The Business of Mining

Top Stories of the Week:

• Vale starts to fight back against tax rulings
  • Vale announced its plans to appeal to the governments intent to charge $5.6bln worth of taxes on foreign earnings. The clash with the government promises to be the first real test for the new CEO Murilo Ferreira.
  • Mr. Ferreira took over the leadership of the company from Roger Agnelli, who was not reelected partly based on a disagreement with the government (which is control Vale via state-controlled shareholders) over $2bln taxation.
  • Sources: Vale press release; Financial Times; Bloomberg
• Rio Tinto assumes full control of Oyu Tolgoi
  • Rio Tinto increased its ownership of Ivanhoe from 49% to 51%, giving it full control over the flagship Oyu Tolgoi copper project in Mongolia, the world’s premier copper development project.
  • Sources: Rio Tinto press release; Wall Street Journal; Financial Times

Trends & Implications:

• Vale estimates the impact of a review of the tax code on the company’s earnings to be approx. 4-5% of earnings. Taxation regimes around the world for specifically iron ore and copper mining are reviewed to make the countries benefit more from ‘extreme’ profits, which could be seen as a temporary phenomenon. However, the key issue in Vale is facing now is a debate about double taxation; paying taxes over profits after taxes realized in countries where the company is operating.
• Rio Tinto’s control over Ivanhoe will help the company to put in place its management structure and have the project managed by some of its top project developers. Gaining full control of the project in this stage will help Rio Tinto to build the project according to the company’s standards, preventing costly and above all time-consuming future transitions in the operating structure. The global standards that enable effective project management more and more set the world’s largest miners apart from the ‘small’ mining firms with only a few operating assets. Very much like GE has become known as a great ‘project management company’, the world’s largest miners are more and more developing into ‘mine development’ companies in which development speed is the key success factor and navigating politics in developing countries is a key skill.

©2012 | Wilfred Visser | thebusinessofmining.com

Top Stories of the Week:

• Peabody and ArcelorMittal get MacArthur; then ArcelorMittal gets out
  • Only 2 days after PEAMcoal, the vehicle set up by Peabody energy and ArcelorMittal to buy Macarthur, announced it obtained a majority interest, Arcelor decided to get out of the combination. The company will sell the 16% of Macarthur it had to Peabody. Peabody had teamed up with ArcelorMittal because an earlier bid had not gained the support of the major shareholders.
  • Sources: Reuters; Financial Times; ArcelorMittal press release
• Vale suffers $2.8bln exchange rate hit
  • Vale posted disappointing results for the 3rd quarter: the weak Brazilian real compared to the US dollar hit the company hard, iron ore spot prices dropped 27% q-on-q, and production volumes were lower than planned.
  • Sources: Vale press release; Financial Times; Wall Street Journal

Trends & Implications:

• The move of ArcelorMittal out of the Macarthur acquisition is a surprising sign of hesitance and uncertainty about the development of the global steel market. The company prefers cashing $700mln over having to pay an additional $1.2bln to get 40% of the Australian coal miner. It still plans to build an iron and coal mining business to increase self-sufficiency. US steelmakers are also struggling and iron ores prices have plummeted in expectation of falling steel demand.
• Exchange rates remain a very important factor in the competitiveness of miners because sales for miners around the world are typically in US dollars, irrespective of the currency in which costs are incurred. As shown in the exchange rate graphs below the Brazilian real has been hit harder than the Australian dollar, key currency for iron ore production of Rio Tinto and BHP Billiton, in the past quarter.

©2011 | Wilfred Visser | thebusinessofmining.com

Top Stories of the Week:

• Freeport McMoran faces strikes in Indonesia
  • About half of the workers at Freeports’ Grasberg mine went on strike to demand higher pay, forcing the company to shut down operations. Several strikers have been killed by police and unknown gunmen in the past week.
  • Sources: FCX press release; Financial Times; Wall Street Journal
• Rio Tinto sells aluminium, buys uranium
  • Rio Tinto plans to spin off 13 of its smaller aluminium assets for an estimated $8bln. The company wants to focus its attention on top tier assets.
  • Sources: Rio Tinto press release; Wall Street Journal; Financial Times
  • Rio Tinto buys Hathor Exploration, a uranium exploration business active in Canada, for over $500mln. Key asset of Hathor is Saskatchewan’s Roughrider deposit.
  • Sources: Rio Tinto press release; Wall Street Journal; Bloomberg BusinessWeek
• BHP shops for iron ore in Brazil
  • Junior miner Ferrous Resources, worth just over $3bln, is looking for a buyer. BHP Billiton and a Chinese company are talking with management to negotiate a price.
  • Sources: Financial Times; Fox Business

Trends & Implications:

• Freeport’s social troubles in Indonesia are the latest labor issue in a rise of labor unrest in the latest year after years of relatively peace in the industry. The unrest mainly affects copper producers, which have seen profits rise with high copper prices, but did not want to increase worker’s compensation too much to secure long term competitiveness.



• The large diversified miners are increasingly focusing their attention on a limited number of extremely large operations, divesting smaller operations. With the spending power of the ‘mining supermajors’ a divide seems to open between the few operators of the world’s key supply areas and the many operators of a range of smaller operations.
• Rio Tinto might face challenges selling the unwanted aluminium assets in one package. Very few companies are able to do acquisitions worth over $7bln, and many of the companies that have the spending power might face antitrust limitations.

©2011 | Wilfred Visser | thebusinessofmining.com

“Brazilian mining company Vale SA said Thursday it struck a two-year collective labor accord with all of the country’s mining workers’ unions. The accord will give Vale employees an 8.6% pay rise effective November and a further 8% pay increase in November 2012, Vale said in a statement. In addition, the employees will get a bonus each year of 1,400 Brazilian reais ($744.68), the company said.

Observations:

• Out of 71 thousand of Vale’s employees (Dec 31 2010) approx. 60 thousand work in Brazil.
• The agreement holds the middle between Vale’s initial 7.5%/y offer and the union’s ’15%/y plus bonuses’ demands. In previous years Vale gave a 7% increase annually. Inflation rate in Brazil has been around 5-6% over the past years.

Implications:

• Creative bonus systems will become a more important part of the mining remuneration policies because skilled resources and talent are becoming increasingly scarce in the mining industry.
• Brazil’s National Mining Plan foresees growth of the domestic iron ore production of 58% from 2011 to 2015. Current high ore prices will help to finance aggressive expansion, but the legislative processes around development and the shortage of workers form two important obstacles to realize this objective.

©2011 | Wilfred Visser | thebusinessofmining.com

“A consortium of five state-owned Chinese companies bought a 15% stake in the world’s largest niobium producer for US$1.95 billion in cash, a move that highlights the race among steelmakers to secure resources amid tightening supply.

Observations:

• The group of 5 existing clients of CBMM buys 15% of the controlling stake of the Moreira Salles family. The family sold another 15% to a group of Japanese and Korean companies for $1.8bln in March.
• Niobium is considered a rare earth mineral. Various governments tried to stimulate domestic mining of rare earths because China currently holds over 90% of global rare earth production. In May the new Brazilian government persuaded Vale to look into rare earth production.

Implications:

• It is not fully clear why the Moreira Salles family sells minority stakes of their company. The almost $4bln the family raised by selling 30% is owned by the family, not by the company, and thus will not be used for expansion of the company. As the family held 55% of the company before this year (the other 45% is held by Unocal), ownership is now fragmented, with 2 or 3 of the shareholder groups required to support any major decision.
• CBMM is well positioned to be the world’s leading niobium producer in the coming decades, as most of the world’s reserves are located in Brazil. Strengthening ties with this producer is crucial for steel makers in order to control their input prices. It will be a challenge for the large Indian and European steel makers to secure their niobium supplies without buying into a producer too.

©2011 | Wilfred Visser | thebusinessofmining.com

Murilo Ferreira

The world’s second largest mining company has changed the man at the top. Roger Agnelli, who led the company for almost 10 years, was replaced by Murilo Ferreira last month. Though Agnelli grew the company into a global force in the industry, he did not manage to please the Brazilian government sufficiently. As a result the new president, Dilma Rousseff, pushed for a change. What is on top of the “To Do”-list for the new CEO?

An analysis of Vale’s latest annual and financial reports, the press conference to introduce the new CEO, investor presentations, and the news about the company in the latest months yields a list of 10 issues that are likely to be at the top of Ferreira’s list of priorities.

The list holds strategic, operational, financial and relational activities, each of which are scored in terms of importance and urgency. Priority 1 on the list is to build strong government relationships; priority 10 is to expand the metallurgical coal business in Latin America. Read on for the full list of priorities. For those readers working with Vale: don’t hesitate to forward the list to mr. Ferreira.

1. Build government relationships

Mr. Agnelli grew the company, but he did not manage to please the Brazilian government. The government controls the majority of the voting shares, and hopes to use Vale as a means to stimulate the domestic economy. The key task for mr. Ferreira will be to build strong government relationships without giving in to government requests which would hurt general shareholder value.

2. Develop strategic messages

A first step for each CEO after taking office is to get the key messages to be repeated over and over again to investors and employees. Especially Vale’s communication to the investor world has historically been poor. Selecting the key points to tell to the world the coming year(s) and tuning the communication and communication support is an important task during these first months.

3. Discuss tax & royalty claims

Related to the first point of building government relationships: the government claims a total of $16.0bln tax over the period 1996 to 2008 plus some $4.7bln in royalties (CFEM). Furthermore, Vale’s current effective tax rate is some 10% below official tax rate because of various tax incentives, for which the continuation is not sure. Reaching agreement with the authorities about these claims and the future tax incentives is crucial for the share price to increase.

4. Build global culture, integrate & decentralize

One of the key points mentioned in mr. Ferreira’s first press conference as CEO was the change of the company style towards a more decentralized system in which team work is incentivized more. Next to driving execution mr. Ferreira will need to be the living example of a global cultural change, in which each part of the business feels equally valuable.

5. Manage vertical integration in Brazilian steelmaking

The next (potential) issue with the Brazilian government is Vale’s role in the Brazilian steelmaking industry. The government wants to create a strong vertically integrated player, and therefore needs Vale to cooperate with players like Gerdau and Usiminas. Although it is in Vale’s best interest to stimulate domestic demand for iron ore to offset the disadvantage in transportation costs to supply the Asian market versus Australian mines, the company wants to stay a pure miner. Developing and discussing strategic options for the domestic industry will be an important task for mr. Ferreira to demonstrate his leadership.

6. Solve roadblocks for development execution

Vale plans to invest $17.5bln in new project development this year, but various projects run the risk of delay. Most roadblocks have to do with demands by federal and regional governments (e.g. the temporary suspension of the Rio Colorado project in Argentina), signalling the requirement to more proactively involve governments in planning procedures.

7. Manage operating cost pressures

A key competitive advantage to Vale is the low cost base of its operations in Brazil. The risk of lower iron ore prices forces mr. Ferreira to try to keep costs down at a time of cost inflation. Especially the management of the energy matrix (energy costs account for over 15% of COGS) and of outsourced services, which are sensitive to Brazilian wage inflation, will require management attention.

8. Compete for position in China

A key task for any big mining firm this decade is to fight for pole position in supplying the number one growth market: China. Mr. Agnelli secured various lucrative supply deals, but Vale did not yet sign significant partnerships. Mr. Ferreira has limited experience with the Chinese market and will thus need to spend time on getting to know the key players and developing relationships which are important for both future development and future supply contracts.

9. Transform internationalization organization

Vale still is a very much Brazilian company: out of the 120 thousand workers (incl. 40% contractors) 80% is located in Brazil. However, this Brazilian focus is starting to hinder the company in attracting international investors, customers, and employees. Even press conference in which new CEO was presented was conducted in Portuguese, certainly posing an obstacle to some investors. Appointing CEO with experience of working in North America is step in the right direction, but mr. Ferreira will need to do more to improve the international image of his company.

10. Build metallurgical coal business in Latin America

Partly driven by the need to diversify the company’s revenue base (68% of revenue still comes from iron ore & pellets, with an even higher percentage when looking at profits), partly driven by the need to build the domestic steel industry, Vale needs to gain access to metallurgical coal close to home. The company operates thermal coal mines in Brazil, but metallurgical coals needs to be imported. Exploration in Colombia is promising, but more needs to be done to build the coal business.

Sources: Vale annual report 2010, Vale CEO press conference May 2011, Vale investor presentation February 2011

©2011 | Wilfred Visser | thebusinessofmining.com

“Vale, the world’s biggest iron ore producer, is gearing up to move into rare earth mining as Brazil tries to compete with China to supply some of the world’s most sought-after metallic elements, says Brazil’s science and technology minister, Aloizio Mercadante. The government has met several industrial companies to line up customers for rare earths, a group of 17 elements which are primarily used to make components for such items as wind turbines, electric cars, and computer screens.

Observations:

• Chinese export restrictions on rare earths have drawn global attention to the risks of having China produce 97% of the total global production of these raw materials to high-tech products.
• Brazilian company Companhia Brasileira de Metalurgie e Mineracao (CBMM) already produces the rare earth niobium. The government is now aiming to start producing some of the minerals for which China holds a more dominant position, partly to stimulate the domestic high-tech industry.

Implications:

• Apart from rare earths being a potential source of profits for Vale contributing to the government’s push to make Brazil a producer will help the new CEO develop goodwill with the government. Small concessions like these could help Vale sustain independence in more impactful iron ore related issues later.
• The enormous increase in rare earth prices after the export restrictions by China are not expected to last for very long. Many other countries and companies are looking into starting up production; a development that is not so much slowed down by the ‘rareness’ of the ores, but more by the time required to set up the recovery process.

©2011 | Wilfred Visser | thebusinessofmining.com

“After the recent carnage in commodities markets, iron ore stands out for its price stability. The commodity used in steelmaking has been trading at around $180 a tonne for most of the month, just as the costs of raw materials ranging from crude oil to copper and cotton have gyrated wildly.

Observations:

• The iron ore pricing mechanism was changed last year, moving to a spot-price linked price instead of the historic annual benchmark price. As a result the miners have gained more flexibility in setting contracts.
• Iron ore price increased threefold over the last years, with Asian growth and supply constraints mentioned as the most important drivers.

Implications:

• Both Rio Tinto and BHP Billiton are planning to increase capacity of iron ore mines in Western Australia significantly, but supply is expected to be short for at least an other couple of years. As Indian ore will more and more be used for domestic steel production the long term prospects of Australian exports are good.
• The high ore price will trigger development of projects with relatively high cost base, breaking even at prices far above the $50/tonne level. Low cost operations will be operated at maximum capacity while focus at these new high cost operations will be on cost control.

©2011 | Wilfred Visser | thebusinessofmining.com

Observations:

• Dilma Rousseff appears to have won the battle to replace Vale’s CEO Roger Agnelli, as various Brazilian and international newspapers are reporting a more government-minded chief will be appointed instead of renewing mr. Agnelli’s contract.
• As displayed above the government has strong control over the world’s largest iron ore miner. Valepar S.A., the controlling shareholder, is 49% owned by state pension funds and the government has large influence on two of the three other major shareholders: BNDES, the state development bank, and Bradespar, a daughter of Brazil’s second largest private bank.
• Key reason for the Brazilian government to push for replacement of mr. Agnelli is the conflict of interests between the company’s shareholders and the Brazilian government. Vale focused on cost cutting in the crisis while the government would have liked the company to keep employment high; Vale had ore carriers build in Asia, while the government would have like to have domestic shipyards build the ships; Vale tries to minimize taxes and royalties paid, while the government tries to maximize revenues.

Implications:

• As long as iron ore prices stay high the change of leadership is not likely to have a major impact on Vale’s international behavior. The company will likely get more closely involved in Brazilian steelmaking, potentially allying with Gerdau in development of domestic projects. If prices drop, expansion focus will be more centered on Brazil to please the government.

©2011 | Wilfred Visser | thebusinessofmining.com

“Gerdau SA, Latin America’s biggest steelmaker by output, Wednesday strongly denied rumors that it will use funds from its new share sale to buy stakes in fellow Brazilian steelmaker Usinas Siderurgicas de Minas Gerais SA, or Usiminas. At the same time, Brazilian industrial group Votorantim denied it is seeking to sell its 13% stake in Usiminas’s controlling shareholders’ group.

Observations:

• Gerdau owns rights to four iron ore deposits in Brazil’s state of Minas Gerais. Total reserves were revised up from 1.9bln to 2.8bln tons last month.
• In comparison, Vale, Brazil’s and even the world’s largest iron ore miner, holds proven reserves of approx. 10bln tons at production over 300mln tons of ore per year.

Implications:

• Some analysts expect Gerdau to search for options to expand by acquiring one of the smaller steelmakers in Brazil. Acquiring a flat steel maker would complement Gerdau’s strength of producing long steel.
• Other analysts expect Gerdau to team up with an experienced mining house in order to step up production in its mining assets. Current low margins in steel making caused by high iron ore, coal and electricity prices lead many steelmakers to analyze options to move upstream.

©2011 | Wilfred Visser | thebusinessofmining.com