The Business of Mining

“Vale’s finance chief said the Brazilian miner would invest in development programmes in Guinea in an attempt to safeguard a $2.5bn mining concession and avoid making a large pay-out to the African country’s new government. In spite of still being vulnerable to a review of mining licenses in Guinea, Guilherme Cavalcanti said that Vale could win the government’s approval for its Simandou iron ore project that it shares with rival Rio Tinto by paying for education and agriculture in the communities where it mines.

Observations:

• The Simandou deposit is divided into 4 blocks: Vale controls blocks 1 and 2 with the Benny Steinmetz Group (BSG) as minority shareholder; Rio Tinto controls blocks 3 and 4 of the Simandou deposit, working together with Chalco. In an earlier stage Rio Tinto held title to the full deposit, but the Guinean government cancelled this deal.
• In a review of mining licenses announced in March the Guinean government requires a minimum of 33% of ownership of strategic mining projects in the country to increase government control.
• Rio Tinto struck a deal on the redistribution of ownership at the end of April, setting up a long term phased process of acquisition of ownership by the government. Furthermore the company agreed to a conditional one time $700mln payment to the government and promised to develop a railway to export the ore via a Guinean port.

Implications:

• The social projects promised by Vale are a mere hygiene factor in the negotiations about transfer of ownership. The government will clearly expect any operating partner to take an active role in community development. However, Vale’s experience with large scale operations in developing areas in Brazil and Mozambique might help to gain trust.
• Most likely Vale will agree on a conditional and phased deal similar to Rio Tinto’s agreement with the government. The agreement will be designed to make any payments or ownership deals conditional on crucial milestones and actions by the government. Vale will still need to decide on a way to export the ore, either negotiating to use the railway build by Rio Tinto, or setting up the infrastructure to export via Liberia.

©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

“A $5.9bn potassium project in Argentina has gone into limbo after authorities in Mendoza province suspended development, alleging that Vale, the Brazilian miner, had failed to meet requirements to hire and buy supplies locally. The project, which includes the construction of a railway and a port on Argentina’s Atlantic coast to transport potassium, is still in its initial planning phase. In its first-quarter earnings report, Vale said it had pushed back the planned start of production to the first quarter of 2014 from the second half of 2013.

Observations:

• One of Vale’s strategic priorities is to build a strong potash business. The Argentinian Rio Colorado project, which should start production in 2014 with some 20% of Vale’s current potash production, is key part of this strategy.
• Argentina’s province of Mendoza is situated in the region del Nuevo Cuyo in the midwest of the country, bordering to Chile. The province has set strict ‘buy local’ and ‘hire local’ regulations in order to stimulate the economy, forcing Vale to hire 75% of total workforce locally.

Implications:

• Both the provincial government and Vale are very polite in their communication, signalling the importance of the project to both of the parties. The province is using a rather uncertain moment in the development phase of the project to stress the importance of collaboration with local authorities. However, this discussion is not expected to seriously derail the project, unless governmental changes chance the standpoints of the provincial government.
• In the worst case for Vale issues on development of a port for the same project in a different province will be made part of new negotiations with Mendoza province, indicating involvement of the national government.

©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

“Rio Tinto’s most troubled mining project appears poised for multibillion-dollar development after the company agreed to pay $700m to the government of Guinea and grant it a 35 per cent stake in its iron ore mine. The deal was reached on Friday ahead of plans by Guinea, a west African country rich in iron ore and bauxite, to review all mining licences as part of its push to secure bigger returns from its mineral wealth.

Observations:

• Last month Guinea announced a review of mining licenses, including the demand to get minority stakes in all major mining projects in the country.
• Rio Tinto controls blocks 3 and 4 of the Simandou deposit, with Brazil’s Vale controlling blocks 1 and 2. First shipment of iron ore by Rio Tinto is expected by mid-2015.

Implications:

• The agreement of Rio Tinto to construct a railway through is a major blow for the government of Liberia, which hoped to convince the miners to export the ore with a shorter route via Liberia. The decision on the export route will further trigger challenging negotiations with Vale about using the same infrastructure to export ore from the area.
• The 35% government stake can be build up over time, with the final 10% to be bought at market value in 15-20 years time. Tax rate is set at 30% after the first 8 years, with additional 3.5% royalties. The $700mln payment is only made conditional on granting the concession and approving the Rio Tinto / Chalco joint venture. Based on these conditions it appears Guinea intends to be a friendly host to international mining companies in the long term, but requires strict payment and infrastructure development contribution in the short term.

©2011 | Wilfred Visser | thebusinessofmining.com

“Brazilian iron-ore giant Vale SA said Friday it will acquire control of South Africa-based copper and cobalt miner Metorex Ltd. for nearly $1.13 billion. The deal will help Vale inch closer to its aim of becoming one of the world’s biggest copper producers, with a long-term production target of one million metric tons a year of the metal.

Observations:

• Shareprice of Metorex has doubled since September 2010, driven by high copper price, weakening South African currency. The price jumped from R5.50 to R7.50 in the past 3 weeks.
• The current 26 thousand ton (long term production target of a million tons of copper per year) adds to Vale’s 208 thousand ton sold in 2010. Other copper expansion projects of the company are the Chilean Tres Valles project and Salobo copper mine in Brazil. These 2 projects together should add approx. 120 thousand tons.

Implications:

• The stronger diversification into base metals and other geographies is an important means for Vale to become less dependent on iron ore prices. Vale’s 208 thousand tons of copper production compared to 678 thousand tons for Rio Tinto, 913 thousand tons for Xstrata. It is a good sign that the company is trying to grow by carefully selecting bolt-on acquisitions with high growth potential.
• Next to buying a set of assets and projects with high growth potential located close to the Konkola North project it operates with African Rainbow Minerals, the company gains access to an enormous amount of expertise on doing mining business in Sub Saharan Africa with the Metorex management. Congo clearly is a high-risk business environment, and plunging in greenfield without an experienced management team would greatly reduce the change of success.

©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

“Guinea is planning a comprehensive review of its mining licences that could disrupt a $1.35bn iron ore agreement between China’s Chinalco and Rio Tinto, a $2.5bn iron ore acquisition by Brazil’s Vale, and a slew of smaller mining deals in the mineral-rich west African state.

Observations:

• According to the new licensing structure all foreign investors and their host countries will need to subscribe to the WorldBank’s EITI (Extractive Industries Transparency Initiative). Furthermore the government will request minority ownership of all projects.
• The most important mining project in the country is the iron ore complex around Simandou and Kalia. Rio Tinto and Chinalco, Vale, and Bellzone and CIF hold licenses to various blocks of the complex, from which production should start within 2 years.

Implications:

• China and Chinese companies, as brought in by Bellzone and Bellzone, don’t subscribe to the EITI yet. This could lead to significant development delays and/or break-up of consortia. It is unlikely that the government will push the large foreign investors out of the projects, as they need the foreign money to get the projects going.
• In the Economist’s country operational risk benchmark, Guinea ranks 149th out of 149 countries, tied with Iraq. The 10 risk categories included in the benchmark are: security; political stability; government effectiveness; legal and regulatory; macroeconomic; foreign trade and payments; financial; tax policy; labour market; and infrastructure. Next to the changing regulatory environment the infrastructure risk is important for Simandou’s projects, as Guinea and Liberia are fighting over the port to be used for shipping the ore and the way the ore should be transported to the port.

©2011 | Wilfred Visser | thebusinessofmining.com