we have seen really strong numbers out of China during the Q1 and in fact the first half. The Politburo meeting over the weekend and the notes released, I think what you have seen consistently is China taking very targeted measures to continue to support. And as we expect, China continues to slow and those target measures are having an impact. So you're seeing really strong construction numbers through the first half and that's certainly underpinning steel demand.
As we go forward, look, we'll see fluctuations in those numbers. But the overall macro conditions continue to be sound, and those targeted measures will continue to flow through.
So I mean to add on what Simon is saying, there is no doubt that the change in the economy will continue to slow down. Okay. So 6.3% in the first half will continue to slow, and they are managing very smartly, to be honest. I've got no doubt that they will put stimulus package in place. I have to say, the stimulus package they've put in place so far have been, I cannot put it this way, heavy on steel, all right?
So do I believe that the Chinese government will continue to implement stimulus package going forward? The answer is yes, okay? And there are a couple of areas which give us some confidence about the future. One is the work they have started to do on rebuilding cities or refurbishing cities or part of the cities that were built 20 years, 30 years ago of not the right quality. And that is a great piece of new for us, okay?
And then further investment, especially in some of the Tier 2 or Tier 3 cities around building subways, like rail train and so on and so forth, which will give us some comfort as well. But is the economy is going to continue to slow down? The answer is yes. Now the second point we should never, never forget. There is no doubt that the Chinese government will continue to implement their environmental policies, taking capacity out in order to underpin their Blue Sky strategy and so on and so forth.
So seen from a real standpoint, seen from a real standpoint, there will be an ongoing demand for high quality iron ore going forward. Hence, the decision to protect the prebarrel. That's how it is. So are we having any issues at this point in time in placing our product? The answer is no.
But we have to place the right product and making sure we have a strong and good and sustainable relationship with our customers. So what we're going to do in the next 2 weeks, so flying to the U. S. Next week to do the roadshow in the U. S.
And then after we're going, I'll bring back to us for a few days to with Chris to be on the ground and then we're flying back to China to meet with our customers and so on and so forth. But for us, at this point in time, we have seen no material impact on trade and we have seen no material impact in relation to demand from our customer in China. So if we move to another question from the conference call and then I'll come back to the room.
Thank you. Your next question comes from the line of Paul Young from Goldman Sachs. Your line is open. Please go ahead.
Yes. Good morning, Jays and team. Jays, first question is on the Pilbara rail maintenance. Maybe a question for Chris, actually. Can you add some context to this, I.
E, what percentage of the rail capacity is this impacting? You also mentioned this is continuing into 2020. So how will this impact shipments in 2020? That's the first question. The second question is on OT.
I know it's really complex in the study phase at the moment. I'm looking at that 16 to 30 month delay on the project. It's a very wide range. So considering the study time frame seems quite fixed. What are the 1 or 2 main items that's driving 14 months range?
All right. That's very good. So I'm going to turn to Chris in 1 minute. But the rail maintenance is very simple. The macro level is, as I said in the speech, it's one of the most heavily used rail work system on planet Earth.
So we will have to maintain it at a high level. And what we did today is because I thought we had done it in the past, but clearly people didn't pick it up, is there will be a series of shots on a regular basis to maintain and strengthen the health of the assets. So we want to flag or to reflag the fact that we'll have a Super Shot at the end of October for a couple of weeks. And you will sorry, end of September, my mistake. And then there will be a series of Super Shot next year and there will be a series of Super Shot the year after and the year after and the year after.
So we're just flying that there will be a heavy load of maintenance, I can say, forever in the period for the reason. So Chris, you want to say much more on that? And I think we had disclosed some level of cost as well.
Yes. Thanks, Paul, for the question. Look, just to be clear, this is already built into our guidance, but we chose to be transparent because it's a pretty major shut. It's 2 weeks.
It's going to
take over 2 weeks. It's 25 kilometers of rail. We're going to shut the whole line for 3 days and then actually the east line for 5 and the west line for 5. So it's a major piece of work. It's already built into guidance.
But because it was so significant, we decided to flag it.
And next year? We will
then as part of the detailed planning for 2020, continue to plan these super shuts at appropriate time and the appropriate scope.
And Paul, we'll give you, as I mentioned, the 20.20 guidance for iron ore at the end of October. That's why I was confused between the Capital Market Day. So we'll give you more granularity around this piece. Study, Steve, what are the key elements? I thought we had the slides showing the key decision point, but go for it.
So Paul, thanks for the question. So basically, what we've looked to do here is bookend a range of different options through the study phase. And to Jess' point, with a view to making sure that we both safely construct, operate and protect our investment looking out over 25 to 50 years ahead. So and again to this image that we have here, we have some critical questions that are right ahead of us, as Jay has also noted. Are we able to hold things like what we call a mid access drive?
That drive essentially a horizontal tunnel that cuts up transversely across the resource across the mine footprint actually is in 3 different levels. So in what's called the apex, the undercuts and the extraction level, we get enormous construction efficiency by having that drive in because as you can see with those arrows, it means that we can develop north south into those headings. If they are removed, we have to develop all the way from the south, all the way to the top of Panel 0. So there's a schedule impact. So we're looking at everything here.
How do we keep protect the critical infrastructure in the mine footprint through that complex four d modeling that J. S. Referred to, and we will sequence our way through each of those decisions. But basically, if we remove some of them and we have to then actually take the oil handling system potentially outside the footprint of Panel 0, that has a time, a schedule impact for us. So as we do the modeling through the back end of this year, by the end of the year into Q1 next year, we expect to take the final essentially design into feasibility.
And then we will take that final design that we have approved into the definitive estimate process. And so in half to twenty twenty, we'll have that final definitive estimate.
Yes. And Paul, let's be clear. I mean, there are multiple options, as we say, multiple scenario because just to make it to give a sense of we're looking at all options, including maybe not a full MAD, the MAD meaning mid access driver, because that's only half of it and so on and so forth. So that's the level of optimization that we're doing. So we've thrown it the best resources we have in order to get the best solution to unlock the value of this world class resource.
But keeping in mind that the priority number 1 is safety. I mean, that is absolutely clear on this one. Why don't we go back to into the room? I'll try and exhaust
a few more Oyu Tolgoi questions. So 3 things. First of all, on the impairment because back in December, you had $3,000,000,000 of headroom in your annual report. So it looks like quite a big impairment. Have you changed the long term pricing?
I mean the WACC obviously moved up a little bit, but why is it such a large impairment to the NPV? Secondly, I was reading this kind of financing support agreement from the Turquoise Hill website, and I was getting a bit confused because as I read it, it looks like you have an option to basically determine whether they do an equity issue if there's a cost overrun. Is that I mean, just to get a bit more clarity as to the position with Rio and Turquoise selling deciding how the cost overrun gets shared out? And then the other one was around the parliamentary working group because it there's a lot of noise, and it looks like they're going to put some proposals forward to change the Dubai agreements and that sort of stuff. How should we see that as just noise at this point?
Or how worried should we be around the agreements?
Yes. I mean, Arlo, you want to pick up the last 2? Arlo, you had provided the debt, but if you can give more details on the Partima working group? And then the financing agreement, I think you should cover it in the account.
Okay, good. Thanks for the question. So you would all be aware that the parliament decided to do some audits on the benefits that OTA are bringing to the country. So we fully collaborated with those details. We provided thousands of pieces of information for months.
And it's out of this quite extensive audit report was published and that report has been shared with a subset of the Parliament, which is called the Economic Spending Committee. So, the Economic Spending Committee has nominated some parliamentarians to review all this information and to come up with a recommendation to parliament and to the governments, which is called the Permanent Working Group Resolution. So that work is in progress. And we'll see how things are evolving in the coming weeks. Meanwhile, in parallel to this, there are some typical positions that are being taken by some politicians around OT, around the agreements you're referring to the UDP and so on and so forth.
I think it's important to understand that the UDP has been an important agreement because fundamentally, it has clarified some of the previous agreements and it has enabled for the project financing. So the $4,400,000,000 that we've borrowed to around 20 different international lenders and institutions is underpinned by all of those agreements. So the UTP is as important as the ARSHA as it is important for the investment agreements. And those agreements are really foundational. This is on those agreements that we've been able to borrow money
and
this is on those agreements that we are able to continue heavily investing through TRQ in Mongolia. So as I said before, we are in continuous discussion with the government and working collaboratively with them to look at what can we do within our existing agreements to create more value for shareholders.
Thank you, Arnaud. Jacob, if you can cover the impairment and the financing.
Yes, the impairment part the impairment part is very well captured by you that you have carefully read our annual accounts. You are in part right. We gave an update and explained that we had some delays on particularly the main production shaft. And we built that into our cash flow. And we came to a result where there was headroom of SEK 3,100,000,000.
At the same time, we raised the issue that the ground the weakened ground condition might lead to significant redesign of the mine below the ore body. But we couldn't state anything else that we would get on with that. And therefore, what we convinced ourselves was that what we knew at that time was that there should be sufficient headroom to cover for that uncertainty. So you could say the headroom that we saw in March was between 0 and 3.1. We were just not able to establish that.
Now with the update on 16th July, that was a trigger. And we have new information, and we have done this already, and we have come to, on a 100% basis, the 2.3 $2,200,000,000 lower asset value.
You want to cover the Turquoise Hill financing?
Turquoise Hill, I mean, they have independent governance. So it is really for them to talk about the financing. We are very happy to enter the dialogue with them. And when there's news, it will come out.
Any other questions from Inns?
Good morning. Richard Hatch, Berenberg.
Two questions.
First one, just on your iron ore costs. Perhaps it's too early to ask the question. Maybe it comes through the Capital Markets Day. But do you expect your costs for 2020 to trend back down to the 13, 14 or is it too early to say?
I think it's too early to say that. Now I'll make 2 comments right away is to say we will continue to drive in our business on the back of EBITDA margin, okay. And as I mentioned in the speech is what we need. I will give you more details when we are in Capital Market Day is to make sure we have the right level of costs and sustaining CapEx to maintain the health and maintain the resilience of our business and so on and so forth. So the important piece, if there is one message to take away from this one is we drive this business on the back of EBITDA.
If you drive it only on the back of cost, then you may have a very, very different outcome. And look, I mean, first half of this year, 70%, 72 percent EBITDA margin. So we'll provide more details at the time of the Capital Market Day. Chris will cover it as well. It.
Thanks.
And the
second question? Yes, second question?
Yes, aluminum. Just the operating efficiency, dollars 1,000,000,000
to $1,500,000,000
If we assume that costs stay as they are and they don't retreat back in the aluminium business, what does that $1,000,000,000 to $1,500,000,000
It's in the range. So what we want to flag, I think, is the following. So we know that the cost last year, the impact on the bottom line was around $500,000,000 of cost input. And it was not only aluminum, there was TiO2, a big chunk of it was aluminum. Do we believe that some of the costs have reverted as we're having this concession?
The answer is yes, but not to offset totally the $500,000,000 that we had last year. So there is an element there. But the important piece is why we gave a range. And that's a fundamental point is to say, we will and that's back to the first question about we will continue to drive our iron ore business on the back of EBITDA margin and leads back to the value of our volume. What I'm not ready to do is to drive volume for the sake of it in order to have a fixed cost absorption and therefore to meet a target which is slightly artificial in that sense.
We will continue to drive the iron ore on the back of EBITDA margin. If it means producing more, yes, if it creates value. If it means not producing more, so be it. And I think that is absolutely essential. So that's why we're trying to flag.
What we're trying to flag is we could be at 1.5, we could be at 1. There are 2 key elements, the driver. And the main driver is iron ore. It's not the aluminum cost. You can make the sensitivities, but the bulk of it, of the range is about aluminum volume.
But the message I want to convey is we will take a decision about the iron ore volume on the back of the value of the volume. And I think what we've decided is a good example of it. I want to protect the Piedrah brand. I want to protect the premium. And that's why it is.
So what we're just flagging is and maybe we had done it before and maybe we didn't do it well enough and so on and so forth. At the end of the day, it's about EBITDA, it's about cash and not just picking a target on cost and so on and so. Now I might continue to put Chris and the team and the other EXO member under pressure on cost. Absolutely, because I don't want the business to drift along the cost curve. But the priority to run this business is on EBITDA margin, otherwise you have the wrong outcome.
That makes sense? Another question, I mean, in the 3rd row from the back, yes. Don't move, it's coming.
Jatinder Goyal from Exane BNP Paribas. A couple of questions. First on iron ore, would you be happy to keep this year's volumes in Pilbara if you can't get to your optimal blank till cadherit comes in? And in that scenario, does the $1,000,000,000 to $1,500,000,000 improvement still hold?
I think I've just answered the question on this one. I've just answered exactly the question, which is value over volume is we will add volume in any year at any point in time only if it creates value and so on and so forth, hence the range we're giving on the mine to market.
So the $1,000,000,000 to $1,500,000,000 still holds even if you don't increase any volumes from this year in R and O till Cadagry comes in?
Okay. I just said it is to say, if you get to 1.5 on the cost target, if you increase the volume above and beyond where we are today, okay? But we will take this decision only if it creates value and the EBITDA margin.
Yes, go ahead. I mean, look, we're not going to guide today about future volumes. That's clear. But I can help you a little bit. The updated guidance for this year actually is quite a significant step up in production in the second half compared to the first half.
I think you can get half the answer there.
Thank you. Second question on OT, obviously every investment competes with each other. But if it makes financial sense, would you be comfortable taking more attributable country risk if it comes to that point by increasing your ownership effectively?
I think, well, for the answer to the question is this contract, if you want to pick it up, Jako?
Yes. But I just want to understand fully what's behind your question. Sorry, just one second.
So you're adding 300 basis points as country risk premium to your impairment calculations. If it comes to a point, would you be comfortable increasing your attributable country risk by increasing OT ownership?
Yes, so there's 2 different things, but I actually said 200 basis points in real term. And look, that has nothing to do with the project. That has something to do with the country risk, yes? And the ownership, we are very comfortable with the current shareholder composition. It's very normal that major projects is joint venture and you have some kind of risk.
That's our position.
I'll pick it up on this one. It's pretty simple. I mean, there is no change of policy here because your question is about M and A. Do we have a watching brief on M and A? The answer is yes.
There is no change. And are we looking at opportunities options? Yes. But we will trigger the options only if it means creating value for our shareholders and nothing else. All right.
Why don't we take a question from the phone,
David?
David, any okay, one more. Let's wait.
Your question comes from the line of Hayden Barstow from Macquarie.
Just a couple of quick ones. Firstly, I think we've obviously done an audit there. I just want to touch on IOC a little bit. Realized pricing seemed a bit soft. Can you just remind us how they sell iron ore versus spot and how we should think about that just given it didn't seem like all the spot premium prices came through in that half?
And then just on Pacific Aluminum back here, it's back to an EBIT loss. I mean, where are you sitting with that asset base? It's obviously a little power price pressure in Australia.
No worries. So you want to pick up IOC and then pick it back out? Thanks, Johannes.
There's a number of factors in the IOC pricing, including, for example, Japanese fiscal year, including some lag similar to our iron ore business where prices are reflecting prior period. So that's the main 2 impacts you've got in the realized pricing.
Thank you. And then on Pacal is absolutely, I mean, there is an energy cost issue in Australia. I mean, it's a well known one,
which is
it shouldn't be the case. If you back and you think about Australia being very mineral and energy rich, that should be one of the most competitive place to have energy, all right? So we are working very closely with the federal, the feds and the state government in order to find a solution to this challenge, all right, because the energy cost is massive, we're not making money in those assets and so on and so forth. So those conversations are taking place as we speak, But we inform the market in the appropriate manner. But we're taking it very, very seriously and they are active discussion because the current situation is not sustainable here.
I know that we the market the aluminum market is not being helpful in the sense of for the first time is in terms of demand, the demand on aluminum is pretty weak. Historically, we said and it's the case that the demand for aluminum products is above GDP growth rate, whereas currently it's around 1.4, 1.5, which is pretty low. And the reason being why the aluminum demand is low is because of the situation around transportation and automotive and transfer. So we have a situation where the demand for aluminum product is pretty low. At the same time, as I explained, the supply side is being challenged for a series of reasons, one which didn't surprise us too much, which is the pace of the restructuring of the aluminum industry in China.
But the second point is, as and when one of our competitors was under sanction, they didn't stop producing. They did build a big inventory. And as we are being this concession, they are releasing and monetizing this inventory. So we have a pricing environment which is not very favorable, but at the same time is we have challenges, especially in Canada in relation to the cost structure and energy is a big component of it. And that's why we are having those conversations.
So I see John telling me that I'm going to have to wrap up this meeting. So I think a pretty good conversation. We did cover lots of grants. I'm sure a few of you still have a few questions. I understand there are a few of the meetings coming on.
So we're looking forward to it. So now let's step back. We had a very strong set of results. I mean, look at the results. I mean, 47% EBITDA margin, 23% return on capital employed.
This combined with all the hard work of the last few years, a very strong balance sheet. So all in all, we are in a position to return $12,000,000,000 of cash flow to shareholders this year. Yes, we had operational issues. We fully acknowledge it. It's mining.
Are we addressing those issues? Absolutely. And that's the team is working on as we speak, and we're making good progress. And looking at the outlook, the outlook is positive. China is slowing down.
We talked a lot about it, but we have a strong position to work from. The strategy is working and what the shareholders should expect from us is what we've been doing for the last three and a half years is to continue to create value, superior value in the short, medium and long term. That's all I have on my side today. And then on this note, thanks for coming, and I look forward to the ongoing dialogue. Thank you.