* BHP and rival Rio fight to be lowest cost producer
* Moves follow decline in commodity prices
* BHP readies to face "extended period of lower prices"
* Cuts 2016 spending by deferring shale oil, iron projects (Adds Rio Tinto CEO comments, details on BHP capex cuts)
By Silvia Antonioli
LONDON, May 12 (Reuters) - BHP Billiton said on Tuesday it would slash its iron ore production cost further and cut spending to better withstand a downturn in commodity prices that is testing even mining industry heavyweights.
Giant iron ore producer BHP, the world's largest mining company, and rival Rio Tinto are locked in a battle to become the lowest cost iron producer. At the same time, they are increasing production of the steel ingredient, hoping to squeeze out competitors and gain market share.
BHP Billiton Chief Executive Andrew Mackenzie dismissed criticism that such a strategy was fuelling the sharp slump in iron ore prices.
"We operate in highly competitive and cyclical markets, where earnings outperformance through the cycle depends on being the most efficient supplier, not supply restraint," Mackenzie said, speaking at an investor conference in Barcelona.
"In this environment we are well prepared for the possibility of an extended period of lower prices in several commodities."
Conserving capital has been a theme in the mining sector since metals prices started to cool in 2011 as the commodity supercycle came to an end.
BHP said it would reduce its capital and exploration expenditure to $9 billion in the 2016 financial year from $12.6 billion in 2015.
This compares with a previous forecast of $10.8 billion for 2016, with cuts coming mostly from the deferral of some shale development in the United States and of an iron ore port project at in Western Australia.
The Anglo-Australian mining company said also it expected to reduce iron ore unit costs at its Western Australia operations by 21 percent to $16 per tonne in the 2016 financial year, from just below $20 per tonne last month.
"That's is an incredibly low cost. That's targeting even lower levels than Rio," said Investec analyst Hunter Hillcoat.
Rival Rio Tinto, the lowest cost iron producer, had an average cash cost of $19.50 a tonne in 2014, and forecasts it will be about $17 a tonne this year.
Analyst Paul Young at Deutsche Bank in Sydney said he expected Rio to still be ahead of BHP in 2016, forecasting its cost will fall to $13-14 a tonne.
"I am sure we will encounter further turbulence ... but this part of the cycle is when Rio Tinto thrives. I do feel for the high cost producers," Rio Tinto Chief Executive Sam Walsh told the conference.
Both producers have been helped in their cost-cutting efforts by weaker oil prices and a lower Australian dollar against the U.S. dollar.
But competitors have benefited from these too.
"I don't expect these cuts to result in higher margins for BHP and Rio," said Liberum analyst Richard Knights. "Costs are being cut aggressively by marginal producers as well which in an oversupplied market, leaves more room for the price to fall." (Additional reporting by Sonali Paul in Melbourne; Editing by Keith Weir and Louise Heavens)