Vale Stares At $1 Billion Investment Loss If Guinea Panel Recommendation Implemented

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Vale (NYSE:VALE) might find $1 billion in investments at the Simandou iron ore deposit wiped out if the Guinean government accepts and implements the recommendations of a technical committee. This committee had been set up to review mining concessions awarded under previous administrations. It has recommended that Vale and its partner BSGR should be stripped of the rights to exploit Simandou because BSGR obtained the concession allegedly through corruption. The committee wants the tendering process for the northern part of Simandou to be conducted again. The committee will submit its recommendations to a strategic committee which will take a final decision. [1]

If the recommendations are accepted, Vale’s investments worth $1 billion will have to be written off. It is not clear whether the company will be compensated for the amount it has already paid to BSGR for acquiring a 51% stake in northern Simandou in the first place. A re-tendering process will also witness Vale’s competitors like Rio Tinto and BHP Billiton competing for the deposit. However, a more immediate concern would be the possibility of international arbitration because BSGR has threatened to take this route if stripped of its ownership. This would mean a lengthy and protracted legal battle which will simply delay progress with mining the disputed deposit.

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A Recap On The Simandou Project

It is widely acknowledged in the mining industry that Simandou holds one of the world’s best undeveloped iron ore deposits. The iron content in the ore is so high that experts say it requires very little processing. The problem is that the mine is located 700 km from Guinea’s coast, which means that it will cost at least $10 billion to exploit. A lot of transportation infrastructure will have to be put in place before the ore can be monetized. [2]

Rio Tinto was granted rights to mine Simandou in the 1990′s by the then dictatorial regime. In 2008, the regime of the day stripped Rio of rights to half the concession saying that it had missed deadlines to start mining. The half taken away was given to Beny Steinmetz Group Resources, which in turn sold a 51% stake to Vale in 2010 for $2.5 billion. [3]

After paying $500 million to BSGR , Vale’s plans were upset after the surprise end of military rule and the introduction of a new mining code in Guinea. The government declared that all contracts would be reviewed and reworked. It said that it would cancel licenses obtained through bribes and secure a minimum minority stake for the state in all projects. [4]

A government committee launched a corruption probe to find how BSGR got awarded for just $160 million the half of Simandou stripped from Rio Tinto. It also questioned whether BSGR ever intended to mine its half of Simandou or simply acquired the rights in order to sell them at a higher price. At the time, BSGR rejected the allegations and defended itself by saying that it wouldn’t get paid unless the project got going.

What Happens Now?

BSGR has slammed the process followed by the committee to arrive at its conclusions and termed it a “pre-determined and orchestrated plan” to strip it of its mining rights. It has warned that if the recommendations are accepted the company will opt for international arbitration, a lengthy process that will add to the already delayed development of the mine.

Although the technical committee has recommended that Vale be banned from reapplying for the rights, if eventually the deposit does come up for re-tendering, the government might allow Vale to participate. Even so, Vale will certainly face stiff competition from Rio Tinto and BHP Billiton who have expressed interest in taking part in such a tender.

The Simandou project was put on hold by the government in October 2012 following the constitution of the government committee to review mining concessions. Therefore, any expected production from this deposit is not factored into the company’s growth plans or valuations. We think that this limits the impact on the company’s stock valuation to only the non-cash impairment that will have to be incurred if the deposit gets taken away. This, of course, assumes that an international arbitration process will fail to bring relief to the company. However, if the project does go through at some stage, there could be upside for Vale’s stock in the long term. The production targeted from this deposit is 50-70 million tonnes per year if and when operations begin and Vale’s share would be half of this. To put it in perspective, the company produced 300 million tonnes of iron ore in 2013. The benefits wouldn’t necessarily accrue as soon as production begins because the upfront capital expenditure for the project is expected to be $8-10 billion and Vale would definitely have to fund a large portion of it. [5]

Given that there are too many unknowns at this stage, it is not possible to immediately come to a conclusion about the impact of this news on Vale’s valuation for the foreseeable future. We will keep a watch on further developments on this front and update our outlook once something concrete emerges.

We have a Trefis price estimate for Vale of $15.

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Notes:
  1. Panel says Guinea should strip BSGR, Vale of rights to iron deposit, Reuters []
  2. Guinea reignites $2.5bn mining tussle, Financial Times []
  3. Rio strikes deal on Guinea mine, Financial Times []
  4. Guinea to review mining licences, Financial Times []
  5. The Simandou Deposit, BSGR Website []
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  • commented 6 months ago
  • tags: VALE FCX CLF RIO MT
  • there are many unknowns, as you suggest, but two of the knowns are that RIO and BHP have no interest in this site.