Vale Announces Plans To Idle Australian Coal Mine In Response To Poor Market Conditions

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Vale (NYSE:VALE) and its joint venture partner in the Isaac Plains coal mine, Sumitomo Corporation, have announced plans to place the mine into care and maintenance. [1] The decision to idle the mine has been taken in response to poor market conditions for coal. Vale believes that operations are currently not economically feasible under the prevailing weak coal pricing environment. The mine is expected to be placed in care and maintenance in early 2015. [2]

The move to idle the Isaac Plains coal mine is part of  Vale’s broader strategy to optimize its portfolio as well as adopt discipline in capital allocation, in response to poor market conditions for both iron ore and coal. Following such a strategy is imperative in order to operate effectively under such market conditions.

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The Isaac Plains Coal Mine

The Isaac Plains coal mine is located in Central Queensland, Australia. Vale holds a 50% interest in the mine. The mine’s proven and probable reserves, attributable to Vale, stood at 5.4 million tons at the end of 2013, less than 1% of the total coal reserves attributable to Vale, most of which are concentrated in the giant Moatize deposit in Mozambique, which started production in 2011. [3] The Isaac Plains mine produces both metallurgical and thermal coal. It accounted for 9.5% and 18.5% of Vale’s metallurgical and thermal coal production in 2013, respectively. [3] According to the company’s estimates, the mine would have been exhausted by 2017, as per the current mine plan. [3] With the company mainly focused on developing its coal assets in Mozambique, it has decided to idle the Isaac Plains mine as a part of its disciplined approach to capital allocation in the prevailing subdued coal pricing environment.

Coal Prices

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The prevailing coal pricing environment is characterized by subdued prices of both metallurgical and thermal coal.

Metallurgical coal is a major input in steelmaking. Thus, demand for metallurgical coal is indirectly influenced by the demand for steel. China is the largest consumer of metallurgical coal in the world. There has been weak demand for the commodity by the Chinese steelmaking industry, along with subdued demand from other major consumers such as Japan and the EU. Chinese steel demand growth is expected to slow to 3% and 2.7% in 2014 and 2015 respectively, from 6.1% in 2013. [4] A slowdown in economic growth has tempered the demand for steel. China’s GDP growth is expected to slow to 7.3% and 7.1% in 2014 and 2015 respectively, from 7.7% in 2013. [5] Further, a Chinese government crackdown on polluting steel plants has forced many of them to shut down. In addition, tightening of credit by Chinese banks to steel mills that are not performing well, will negatively impact these mills’ prospects. [6] Furthermore, 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 steel in the long term. Weak demand for steel has translated into weak demand for metallurgical coal as well. Weak demand, coupled with an oversupply situation due to expansion in production by major mining companies, has resulted in plummeting metallurgical coal prices. [7] Vale’s average realized price for metallurgical coal stood at $107.87 per ton in Q2 2014, down nearly 23% as compared to the average realized price in the corresponding period a year ago. [8]

Thermal coal is primarily used in the generation of electricity. Weak demand from major consumers of thermal coal, China and India, has put downward pressure on thermal coal prices. [9] In addition, Chinese efforts to shift towards natural gas for energy generation may also affect demand going forward. [10] A supply glut due to an increase in production by major coal mining companies has kept prices subdued. ((Coking coal prices set for modest gains, thermal still marooned, Reuters)) Vale’s average realized thermal coal prices stood at $68.49 per ton in Q2 2014, down nearly 34% as compared to the average realized price in the corresponding period a year ago. [8]

Iron ore prices have mirrored the decline in metallurgical coal prices. Iron ore and iron ore pellets collectively accounted for around 73% of Vale’s net operating revenues in 2013. [3]

Disciplined Capital Allocation

In view of the weak iron ore and coal pricing environment, Vale has adopted a strategy of 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. [11]

In addition, the company has also significantly reduced its capital expenditure. Going forward, it is focusing on a smaller project pipeline that would generate greater value for shareholders. Vale’s capital expenditure reduced from $16.2 billion in 2012 to $14.2 billion in 2013. The company’s capital expenditure budget for 2014 is even lower at $13.8 billion. [3]  The decision to idle its Isaac Plains coal mine is consistent with its strategy to allocate capital to projects that will generate better returns. Such an approach will allow Vale to operate more competitively under the prevailing market conditions.

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Notes:
  1. Vale comments on Isaac Plains mine, Vale News Release []
  2. Vale and Sumitomo have decided to close their Isaac Plains coalmine in Queensland’s Bowen Basin,  Sydney Morning Herald []
  3. Vale’s 2013 20-F, SEC [] [] [] [] []
  4. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association []
  5. Goldman Sachs cuts China growth forecast sharply, Market Watch []
  6. The Latest Iron Ore Price Slump: Causes and Effects, Forbes []
  7. Coking coal price crashes through $100, Mining.com []
  8. Vale’s Q2 2014 Earnings Release, SEC [] []
  9. Coking coal prices set for modest gains, thermal still marooned, Reuters []
  10. Thermal Coal Prices To Drop Further On Oversupply, Weak Demand, Reuters []
  11. Vale’s Q4 2013 Earnings Conference Call Transcript, Seeking Alpha []