Rio Tinto PLC Q4 FY2021 Earnings Call

Good evening, and good morning, everybody. Welcome to Rio Tinto's 2021 results presentation, and thank you for joining us. Today's presentation is virtual, but we hope to see many of you face-to-face in the next few days. Our CEO, Jakob Stausholm; and CFO, Peter Cunningham, will go through a presentation, which will be followed by a Q&A session. Before we start, please have a look at the cautionary statement on Slide 2 for a moment. Thank you very much, and Jakob, over to you.

Thank you, Menno. Good morning, and good evening from Sydney. I would like to acknowledge the Gadigal people of Eora Nation as the traditional custodians and pay my respect to elders past, present, and emerging. I extend that respect to all Aboriginal and Torres Strait Islander people. When I presented my first result as Chief Executive last February, I set out four key objectives to make Rio Tinto an even stronger company: to become the best operator, to strive for impeccable ESG credentials, to excel in development, and to strengthen our social license. This is what we have done, and I'm proud to say that we have made progress against each objective. In October, we launched a new strategy, including more ambitious climate targets. We also set out how we will grow in commodities that facilitate and benefit from the energy transition, decarbonize our assets and value chain, and maintain our tight capital allocation, enabling us to pay attractive dividends. Achieving our objectives and delivering the strategy are entirely aligned. We're all focused on execution. But as I've stated previously, it is a multiyear journey. However, even after 12 months and only four months after our Capital Markets Day, there's tangible progress. Today's results highlight the underlying strength of our business. We achieved a third consecutive year of zero fatalities, which we have never achieved before. We realize this record disappears the moment we let down our guard. Having our people return home safely each day remains our first priority, and we continue to focus on this. I'd like to take this opportunity to sincerely thank our people for their commitment, resilience, and sacrifice during another COVID-constrained year. They've done a superb job. I'm very proud. Turning to our financials. Our results were very strong. They demonstrate both the quality of our assets and the strength of our business model. We are firing on all cylinders in terms of our financial performance. Each of our four product groups were highly profitable and achieved significant EBITDA growth and double-digit return on capital employed while delivering strong free cash flow. Our iron ore business continues to be the primary contributor. But we also benefited from an increased contribution from the other three product groups, not least aluminum, which recorded a 20% return on capital employed in the second half of 2021, up from just 3% during 2020. In aggregate, we achieved the strongest financials in our history with EBITDA of $38 billion and net earnings of USD 21 billion. A highlight for me comes when you compare base results with our performance during a similar period of strong demand and high commodity prices a decade ago. In 2021, we converted a far higher proportion of strong commodity prices into earnings. And subsequently, because of our strict capital allocation, we converted those earnings into far higher free cash flow. This enabled us to declare record dividends of $16.8 billion, a 79% payout ratio. This performance reflects our tight cost control, disciplined capital allocation, and the fact that our balance sheet is the strongest it has been for at least 15 years. In the past year, we have made important and significant shifts in how we engage, how we see ourselves, and what really matters to us. We have become more humble and better listeners, both internally and externally as we extract the full learnings from Juukan Gorge, developing relationships that go beyond just agreements and that can deliver mutual prosperity. What we and the team achieved in Mongolia is a perfect example of what can be mutually achieved. Combining our operating and development know-how with tenuring relationships unlocks valuable opportunities. Looking ahead, we see a positive outlook for all our commodities. This is driven by the global energy transition, which is creating new demands for our products and near-term Chinese policies that are becoming more growth-focused. While the current global macroeconomic environment is strong, there are significant geopolitical and economic uncertainties, for example, surrounding Ukraine. Rio Tinto has demonstrated that we are able to continue to perform in uncertain times due to our very robust assets. That is why we remain highly competitive when demand and prices are low and benefit fully in periods of tight supply and demand balances. When I became CEO, I also committed to improve our culture. This goes well beyond operational safety. It's about how we care for our people, how we become less hierarchical and more humane as an organization, and how we unleash the potential of each individual. We're not wasting time. We have introduced measures and frameworks to strengthen the business and empower our people. We have rolled out our new values of care, courage, and curiosity. And we're investing in our people. Through the Rio Tinto Safe Production System, we will empower our people to achieve consistent operational excellence and unlock real and sustainable improvements. In March last year, we commissioned Liz Broderick to conduct a thorough review of our culture. The findings of the comprehensive report are very disturbing and confronting. But in order to improve, we had to identify the extent of our problems. We will implement the report's recommendations in full, building on the changes already put in place to make Rio a safer, more inclusive, and more respectful place to work. At the heart of all our efforts, from changing our culture to operational excellence, is trusting and respecting our employees, becoming less hierarchical and empowering our people. To make a real difference across the business, we are driving outcomes, not just setting targets. This applies across all four objectives. However, let me now hand over to Peter, who will examine our strong set of financials in detail. Peter, please?

Thank you, Jakob. Good morning, and good evening, everyone. Let's start by taking a look at the numbers. We've announced a record set of results following strong global demand for all our major commodities. The 42% increase in revenue was driven by price, in particular, iron ore. Aluminum and copper were also significant contributors. Importantly, we maintained our financial discipline throughout 2021, achieving underlying EBITDA of $37.7 billion and operating cash flow of $25.3 billion after record taxes and royalties of $13 billion. Free cash flow of $17.7 billion was after $7.4 billion of capital expenditure and a $1.1 billion temporary working capital outflow, reflecting the increased China portside trading inventories and supply chain disruptions. Underlying earnings rose to $21.4 billion, which lifted our return on capital to 44%. This enabled us to declare total dividends of $16.8 billion for the full year. Net earnings were also a record, although we did have some exceptional items, notably the $500 million increase in the closure provision for ERA, where we have taken the midpoint of ERA's guidance, recognizing 100% of the increase. Let's now take a look at our key markets. Iron ore prices rose to record highs, with China importing well above 1 billion tonnes and consumption in the rest of the world largely recovering to pre-COVID levels. The steel intensity of the recovery lifted global crude steel production by almost 100 million tonnes to a record of almost 2 billion tonnes. Global scrap generation also improved, but high-cost iron ore supply was required to balance the market. This did taper off in the second half as prices declined. Aluminum and copper prices rose to multiyear highs on firm recovery in global demand and supply challenges. Looking forward, we're encouraged to see continued momentum in our markets, but also fully alert to potential disruption from new COVID variants and geopolitical tensions. Let's now take a closer look at the drivers. Unsurprisingly, commodity prices were by far the biggest movement, boosting EBITDA by $17.5 billion in aggregate. In past cycles, higher prices have given rise to significantly higher costs, often wiping out up to one-third of the price gains and resulting in painful adjustments later on. This year, the cost variance was more modest, reflecting our intense focus on cost control throughout the cycle, with a $1.1 billion impact mainly due to fixed cost inefficiencies from lower volumes. This meant that we converted most of the price benefit into higher EBITDA. Our cash conversion was also strong with record operating and free cash flow and continued focus on capital discipline, which has not always been the case in previous cycles. However, we are not satisfied with our operational performance and recognize that it will take time to turn it around, a multiyear journey, in fact. Let's look at each division, starting with iron ore. The team did a great job keeping the assets running and delivered record underlying EBITDA of $28 billion and a 76% margin. In the first half, we experienced challenging operating conditions from prolonged wet weather, heritage management, and tying in 90 million tonnes of replacement mines as well as bringing on Gudai-Darri. Our production performance certainly improved in the second half, but tie-ins were delayed due to labor shortages and COVID restrictions. These were compounded by a high amount of project rework as we were able to carry out quality assurance steel and equipment manufacturers. Overall, this led to a 3% reduction in shipments. Inventory levels at China portside increased with higher volumes of lower quality SP10 and constrained availability of high-grade blending stocks. These are now being drawn down in line with market demand. Our unit cash costs in 2021 at $18.60 per tonne were marginally above guidance with higher input prices for contractors, explosives, and energy. The work index also increased with vital improvements in cultural heritage protection, leading to a redesign of our blasting practices and longer haul distances to protect heritage sites. There are three key drivers of unit costs in 2022. The most significant is the full year impact of higher input prices, which increased significantly in the second half of 2021. The second is around making the necessary investment in asset reliability with increased maintenance on our processing plants. We're also targeting further investments in our heritage and environment teams and continuing to invest at an increased level in studies for the next set of mines. These are conscious decisions that will strengthen us for the future. The third driver is further increases in the work index, driven by a rise in waste movement and longer haul cycles. Now we expect to partly offset this through efficiency gains with about 80% of our haul truck fleet now fully autonomous. Overall, around half of the increase to $19.50 to $21 per tonne is driven by market factors and the remainder by the work index and longer-term investments to improve our operating performance. But overall, let's not lose sight of the fact that we achieved very strong financials with operating cash flow of $19 billion and free cash flow of $15 billion. Let's now take a further look at 2022. We expect the first half to remain challenging, with first production from Gudai-Darri in the second quarter and the ongoing ramp-up of the replacement mines. We have experienced some quality issues at the Mesa A wet plant and rectification work is underway. But until this is complete, we will continue to be constrained in the Robe River system. As a result, we expect to see elevated quantities of SP10 until midyear. In the second half, pressure on the system will ease with Gudai-Darri ramping up and replacement mines fully operational. We then expect SP10 to gradually decrease. We are advancing the studies that will enable us to operate within our medium-term capacity guidance of 345 million to 360 million tonnes a year and also making progress with the modernization of agreements with traditional owner partners. Just last week, we agreed to a new social cultural heritage plan with the Noongar people. This enables us to progress the approvals process for Western Range, one of the key replacement mines in the 2025 to 2026 period. Moving on to aluminum, where we had our best financial performance ever, benefiting from the stronger pricing environment and higher premiums for primary metal to deliver EBITDA of $4.4 billion. This flowed through to both operating and free cash flow, which at $2.3 billion was more than 2.5 times the 2020 level, with all four PacAl smelters making a robust contribution. Aluminum production was only 1% lower despite Kitimat operating at 25% of capacity following the strike, which commenced in July. While an agreement was reached in October, it will take time to clean and repair the block with a gradual restart late in the second quarter of 2022 and full capacity reached in December. Our underlying EBITDA margin was 38% for the full year with return on capital employed hitting 20% in the second half of the year. Overall ROCE averaged 16% for the year, up from just 3% in 2020, and we are set to benefit further from price momentum this year with aluminum close to an all-time high, 12% higher than in the second half of 2021. This underlines why we believe this is the premier global integrated aluminum business. We continue to work on finding solutions to reduce our carbon footprint. The ELYSIS inert technology is an important contributor. We made significant progress in 2021 with the first aluminum produced at the R&D center in Quebec, and construction of larger commercial scale prototype cells is underway at our Alma smelter. On to copper. At $4 billion, underlying EBITDA was up 90%. The stronger market environment was the key driver by $2.2 billion. We also benefited from higher sales volumes of refined metal at Kennecott and temporarily higher gold grades at Oyu Tolgoi. These compensated for lower volumes at Escondida, where ongoing measures in response to COVID-19 continued to impact workforce availability. Our C1 unit costs at $0.82 per pound were down 26%, which was mainly volume-related, in particular, the higher gold grades at Oyu Tolgoi, which is set to reverse in 2022. Free cash flow was positive at $1.3 billion after paying $400 million to the Mongolian Tax Authority in relation to disputed items from 2013 to 2018 and $1.3 billion of investment mainly in the Oyu Tolgoi underground. Turning to minerals. An important addition to the business was the $825 million acquisition of the Rincon lithium project in Argentina last December. It is set to be a long-life, low-cost asset that will shape our battery materials portfolio. We're targeting completion in the first half. Demand conditions were strong across all sectors, but we did have some operational challenges. Titanium dioxide was 9% lower, with community disruptions, followed by curtailment of operations at RBM in South Africa for around three months, coupled with an extended ramp-up period as well as unplanned maintenance at RTFT in Canada. At IOC, labor and equipment reliability issues impacted production. But a 68% increase in pellet prices boosted the financials. Our QMM operations in Madagascar continued to perform well, with production up by nearly 30% and decarbonization progressing to plan. Boron's performance also improved following some major planned maintenance. And diamond production rose in line with our 100% ownership of Diavik. We also benefited from a sharp recovery in prices. Overall, EBITDA of $2.6 billion was up 52%, while operating cash flow increased to $1.4 billion and free cash flow to $0.8 billion. You've seen our capital allocation slide many times before, and our disciplined approach is unchanged. We will also apply the same rigor to our decarbonization projects. These deliver a range of economic outcomes, but in aggregate, value accretive at a very modest carbon price. Moving on to our capital forecast. This is consistent with our October seminar. We still expect a disciplined increase in our capital expenditure over the coming years. In 2022, it will be around $8 billion and between $9 billion and $10 billion in '23 and '24, which includes the ambition to invest up to $3 billion in growth each year. But it is highly dependent on opportunities being available. It's not a commitment or predetermined budget. If we cannot develop or find value-accretive options, we will simply not spend the money, but we'll follow our well-established capital allocation framework. The recent news that does mean we're more likely to be at the lower end of the range in 2023. The best estimate of investment to decarbonize the business stands at $7.5 billion until 2030, which includes about $1.5 billion over the next three years. Sustaining capital of $3.5 billion a year includes $1.5 billion for Pilbara iron ore, subject to ongoing inflationary pressure. Replacement capital is also unchanged at $2 billion to $3 billion a year. We are seeing some increases in the Pilbara projects of up to 15%, but this is mainly due to longer time frames and remains within the boundaries of our overall guidance. Lastly, it's just worth reiterating that any M&A, such as Rincon, is in addition to this. At our seminar, we disclosed our plans for decarbonizing the business with a tripling of the target by 2030. We believe this will safeguard the integrity of our assets over the longer term, reduce the risk profile of our cash flows, and therefore, protect our cost of capital. Our focus over the next three years is on repowering the Pilbara, where we currently spend about $150 million on gas each year. We're now focused on expanding our tenure for wind and solar sites for the installation of 1 gigawatt of renewables. We believe this could replace up to 80% of the cost and support the diesel transition. It will abate about 1 million tonnes of CO2, a third of our carbon emissions from the Pilbara. Reaching a 15% reduction by 2025 is not going to be easy. It will require a lot of planning and rapid execution. The full electrification of our Pilbara system set to commence later this decade, including trucks and rail, will require further gigawatt scale renewables combined with advances in fleet technologies. Across the group, we're looking at multiple opportunities to decarbonize the business. And we've included some of these as appendices. One such example is at our Queensland alumina refinery, where the installation of heat recovery equipment could reduce the steam required for heating by up to 50% and eliminate 115,000 tonnes of CO2 emissions per year by 2024. Let's now have a look at the balance sheet. Net debt turned into net cash of $1.6 billion at the end of December. But let's not forget that this is just one point in time. Today, we have made a $7.7 billion dividend commitment, which we'll pay in April, moving us back into net debt territory. We also have a $1 billion Australian tax payment in June with respect to 2021 and $825 million for Rincon. This financial strength allows us to reinvest for growth, accelerate our own decarbonization, and continue to pay attractive dividends following our policy. And finally, on to shareholder returns. Our policy is tried and tested and has resulted in record returns. Over the last six years, we have consistently exceeded the 40% to 60% range with an average payout ratio of 74%. Going forward, we've indicated our ambition of investing more in growth, but you should not expect us to hoard cash. We will continue to return any excess as we have in the past. The record earnings and cash flows in 2021, along with the continued strength of our balance sheet, mean we have declared our highest-ever full-year dividend of $16.8 billion. This includes the final ordinary of $6.7 billion and a final special of $1 billion and brings the payout ratio to 79%. With that, let me pass back to Jakob.

Thank you, Peter. I'm convinced that the four objectives I set a year ago are the right ones. We have made tangible progress on each one on the back of a significant volume of work. In October, we launched a new strategy aligned with these objectives. This set out a long-term approach to make Rio Tinto a stronger and more relevant company for society and to secure future shareholder returns. We've put in place the right structures and frameworks, creating an organization that is people-centric. We have established centers of excellence in communities and social performance and in energy efficiency and development, to name a few. In some areas, it will take time to make a lasting difference, but we have already achieved notable successes. The start of underground mining at Oyu Tolgoi and the acquisition of Rincon are two standout examples. They're both driving our strategy implementation and are aligned with our objectives and will benefit our shareholders for decades to come. We have also addressed how we engage with stakeholders. We had become too transactional, relying too much on agreements at the expense of developing proper, mutually beneficial relationships. I'm determined that Rio becomes a more inclusive and diverse place to work, where people live our values, feel empowered to challenge decisions, and speak up freely if something doesn't feel right. There's a lot of work underway, including making our camps and villages safer. It also means increasing diversity, including gender diversity and lifting indigenous representation. We're investing $50 million to retain, attract, and grow indigenous professionals and leaders in our Australian business. We are already seeing real improvements in this area. We're also strengthening our communities and social performance work, taking a different approach to how we engage and operate. We have made progress in resetting relationships and agreements with traditional owners, including the Butugunti, Guinea, and Binigura people. We're proud to have agreed on our first co-design social cultural and heritage management plan in the Pilbara. This is with the Innawonga Aboriginal Corporation and enables us to move forward with the Western Range project in a way that reflects the views and wishes of the traditional owners of the land. To reinforce and embed this approach, we're rolling out enhanced cultural awareness training for all employees. This will promote better, more informed decisions while improving relationships and outcomes for traditional owners, indigenous communities, and employees. And to support and guide our work, we have established an Australian Advisory Group. It will have a key role in being a sounding board for Rio Tinto on policies and positions that are important to our Australian business. Turning to our operational performance. The safety, health, and well-being of our people remain our top priority. I'm proud of our performance in this area. We work hard at this every day and are becoming more sophisticated in monitoring, evaluating, and addressing risks. While being the best operator is in our DNA, we won't restore that instantly. It's a multiyear journey. However, through the Rio Tinto Safe Production System, we will safely unlock real and sustainable improvements. Let me stress this is not about stripping out costs. It's about sustainably unlocking capacity and improving operational stability. It is targeting bottlenecks and inefficiencies. We are focused on having our leaders understand it's important to empower their frontline. And for the frontline to recognize that they can now make their job safer, simpler, faster, cheaper, smarter, and better. It's a galvanizing program that will deliver tangible benefits, and we are pursuing it with rigor. The results we are seeing from the initial pilot site after only half a year's deployment confirm the potential of this initiative. For example, Cannacord's concentrate asset utilization ratio improved 3.5% compared to the previous 12 months. And at West Angeles, drilling utilization rates improved by 12%, equivalent to 1,000 additional meters per day. We will look to replicate best practice and significantly ramp up the Rio Tinto Safe Production System rollout in 2022. The world will have to massively transform to combat climate change and undertake an unprecedented energy transition. Mining is bound to play a vital role. I attended COP26 in Glasgow last year to engage with governments and other partners on the critical role we are playing. We must start by addressing our own footprint. Rio Tinto is amongst the biggest electricity users in the Western world. We also have significant land holdings. This provides a great opportunity, but also comes with responsibility and an obligation. But if we do it well, we can make a real difference. This will also lead to new business opportunities. Our new climate targets are underpinned by an intention to invest $7.5 billion. We will be disciplined. And these investments will, in aggregate, be value-accretive at modest carbon prices. They will also safeguard the long-term cash flow of our assets and help us maintain an attractive cost of capital. We are mobilizing the organization, identifying various opportunities to decarbonize our assets and invest in renewable power. For example, we are developing engineering plans for 1 gigawatt of Pilbara renewables. And we are working with suppliers and technology providers on ways to convert from diesel-powered trucks and trains to battery-powered fleets. With various partners, we are working on a number of potential technologies to decarbonize our value chains. Our ELYSIS joint venture with Alcoa, supported by Apple and the governments of Canada and Quebec, is the most advanced. Last year, we produced aluminum with zero direct carbon emissions at fairly large scale. At our Alma smelter in Quebec, we are now scaling up to full commercial size sales in 2023. And commercialization of this groundbreaking technology remains on track from 2024. This is even more exciting when you consider the prospect of combining ELYSIS with renewable power like we have in Canada, Iceland, New Zealand, and Tasmania. At the same time, we're exploring a number of pathways to produce green steel, exploring green hydrogen-based DIR in Canada and in Australia and developing partnerships with BlueScope, Baowu, Nippon Steel, and POSCO as we look to decarbonize the entire value chain. These types of partnerships are key to cracking the code on emissions. We also need allies in government and industry associations to join us in making the energy transition happen. But it isn't just about decarbonizing our business and value chains. There's also a huge opportunity for Rio Tinto. All the materials we produce are fundamental for today, even more so for the energy transition and beyond, including iron ore. We are well placed to grow in order to meet this demand. In the past year, we have made focus on various options at different stages of development. We have the ambition to double our growth capital to $3 billion a year from 2023 onwards as we develop new options. We're also looking at ways to bring projects on faster, always with a focus on value and capital discipline. This starts with exploration where Rio Tinto has consistently been a leader. We have a strong portfolio of exploration projects with activity in 18 countries across 7 commodities. We also have an attractive pipeline of other projects at various stages. We will ramp up production from Gudai-Darri this half and are advancing other Pilbara projects such as Western Range. We're progressing Simandou resolution to name a few. Jadar is an amazing project, which we believe in, but you will all have seen the challenges we are facing. We are disappointed by this development. We are exploring all options and remain willing to meaningfully engage with all stakeholders. Finally, we demonstrated our willingness to grow through acquisitions, something we have not done for a decade. The addition of the Rincon project in Argentina brings growth in a commodity essential to the energy transition and with a very attractive outlook. We will continue to look for additional opportunities, but we'll only pursue ones that create value. We will not chase volume or commodities where there isn't value or assets that don't fit our portfolio. But without a doubt, the most significant development in terms of growth was resetting the relationship with the government of Mongolia and Turquoise Hill. One of the highlights of my career was to stand side-by-side with the Prime Minister of Mongolia as we commenced underground mining. It was the culmination of years of hard work and dedication to develop such a complex greenfield project. I would like to thank the Prime Minister for his commitment to reaching this agreement, which also has the support of the Mongolian Parliament. It demonstrates to the world the attractiveness of Mongolia as an investment destination. Together, we have now unlocked the most valuable and complex part of the mine, with the first sustainable production expected in the first half of 2023. At peak production, Oyu Tolgoi is expected to operate in the first quartile of the cost curve and produce around 500,000 tonnes of copper per year from 2028 onwards. This additional copper will come on-stream at a time when copper demand is expected to be robust. So let me summarize. In 2021, we set out four key objectives to make Rio Tinto an even stronger company. We also set a clear strategy for the company to grow, decarbonize, and maintain our strict capital allocation in order to pay attractive dividends. We have made progress on a number of fronts and demonstrated how we are changing and strengthening Rio Tinto. We did this while achieving strong financial results across all our product groups and we had our third fatality-free year in a row. Our culture is evolving and improving, but we must work even harder to strengthen relationships in a respectful way, both internally and externally. We clearly have more to do, and we will continue to work hard throughout 2022 and beyond. But crucially, our underlying business is strong, and we have a clear strategy to make Rio Tinto even stronger for the long term. Thank you. We will now move to questions. Operator, please open the lines.

Your first question today comes from the line of Paul Young from Goldman Sachs.

Jakob, Peter, and Menno, just the financials, gentlemen. So I have a question on growth, in particular, Jakob on OT. No project at the moment. Your portfolio seems easy to execute in advance at the moment. So fantastic to see the government approvals. Jakob, the question is that net of the negotiations, i.e., is the investment agreement now rock-solid with the government?

We feel very comfortable. We feel that it is an agreement, a wide agreement with the Parliament in Mongolia. There's a couple of remaining issues to be solved. There's a tax dispute, but you have tax disputes from time to time. I'm absolutely convinced that with the resetting of the partnership in the relationship in Mongolia that we will be able to also solve issues in the future in a very constructive manner. So yes, I think it was a very important moment to overcome. Thanks for the question.

Your next question comes from the line of Jason Fairclough, Bank of America.

Just to carry on with the growth theme. I mean grow is the first word on the title of your presentation deck, and you've spoken a lot about it today. So a couple of fairly simple philosophical questions. First, you're a $130 billion company. Can you actually grow and have it make a difference and create value? And then second, do you think that your efforts to deliver growth over the last few years have been successful and ultimately had a positive impact on Rio Tinto?

Well, thank you, Jason. It is very clear, given the size of our company and given the markets we are facing, Rio Tinto in aggregate will never be a high-growth company. But we haven't grown for quite a while. And we can see that we can move the company towards modest growth within a strict capital allocation framework. We did not grow last year. If you look at the guidance for this year, we have included modest growth, but that's from our existing business. What I've talked about with my three of my four objectives about excellent development is really about building the portfolio to the next decade and the decade beyond. And that's what we are doing when we unlock Oyu Tolgoi. And that's what we are doing when we are going in and buying Rincon is we don't want to go out and spend a lot of money at probably the high end of the cycle. And therefore, I thought it was quite intelligent to go in and buy a project that is you can buy at a modest price and then develop the project. So we do want to excel in development, but we don't want to lose the strict capital allocation. I think you're absolutely right in making the point. We're never going to be a high-growth company. But if we can have modest, stable growth going forward, that will make imminent sense. We have the competencies in Rio Tinto to be the right owner of a number of assets that we don't have today. That's how we're developing our future. Thank you.

Your next question comes from the line of Hayden Bairstow from Macquarie.

Just a question on the CapEx outlook. Obviously, you've upgraded cost guidance in the Pilbara. But your view on your ability to actually spend the money, I mean, obviously, markets are fairly tight, and labor is still tight. Is there a risk of some slippage in that number, particularly for this year, I guess? But just a line of these projects up and get everything spent that you need to?

Yes. No, it's a very good point. Peter, why don't you underpin a little bit? Because there's fundamentally no changes since the capital markets update in October, but you always have a few things that go a bit slower and certain things we accelerate. Maybe you want to flesh it out, Peter?

Thanks very much, Jakob. And thanks for the question, Hayden. I think for the capital guidance this year, we're very comfortable. And clearly, we are still finishing off the tail of the replacement projects that we bought in the Pilbara, the 90 million tonnes. And as we said, Gudai-Darri will come in, in Q2 for first production. So that is a very, clearly, important component of our capital plan this year. In terms of sustaining capital, in terms of that replacement and in terms of the growth with Oyu Tolgoi, all very, very clear. I think as we get forward into 2023 and '24, Hayden, we've set that, and we've been very explicit that the growth component of our capital plan is an ambition. We're working on a range of projects there that will come through. And it all depends on us really finalizing value-accretive plans as to exactly when that capital comes through. If we don't have the projects that are ready to progress, we won't spend the capital, and we'll just put it to our normal sort of capital allocation framework that we have. So I think that's very clear. Clearly, the news on Jadar does probably put back some of our capital spend. But broadly, I think we're very comfortable with the framework that we set out. Thanks, Hayden.

Your next question comes from the line of Alain Gabriel from Morgan Stanley.

My question is about Gudai-Darri and the replacement projects in the Pilbara. Can you provide details on the operational challenges there aside from COVID? What do you anticipate regarding the risk of further delays into Q3? If, hypothetically, the ramp-up keeps stalling, do you have enough flexibility in your system to increase volumes with SP10? Would those delays pose a risk to your full-year volume guidance?

Yes. Thank you. Let me start off and then hand over to Peter. Look, I visited Gudai-Darri in the first half of last year. There was a really, really good focus. What unfortunately has happened as part of Gudai-Darri is that we haven't been able, because of COVID, to have the same inspection, quality inspections of the material. So when a number of things arrived at the site, we had to do quite a lot of rework. And that has been quite limited access to people to the project in the Pilbara because of the closure of the borders. So that has led to delays. I'm very excited that the borders are opening next Thursday. I'm going there myself, and I'm really looking forward to seeing how we come back on track. But Peter, why don't you share the numbers on CapEx and the question on SP10?

Thank you for the question. Clearly, the progress of Gudai-Darri is very important. We have completed much of the necessary work and are now approaching our first production, as we mentioned for the second quarter. We have managed to address many of the challenges related to COVID, labor constraints, and rework, but there is still more to be done. The timely commencement of Gudai-Darri is crucial. If there are any delays, we still have flexibility in our system, but it would mean we would need to increase production at SP10 to cover the gap. We do have those options available. Regarding our other projects, the main focus is the Robe River system and the issues we've encountered in Misra. We are actively addressing those and expect the Robe River system to be fully operational once we resolve these matters. Thank you, Alain.

Your next question comes from the line of Lyndon Fagan from JPMorgan.

Look, my first question is on the iron ore cost guidance, which now puts you well above BHP and Fortis in terms of unit costs. I'm wondering when you reflect on that, what the key differences are between the Rio Tinto business and your main competitors in the Pilbara? And I'm also interested if there's any potential to rein them in, given that the seminar last year showed the work index going up in 2024. And the next question is just related. There's still really no mention of Simandou in the presentation today. And obviously, it's the elephant in the room when it comes to the iron ore market. When do you think you'll be in a position to articulate the potential scope for that project?

Thank you. I want to start off by discussing Simandou and introduce the first question while Peter explains the differences. We're being quite reserved about Simandou because we are working diligently on it. I visited Guinea in December, and each week, we have more personnel in Conakry. There are intense discussions happening with the government, among joint venture partners, and between the two consortia. The reason for our limited communication is that we are truly focused on finding the right solution. The government is eager to see the project progress, and we are equally keen to be involved, ensuring everything is done to the appropriate standards. Our priority is to complete the work and define the right project, which is both large and complex. I hope we can achieve some significant progress this year and share more information with you. However, there isn’t much I can disclose at this stage. While you might refer to it as the elephant in the room, I don't see it that way. The global iron ore market stands at 1.8 billion tonnes, and developing 100 million tonnes is the kind of replacement needed. Moreover, it offers a much higher quality than Pilbara, so it doesn't directly compete. I believe it would integrate well into our portfolio and I'm excited about the potential for joint ventures with our customers in this area. So, Simandou serves multiple purposes and shouldn't be perceived as an elephant in the room. Turning to Pilbara, I want to take a moment to emphasize what an incredible asset it is. Last year, it generated a free cash flow of $15 billion and is one of the largest industrial assets worldwide. I am fully confident that Simon Short and his team are making the right moves. However, I want to clarify that the results from our current efforts will materialize over the next two to three years. These kinds of assets don't show immediate results from improvements in the following quarter. We are currently at a pivotal point with 90 million tonnes of replacement volumes trying to come in, as Peter mentioned, and it will take time for us to achieve the efficiencies we need. The Safe Production System will be a significant asset for us as well, but patience is necessary in this multi-year journey. Peter, would you like to share information about the development of costs?

Thanks very much, Jakob. When we provided guidance at the beginning of 2021, we indicated we expected to be around $17 to $20. We ended up at $18.60 as projected. This increase was largely due to two factors. First, in the second half, we experienced higher input prices for the business. Additionally, there was some project delay due to COVID and labor challenges in Western Australia. Looking ahead to 2022, we are being very strategic in our approach. It's clear that we need to invest more in our plants in the Pilbara and ensure we are committing the necessary resources for future studies. We must also consider the replacement mines that will be needed by the middle of the decade. Moreover, we have to address increased work index, making productivity essential. These are our key focus areas. We are intentionally planning our steps forward, as Jakob mentioned, this is a multiyear initiative to optimize the Pilbara. Meanwhile, I want to emphasize that our excellent financial results provided a 100% return on capital employed in 2021. Thanks, Lyndon.

Your next question comes from the line of Liam Fitzpatrick, Deutsche Bank.

Jakob and Peter, just another one on Simandou, but more from an ESG perspective. From the discussions that you've had so far, what is giving you comfort that Rio can participate in this project without risking your goal of impeccable ESG credentials? And are there any specifics you can give us over some of the ESG-related challenges that you're aiming to address and derisk with your partners?

Yes. Look, I can give you two things. First of all, when I was visiting the government and meeting with the President, I made it very clear, it's a red line for us, regarding environmental, social, and governance aspects. Environmental is highly sensitive. It's about biodiversity, the chimpanzees, etc. It has to be impeccable. Social is about in-migration that we have everything controlled, and that has to be done together with the government. And governance, of course, there has to be integrity in everything we do. So that's absolutely a red line. The second part that gives me a lot of confidence is that if you look carefully and listen carefully to what Chinese leaders are talking about, they're actually emphasizing the same things. So I think we are very aligned with our partners Chinalco and Baru in terms of that this has to be done to the right ESG standards. That gives me hope and confidence. Thank you.

Your next question comes from the line of Kaan Peker, World Bank of Canada.

A question on copper. Really good to see a large resource increase there. But just on the back of the envelope, it suggests that will be producing around 70,000 tonnes of copper. Given the size, is there an asset that belongs in Rio's portfolio over the long term?

I'm really struggling to hear what you're saying. Peter, could you capture it?

Unfortunately, I could not, Jakob.

Do you think there's any way you can speak differently to the microphone and repeat the question?

Sure. Is that better? Just wondering the size of Winu. It looks like it's going to be something around 70,000 tonnes per annum copper asset. Given its size, does it belong in Rio's portfolio over the long term?

Peter?

Thanks very much for the question. I mean we're progressing. We knew, as we said, we've done a lot of the actual sort of project work. And a lot of the reasons Winu hasn't yet come forward is for very good reasons. The permitting process and the engagement with the traditional owners has just taken longer. And that's just within the context of which we're not operating, and it's just very important to do that at the right pace. So that's the context around Winu. I mean I just think this with Winu, it's something that there's the initial mine and then there's a potential around it. And we've been very focused on trying to really make sure that we develop something with Winu. That has the potential there if the regional district proves perspective for us to grow over time. We need to just work through that and finalize our studies and that broader piece around getting the appropriate approvals for the project. And then we'll make the decision on where to go from there. Thanks very much for the question.

And let me make a little announcement because we have done extensive disclosures today, and one of them is an update on the reserves maturation and you might like to just look at what we're announcing from Winu, it's heading in the right direction. Thank you.

Your next question comes from the line of Bob Brackett from Bernstein.

In terms of the $7.5 billion of decarbonization investments, the way to think about that, for example, the marginal abatement cost curve projects, those have to clear a 10% hurdle rate at an internal carbon price of $75 a tonne? Is that the right way to think about that overall block of investments? And then the follow-up would be, how often do you think that the external or local carbon price will match your internal carbon price?

That's an excellent question. Let me ask Peter to explain the exact methodology, but I would like to make just a philosophical comment. What really for the economics is, of course, not what the carbon price is today. It's what it is 5 years from now and 10 years from now, that's what really has an impact. But if you want to be really specific, that's not what we're saying. We're saying we're using $75 as a carbon price internally. And we're saying independent of the $75 we're saying that our portfolio that we will spend $7.5 billion on is value accretive at modest CO2 prices, so well below the $75. Peter, do you want to elaborate? I think you covered it quite a lot in your presentation.

Happy to do so, Jakob. I mean that's exactly right. I mean what we're talking about is a whole range of projects here that have different economics, and those economics will change over time as we do more work. So clearly, we will sort of prioritize those projects that actually some of them being positive without any carbon price at our sort of hurdle rates of investment at the lower end. And we've given a couple of examples of those in the pack in the appendices to the presentation. So it is a whole range. What we want to do with the $75 a tonne is make sure we're incentivizing the work, make sure that we're doing that work that later this decade when we need it around projects around the group to continue taking us down the decarbonization path. Because we have to do this. We have to derisk the long-term cash flows of the company. As Jakob said, what will carbon prices be in the future, that determine so much of the competitiveness of our assets. And this to me is just a continual process of our investing to take us down that carbon intensity curve and to derisk our cash flows for the long term. Thanks very much.

I was in Brisbane a week ago, sitting down with the decarbonization team, and we have a lot of progress. But it's only four months ago we announced our targets. But I can see that we are focusing and maturing our plan. And there's nothing in it that doesn't give me confidence in what we said at the Capital Markets Day. But we are still not there where we have the kind of final projects. But we're pushing ahead as fast as we can. Thank you.

Your next question comes from the line of Myles Allsop from UBS.

Going back to the question about mergers and acquisitions, you mentioned that you are only interested in opportunities that add value and fit within your portfolio. Can you provide some insight into the size of the acquisitions you are considering in the commodities sector? Are you looking at future-focused commodities, smaller ones, or larger ones? Additionally, are there opportunities available? Rincon suggests there are some possibilities, but is there an extensive list? Will this be a more prominent theme in the next 12 months? Relatedly, there has been discussion in the media about large-scale mergers and acquisitions. Do you believe there is potential in the industry for larger-scale M&A that Rio could be involved in?

Yes. Thank you. Well, I can just talk for Rio Tinto. And I will say to you, I'll be very cautious right now to talk about big M&A. Because I don't know where we are in the cycle, but we are certainly not at a low point. We are pretty high up in the cycle. And I just really would dream about looking back one day and say that we invested countercyclically. And making acquisitions right now could very easily be pro-cyclical. So you could say that larger scale M&A is really not for now, but there are opportunities. And I think Rincon is a good example of it, whereas it would have been very expensive to buy a lithium company right now. We are buying a lithium project at a decent price. And we use our technology, our competence, our people to develop that project. That's an example of how we add value. But the overall guidance from my perspective is, first, ask yourself why we are the best owner of an asset, what can we bring to it? And then, of course, we tend to look quite conservatively on prices through the cycle. And when you have very high prices and people expect a high price, it probably doesn't stack up. So I think Rincon is the example of it is possible. But overall, for Rio, I don't see the big M&A out there. Thank you.

Your next question comes from the line of Richard Hatch from Berenberg.

I have two questions. First, regarding costs, you mentioned the goal of returning to previous levels. In 2017, iron ore costs were $3.40 a tonne, while we're now projecting $19.5 to $20.5 for this year. What can we anticipate for costs in the medium term? Can you provide a target? Secondly, concerning IOC, it appears that the asset continues to underperform. You're mentioning various operational issues; can you clarify what's happening there? When do you expect to achieve a stable operational run rate? Also, leasing costs seem to have increased by about 40% compared to 2017. While I understand the inflationary factors, what can be done to manage the costs associated with that asset?

Yes. Thank you. I'll let Peter explain the cost development in the Pilbara, but I do think I have to take account of IOC. I think it's an amazing asset, but it hasn't been operating super well. I think we have, last year, externally recruited a great CEO for the asset. It was already improving beforehand. And I think we are right now taking it to the next step. There are some very basic things that need to be improved. There are also some investments that need to be made. I'm really excited about implementing the Rio Tinto Safe Production System in IOC. My starting point, just to say, is it produces the world's best quality of fines and pellets. It has a very long mine life. It has great infrastructure. We've got to get that asset to perform every day at its best. And we'll get there, but it will take a while. Peter, the cost split down, please?

Thank you, Jakob. I want to highlight that IOC generated $2 billion in EBITDA in 2021 to provide context. Regarding unit cost trends in the Pilbara, we have observed various industry-wide factors affecting exchange rates and input prices. Over the past couple of years, and looking ahead to the first half of next year, there are specific factors we are addressing, including increasing our operational capacity. In 2022, we are intentionally investing more in the business, especially in maintenance and developing mid-term capacity, which is vital for us. As we move into the second half of the year, the addition of Gudai-Darri will offer us more flexibility in our mining operations, which is crucial. However, it won't completely eliminate our challenges, and we will continue to face work index increases and other issues. Our focus will be to stabilize our current system, enhance production through Gudai-Darri, and effectively implement the Safe Production System across the Pilbara, allowing us to manage the natural impacts of work index as we expand our mid-term capacity. Thank you.

Your next question comes from the line of Rahul Anand from Morgan Stanley.

Jakob and Peter, look, I had a question on lithium and Rincon. So in terms of the BLE absorption technology, I think Livent is the only other producer in Argentina that's currently using that technology. But that's used in conjunction with solar evaporation. So I guess a pure DLE process that's required for the project remains at pilot stage. So what I wanted to understand really was what level of due diligence occurred that gave you the confidence that there is actually a solution available for the project? And what are your next steps here? Can you provide some kind of a timeline as to when we should expect some more news around Rincon?

Thank you. We conducted extensive technical due diligence, and I recommend speaking with our technical team for more insights. Both Peter and our investment committee thoroughly analyzed the situation. While the commercial aspects, such as pricing, were present, our primary focus was on involving our top technical experts. Rincon has made significant progress, and we went through it meticulously with our technical evaluation. Although there is some risk involved, we feel confident that it is a risk worth taking. The project not only aims to produce high-quality battery-grade lithium but will also be executed in an environmentally friendly manner. I'm comfortable with this assessment, but if you would like further details, we can arrange for you to speak with a couple of our technical experts. Thank you.

Your next question comes from the line of Tyler Bulva from RBC.

Great. In fact, the recent intervention by China into the iron ore market, obviously, it's a massive customer. Is there anything you can share from the meeting that you reportedly had with the government? And then I guess on a wider basis, just with the increased volatility we've seen over the last year or two, do you see the current spot sales structure construct as being optimal? I guess is there any thought from Rio's side in terms of seeing that evolve as we go forward?

Sorry, I need a little clarification. What meeting with the government are you referring to and what government?

Sorry, from the Chinese government. So there's a report from Bloomberg just yesterday, Rio Tinto met with the government as part of their current investigations into that. Yes.

So it's very difficult for me to comment upon an article. It's rumors. I mean the only thing I can say is that we work and we have always worked constructively with our customers and other stakeholders for having free and transparent price setting in a free market of iron ore, and we'll continue to constructively work on that. But I cannot say anything concrete. But what you're referring to is simply rumors.

Your next question comes from the line of Lachlan Shaw from UBS.

Yes. So maybe just a lithium strategy, first question. So obviously, Gudai-Darri has a paper to play out, and Rincon sounds pretty interesting. But assuming Rincon goes through development, is that where you want to get to? Or do you see yourself wanting to get bigger in that space given the growth outlook there? You've obviously indicated by acquiring the asset, you've got quite good appetite for lithium. So just interested in how you're thinking about the broader strategy in terms of lithium in the portfolio.

Yes. Thank you. I don't look too much at kind of the spreadsheet part of it where the numbers should bring us. But the starting point is that we expect the global lithium market to be 10 times bigger in 2030 than in 2020. That means that the world needs a number of new mines. And what we're doing, we have actually been working since 2003 in Gudai. We have developed a lot of good technology. With Rincon, we can give something new to now going into lithium giving something new to our technical experts, and we develop technological know-how and competencies. And it's really from that technical expertise pool that we want to see expansion. So it's actually more the technical competencies that drive it than necessarily setting a specific target because, quite frankly, it's going to be opportunity driven. The only thing we know, and it might not be a linear development, but what we know quite sure if we believe in the energy transition is that the world needs much more lithium, and we think we can contribute here.

Your next question comes from the line of Dominic O'Kane from JPMorgan.

Peter, could you provide more detailed quantification on the SP10 guidance for 2022? You mentioned about 11% of the sales mix in 2021. Should we expect it to be higher than 11% in the first half of this year? Additionally, how should we anticipate this evolving throughout 2022?

Peter?

I mean, I think broadly, you should see the first half of 2022 as similar to the second half of 2021. The key is then Gudai-Darri coming on, which will then give us much more flexibility. And at that stage, we should then assume sort of SP10 will come down towards the sort of that midterm guidance that we've given. Thanks very much, Dominic.

The next question comes from the line of Amos Fletcher from Barclays.

Jack and Peter, the first question is just on the iron ore unit cost guidance, which implies year-on-year inflation of 5% to 13%. Can you give us some color on what scenarios at the top and bottom end of that range? And then the follow-up would just be on the aluminum business. Can you give us a little more color around what's happening at Kitimat and why the ramp-up is taking so long there?

Yes, let me start with Kitimat and discuss the cost guidance later. I visited Kitimat last September, and it is disappointing to see the strike situation. When a strike occurs, especially if it happens quickly, there is a lot of cleanup that needs to be done before operations can resume. There was also a clear need to improve the work culture at the site. We have communicated very clearly to management and staff that we need to figure out a better way to collaborate moving forward. Therefore, we are taking our time. We have brought people back and are focusing on maintenance and cleaning the pots to ensure a controlled start-up. Unfortunately, aluminum smelters can be slow to restart after a quick shutdown. While we would have preferred to start up earlier, we are working towards several goals with our start-up plan. Peter, it's your turn to discuss the iron ore.

Thank you. We've developed what we believe is a realistic set of input price assumptions, which is crucial for understanding the cost progression as we enter 2022, especially considering the increases we've observed in diesel and other business inputs. Another important factor is the commissioning and ramp-up of the new replacement mines, including Gudai-Darri. We think the guidance range we've established is sensible based on our current observations. We're also clear about investment and maintenance, as well as investments in studies for midterm system development, making those variables quite understandable. Thank you.

Your next question comes from the line of Peter O'Connor from Shaw & Partners.

Jakob, Peter, my question is twofold, and it comes through the lens of the narrative of income versus growth. So my first question is, given the spin that Jason asked about earlier of $3 billion per year in growth versus $120 billion market cap size, is that again sufficient to grow the company at that level? As your pie chart on Slide 17 seems to be skewed less than 1/3 of that pie. And secondly, a you've mentioned twice in your commentary in the Q&A about the high point of the cycle. The key word being high in the second cycle. So are you foreshadowing it into the cycle, and so rhetoric and narrative about big dividends, is that about to change? And how do we think about the income business growth of the company given that line of commentary which you presented?

Yes. Thank you. I have to admit it was a little bit difficult to hear your question, but I think I captured it. But do come in if I'm not answering it sharply enough. But the thing about the cycle is that what we're trying to do is we're trying to ramp up our organic investments. And organic investments are, of course, to a certain extent, when it comes to inflation, exposed to the cycle. But the real exposure to the cycle is M&A. You just don't want to buy at a very expensive point of view. So my comment about the cycle is mainly about M&A. I think organic development is actually quite important, that you try to have some stability there because it's not just a matter of money. It's also a matter of competence, having a great organization that can execute projects in the most efficient way. So I think that's the gist of it. But there might be one or two things I missed in your questions. So please clarify what you're missing. Well, exactly I don't know what the commodity prices are. But obviously, we have very attractive commodity prices right now. And the only thing I can say is it's certainly more expensive to buy assets than it was a couple of years back. And I think, as I said earlier on, we only know it afterwards. And five years from now, looking back, I would love to see that we have not bought too much on top of the cycle, but rather at a lower point in the cycle. And that's why I'm cautious about M&A, but I'm not cautious about us really investing in our project capabilities and experiencing and becoming better and better and really what I call excel in development.

Your next question comes from the line of Carsten Riek from Credit Suisse.

Peter and Jakob, I have a question about aluminum. You mentioned in your release that the tensions between Russia and Ukraine could potentially drive aluminum prices even higher. Do you think there is a possibility for Russia to redirect those aluminum volumes to China? Would the price impact be less significant in your view? Additionally, is there a way for you to produce aluminum in the short to midterm outside of the Kitimat smelter in British Columbia to take advantage of strong aluminum prices?

Yes. Thank you. You're right. I think it goes for VTEs, and it goes for all aluminum smelters. You have very little flexibility. You either run a smelter or you run a smelter flat out. I don't think I predicted increased prices in aluminum because quite frankly, I don't know where prices are going. What I said about the Ukraine conflict is that it has the potential to create disruption in the market. And I think what you're saying there is one scenario. There are many scenarios that can pan out. What I'm trying to say is I think, actually, we have tried sanctions before. I think we are quite well placed because we have that integration between bauxite mines, refineries, and smelters so that we would be quite robust if there are disruptions. But predicting prices, I leave for you.

I will now hand the call back for closing remarks.

Well, thank you very much for taking the time here attending and showing interest in Rio Tinto. It's an important day for us. We have disclosed a set of very strong financial results. But leave no doubt, we see everyday opportunities to continue to improve. We tend to strengthen our culture, strengthen our operational performance, always in a safe manner. Thank you for joining, and have a nice day.