A Look At Vale’s S11D Iron Ore Project

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Vale (NYSE:VALE) recently gave an update on the progress of its S11D iron ore project. The first stage of construction of plant foundations has concluded as per schedule. [1] Simultaneously, the company also announced that the modules that will comprise the S11D plant have been assembled. [2]  These are important steps towards completion of the S11D project, which is expected in the second half of 2016.

The S11D project is an expansion to mining and processing capacity at Vale’s Carajás Mining Complex. It is one of the most important components of the company’s strategy. In this article, we will take a look at the S11D project and why it is so important for the company.

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The S11D Project

The Carajás Serra Sul S11D is a giant iron ore deposit in the southern range of Carajás, located in the Brazilian state of Pará. S11D stands for iron ore body 11, block D. It has 2.78 billion tons of iron ore reserves. [3]  The project involves the development of a mine and a processing plant at a total cost of approximately $8.09 billion. [4] Development of associated logistics infrastructure is estimated to cost approximately $11.6 billion, resulting in an overall cost of around $20 billion for the entire project. [4] The S11D project will contribute around 90 million tons of iron ore per year, when operating at full capacity. [3] This is expected to be achieved by 2018.

Being a part of the Carajás complex, S11D is one of the highest-grade iron ore deposits in the world. The Carajás complex produces ore with high iron content (around 66%) and low concentrations of impurities. [3] As a result, production costs are expected to be quite low for the S11D deposit. The cash cost per ton, on a Free On Board (FOB) basis, for producing iron ore from the S11D deposit is expected to be $15. [5] This compares favourably with Vale’s company-wide cash cost per ton of $21.59 in Q1 2014.

The high-grade and low-cost S11D iron ore deposit fits in well with Vale’s strategy to operate competitively in a weak iron ore pricing environment. The sale of iron ore and iron ore pellets accounted for around 73% of Vale’s net operating revenues in 2013. ((Vale’s 2013 20-F, SEC)) Thus, iron ore prices have a major impact on the prospects of Vale, the world’s largest iron ore producer.

Iron Ore Prices

Vale’s iron ore and iron ore pellets are sold to the global steel industry. Demand for iron ore by the steel industry plays a major role in determining iron ore prices. International iron ore prices are largely determined by Chinese demand since China is the largest consumer of iron ore in the world. China also accounted for nearly half of Vale’s iron ore and iron ore pellet shipments in 2013. Flagging demand from China in the wake of an economic slowdown has put downward pressure on iron ore prices. According to data from China’s National Bureau of Statistics, growth in investment, factory output and retail sales has slowed to multi-year lows in the first two months of the year. [6] A Chinese government crackdown on polluting steel plants has forced many of them to shut down. In addition, the tightening of credit by Chinese banks to steel plants that are not performing well will affect their ability to purchase iron ore, and hence, the overall demand for it. This has resulted in an inventory build-up at Chinese ports which will further curtail imports. Further, the Chinese leadership has proposed structural reforms of the economy, shifting the emphasis from investment and export driven growth to services and consumption led growth. Such a transformation of the Chinese economy may negatively impact Chinese demand for iron ore in the long run. [7]

On the supply side, iron ore majors such as Rio Tinto and BHP Billiton have expanded production of the ore. These companies are banking on higher volumes to compensate for lower prices and drive profits, given their low costs of production of iron ore. These iron ore majors are betting on continued strength in iron ore demand over the long-term. The main drivers of such long term demand are increasing levels of urbanization and industrialization in developing and emerging economies, particularly China and India. However, given the weak demand scenario at least in the near-term, expanded production by iron ore majors has resulted in an oversupply situation, which is expected to keep prices subdued in the near-term. [8]

Vale’s average realized iron ore price has declined from $ 143.46 per ton in 2011 to $107.43 in 2013. [9] It further declined to $90.52 per ton in Q1, 2014. [4]

Vale’s Strategy

In view of the weak iron ore pricing environment, Vale has adopted a strategy of cost reduction, disciplined capital allocation and divestment of non-core assets in order to remain competitive. Vale has embarked upon a mission to optimize its portfolio, divesting non-core assets in order to free up capital and invest it in projects that will give better returns. The company sold non-core assets and investments worth $6 billion in 2013. [10]

As a part of its efforts to enhance efficiency and cut costs, Vale generated savings of $2.8 billion in 2013. [10] In addition to cutting costs, the company plans to expand production to lower unit costs by diluting total costs over larger production volumes. Various planned iron ore projects will ramp up Vale’s iron ore production capacity from 306 million tons per annum in 2013 to 450 million tons per annum in 2018. [11]

The high grade, low-cost S11D iron ore deposit is consistent with Vale’s strategy of focusing on its core businesses. Also, with the project expected to deliver 90 million tons of iron ore per annum, it is essential for Vale’s plans to reap economies of scale through scaling up production. S11D’s low cost of production will help the company lower average costs as well.

Other Developments

Vale was recently stripped of its mining license to the Simandou iron ore deposit in the Republic of Guinea. Vale’s Simandou project would have added approximately 25-35 million tons of iron ore to the company’s annual production. [12] In view of the loss of the Simandou mining license, the S11D deposit assumes even greater significance to the company’s medium and long term strategy.

Thus, to a large extent Vale’s success in the medium and long term is tied to the successful completion of its S11D project. The project was 50% complete at the end of Q1 2014. It is on schedule for completion by the second half of 2016. The project is proceeding as per plan. [13]

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Notes:
  1. S11D Project Concludes First Stage Of Plant Foundations, Vale News Release []
  2. Construction Of S11D Plant Evolves To Module Assembly Stage, Vale News Release []
  3. Carajás S11D Iron Project, Vale Website [] [] []
  4. Vale’s Q1 2014 6-K, SEC [] [] []
  5. Vale Day 2013 Conference Transcript, Seeking Alpha []
  6. China Premier Warns On Economic Slowdown As Data Fans Stimulus Talk, Reuters []
  7. The Latest Iron Ore Price Slump: Causes and Effects, Forbes []
  8. BHP, Rio Gamble With A Stacked Iron Ore Deck, Mineweb []
  9. Vale’s 2013 20-F, SEC []
  10. Vale’s Q4 2013 Earnings Conference Call Transcript, Seeking Alpha [] []
  11. Vale Day 2013 Presentation, Vale Website []
  12. Vale Loses Mining License, Faces Legal Battles, Trefis []
  13. Vale Steels Itself For Changing Times, Financial Times []