Vale Might Choose To Prioritize Brazilian Project Over Simandou In Guinea
Vale (NYSE:VALE) is likely to give priority to its Serra Sul iron ore mine project in Brazil over its Simandou iron ore project in Guinea, according to a source familiar with the company’s strategy. Serra Sul is an extension of Vale’s giant Carajas iron, copper, and nickel mining complex in Brazil’s Para state. It is expected to have a capacity to produce up to 90 million metric tons a year, about 9% of current world iron ore exports, thus helping Vale maintain its position as the world’s biggest producer of iron ore. It is a $19.5 billion project. [1]
Simandou has one of the highest-quality untapped iron ore resources in the world and has attracted both Vale and Rio Tinto (NYSE:RIO) to Guinea despite the country’s history of volatile dictatorship, a weak rule of law, and recurring threats of license re-negotiations. Rio controls the southern half and Vale the northern half of the concession. Vale controls only 51% of its concession. The remainder is held by Beny Steinmetz Group Resources. ((Vale woos Guinea with social projects, Financial Times))
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Why Sera Sul And Not Simandou?
In June, Vale was granted a preliminary environmental license for the Sierra Sul project, which includes railway and port investments. The railway and port infrastructure is a crucial component of Sierra Sul because most of this ore is meant for export to China. Without building these, there is no way that the produced ore can be exported. The Serra Sul mine is at the center of the plans to boost Vale’s iron ore output by 40% to 460 million metric tons a year in 2017. The granting of the license for the project thus makes a strong case for paying attention to the Sierra Sul project.
But, why would Vale simply ignore Simandou, which, as already mentioned, has a high-quality and rich resource base?
While Simandou holds enormous high-quality reserves, it faces major political, commercial, and transportation hurdles. There is a pervasive atmosphere of policy uncertainty in Guinea. The government keeps locking horns with mining firms over control, ownership, and financing of projects. Guinea recently revised its mining code, raising the state’s mandatory stake in mining projects to 35% from 15%, and it also plans to change other clauses in the code after “consultations” with mining companies.
It is unsettling for any company to operate in an atmosphere where the law of the land keeps changing as a result of political posturing, rhetoric and resource nationalism. If a new government doesn’t honor contracts signed by the previous government and insists on re-negotiations, the contracts lose all sanctity and meaning. In July, BHP Billiton, the world’s largest mining company, decided to pull out of its Mount Nimba iron ore project, one of Guinea’s biggest projects. [2]
While a volatile political atmosphere and regulatory hurdles are big concerns, we think there are additional forces at play as well. With its economic engine having slowed down, demand for iron-ore from China has taken a hit. This has caused iron ore prices to slump. Also, governments and institutions in the U.S., Europe, and China are trying to counter the economic slowdown using fiscal and monetary stimulus measures. Going by the commentary in the mainstream media, we conclude that there is a lack of consensus on whether these stimulus measures will work in the long term or cause only a short-term buoyancy in the market. As a result, the future outlook for the commodity demand is quite uncertain.
In short, we think that low iron ore prices, an uncertain demand outlook, and a hazy operating environment together might force Vale to cut down on capital expenditure and prioritize projects. Simandou would require billions in infrastructure spending for development, and there seems to be little upside in doing so, for now.
Iron ore prices fell to a three-year low this month, which has eliminated billions in potential revenues and prompted mining companies to consider cuts in investment budgets. You can project your own iron ore shipment figures for Vale by using our interactive graph below:
Vale’s iron ore business constitutes 64% of its Trefis price estimate.
We recently revised the Trefis price estimate for Vale to $19 which is in line with its market price.
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