Will Vale Cancel $6 Billion Argentina Potash Project After Tax Break Rejection?
According to newspaper Folha de S. Paulo, Vale (NYSE:VALE) is likely to cancel its $5.9 billion Rio Colorado potash project in Argentina after having failed to win tax breaks for the same. The newspaper claimed that not only did the Argentine government reject requests for tax breaks, it also ratcheted up its own demands on the company. The newspaper quoted unnamed Vale officials. The company’s board is scheduled to meet today to discuss the project and a final decision could be taken. Without tax breaks, the project’s costs could soar by 86% to $11 billion. [1]
Vale had announced an indefinite suspension of the project in January. Operations were halted in December during the holiday break given to workers and did not resume thereafter. The company had a particularly bad year in 2012 with net profits of $5.5 billion compared to $22.9 billion earned in 2011. As a result, it has put mining projects around the world on review and is now looking to sell non-core and unprofitable businesses. [2]
Vale has been seeking tax breaks for the project to help compensate for soaring costs related to inflation and exchange rates. Unofficial estimates measured inflation in Argentina at about 25% a year, well above the official rate of 10.8% in 2012. This might well be true since private economists have long discredited the quality of official Argentine data and even the International Monetary Fund(IMF) has censured the country for the same. [3]
In response to questions posed in the wake of the newspaper report, Vale stated that it is seeking no changes to Argentine labor or tax law and is looking for ways to make the project financially viable.
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The Rio Colorado Project
The Rio Colorado project includes the developing of a potash mine in Mendoza, the renovation of 440 kilometers of railroad tracks and the construction of a 350 kilometer-long railroad line to transport the potash to a terminal in the port of Bahia Blanca for export. Production was earlier expected to begin in the second half of 2014 but that target looked ambitious even at the time of announcement. The annual production capacity was targeted at 2.4 million tonnes initially and to go up to 4.3 million tonnes eventually.
In a presentation given in December, Vale informed that 42% of the work at the project site was complete but the pace of further execution would slow down owing to a company-wide austerity drive. The budget for the project was slashed from $1.08 billion to $611 million for 2013. Approximately $1.8 billion had already been spent by October last year. Vale has since then been looking for a partner for the project to reduce its own cost burden. [4]
Why Was The Project Suspended In The First Place?
Vale is heavily dependent on iron ore and prices for the same were very low on average in 2012 due to weak economic conditions in the Eurozone and a slowdown in demand from China. The average realized price in 2012 at $97 per tonne was much lower than the price of $136 per tonne the previous year. Furthermore, it booked non-cash non-recurring charges of $5.7 billion for 2012. These include a $5.2 billion write-down of nickel, coal and aluminum assets, a $232 million charge to settle a tax dispute with Switzerland and a $254 million charge for back tax payments to Brazil’s Minas Gerais state. ((Vale Q4 2012 Results, Vale Press Release))
The suspension of Rio Colorado was a casualty of Vale’s slashed investment spending target for 2013 to $16.3 billion, which is at the lowest level in three years. The company aims to slash investments by $1.2 billion this year as it struggles with a slowdown in demand for iron ore. Given the limited capital at the company’s disposal for investment, it would be understandably reluctant to absorb a cost increase of 86% on a project which may not give returns till 2015. ((Vale Capex 2013, Vale Press Release))
Our assessment is that if Vale’s board decides not to cancel the project today, the alternative strategy would be to buy some time to scout for a partner to bear some of the additional cost burden. Cancelling the project would be a setback to the company’s efforts to diversify away from iron ore whose prices are quite volatile.
We have a Trefis price estimate for Vale of $20.
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Notes:- Brazil’s Vale likely to cancel $5.9 billion mine in Argentina -Folha, Reuters [↩]
- Vale Argentine Potash Project Suspended Indefinitely, Bloomberg [↩]
- Argentina Says Inflation at 11.1%, Economists Say It’s 26%, NASDAQ [↩]
- Brazil’s Vale: Work on Rio Colorado Potash Project Remains Suspended, Fox Business [↩]