UPDATE 1-BHP eyes boost to shareholder returns as productivity rises

* BHP signals well placed to reward shareholders

* Production up 10 percent in December half

* Quarterly iron ore output rises 16 pct

(Adds details, ceo quote)

SYDNEY, Jan 22 (Reuters) - BHP Billiton BHP.AX BLT.L , the world's biggest miner, posted strong rises in iron ore and metallurgical coal output in the December quarter and said it was well positioned to reward shareholders as productivity increased.

BHP reported a 16 percent increase in iron ore production in the December quarter to 48.9 million tonnes and maintained its guidance for fiscal 2014, while its Queensland coal business hit record levels.

Investors in big mining companies, including fund manger BlackRock BLK.N have called on miners to consider higher shareholder returns as the era of high construction costs to build new mines now shifts into production phases.

BHP Chief Executive Andrew Mackenzie said the company aimed to boost returns through financial discipline and internal competition for funds.

"This strategy leaves us well positioned to deliver a substantial increase in free cash flow and higher returns to shareholders," he said in the December production report.

Analysts have previously flagged share buybacks would be possible in the 2015 financial year as free cash flow increases with higher output from recently completed projects.

A share buyback is generally seen as the preferred form of capital management for BHP Billiton as its stock is listed on both the Australian and London stock exchanges.

Iron ore and coal have been designated by Mackenzie as two of the four "pillars" underpinning growth by the world's biggest mining house. The others are copper and petroleum.

BHP reported a 4 percent decline in quarterly output from its petroleum division but held its fiscal 2014 guidance of 250 million barrels of oil equivalent.

Unlike rival global miners like Rio Tinto RIO.AX , BHP has long relied on its petroleum business to offset soft periods in metal and coal markets. Its footprint in the sector has grown with the advent of shale gas and oil exploitation in the United States.

Oil and gas accounted for $13.2 billion in revenue for BHP last year, second only to the $20.2 billion generated by iron ore.

(Reporting by James Regan; Editing by Richard Pullin)

((jim.regan@thomsonreuters.com)(+612 9373-1814)(Reuters Messaging: jim.regan.reuters.com@reuters.net))

Keywords: BHP PRODUCTION/