A Look At Vale’s Copper Mining Operations

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Vale (NYSE:VALE) is the world’s largest iron ore producer. In addition to its iron ore mining operations, which account for the bulk of its revenues, the company is also a significant producer of base metals, coal and fertilizers. Falling iron ore prices have had a negative impact upon the profitability of the company’s iron ore mining operations. Vale’s average realized sale price for its iron ore fines fell 38% year-over-year in Q3. [1] The primary reason for the fall in iron ore prices has been an oversupply situation, created due to a steady increase in production in the face of weakness in demand for the commodity. Prices are expected to remain subdued in the near term.

Given the bleak outlook for Vale’s iron ore mining operations, the company’s other businesses will play an important role in driving its business prospects. In this article, we will take a look at the state of the company’s copper mining operations and its prospects in the years to come.

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Vale’s Copper Mining Operations

Vale’s copper mining operations are spread across Brazil, Canada and Zambia. The company’s prominent copper mines include the Sossego and Salobo mines in Brazil, and the Sudbury and Voisey’s Bay mines in Canada. Vale’s proven and probable copper ore reserves stood at 1.39 billion tons at the end of 2013, with the Salobo mine accouting for over 80% of these reserves. [2] The company produced 370,000 tons of copper in 2013. [3] Vale generated $1.45 billion in sales from its copper mining operations in 2013, around 3% of the company’s overall revenues. [2]

Going forward, the company will significantly raise its production levels, driven by a rise in output at the Salobo mine. The Salobo mine started production in 2013 and completed the Phase II expansion of its processing facilities earlier on in 2014. [4] Salobo produced 66,700 tons of copper in the first nine months of the year, around 52% higher than in the corresponding period last year. [5] Upon ramping up to full capacity by 2016, the Salobo mining operations will produce 213,000 tons of copper. [6]

Copper Prices

London Metal Exchange (LME) spot copper prices currently stand at levels of around $6,750 per ton. [7] These are around 5% lower as compared to levels of around $7,050 per ton at the corresponding point of time last year. [7]

Copper prices have fallen largely because of concerns over weakness in Chinese demand for copper. China is the world’s largest consumer of copper, accounting for nearly 40% of the world’s demand of copper. ((Copper Ends at 5-Month Low on China Worries, Wall Street Journal)) Copper has diverse applications in industry, particularly in the manufacturing, power and infrastructure sectors. Weakness in economic growth, particularly in the manufacturing sector, has raised concerns over the strength of Chinese demand for the commodity. China’s GDP growth is expected to slow to 7.3% and 7.1% in 2014 and 2015 respectively, from 7.7% in 2013. [8] The state of China’s manufacturing sector can be gauged through the Manufacturing Purchasing Managers’ Index (PMI). The Manufacturing PMI measures business conditions in the manufacturing sector of the concerned economy. When the PMI is above 50, it indicates growth in business activity, whereas a value below 50 indicates a contraction. Chinese Manufacturing PMI, reported by China’s National Bureau of Statistics, stood at 50.8 for October, and has ranged between 50.2 and 51.7 for the whole year. [9] These readings indicate subdued Chinese manufacturing activity. Further, question marks remain over the impact of a proposed structural transformation of the Chinese economy from an investment and export-led growth model to a consumption-driven growth model. ((China Premier Warns On Economic Slowdown As Data Fans Stimulus Talk, Reuters)) Much of China’s consumption of industrial metals such as copper was driven by the country’s massive investment in infrastruture. A structural transformation of the country’s economy could potentially hamper the growth in demand for copper.

Outlook

Vale’s copper production will rise sharply over the next couple of years as a result of the ramp-up of output from the Salobo mine. Unit production costs costs will fall with the rise in output, providing a boost to margins. However, margins for the company’s copper mining operations will largely be driven by the trajectory of copper prices. These will depend upon the balance of global supply and demand.

China will continue to drive the demand for copper in the years to come. With the pace of Chinese growth expected to slow in the near term, demand from China may remain subdued. There are also concerns about long term Chinese demand for the commodity, given the ongoing structural transformation of the country’s economy.

On the supply side, a wave of expansions and new projects is expected to boost global copper output in the near term. [10] With demand conditions expected to remain subdued, there could be an oversupply of copper next year. [11] This is expected to limit the upside for copper prices in the near term. Over the long term, the trajectory of copper prices would depend upon trends in Chinese demand for the commodity. It remains to be seen whether China can absorb the expected increase in copper supply in the years to come.

Though copper prices look likely to remain subdued in the near term, market conditions for copper are much better as compared to iron ore. Due to a massive iron ore oversupply, iron ore prices are expected to fall sharply next year and remain subdued in the years to come. [12] Given the existing state of affairs, Vale’s copper mining operations will play an important role in boosting the company’s results in the next few years, despite the subdued market conditions for copper. 

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Notes:
  1. Vale’s Q3 2014 Earnings Release, SEC []
  2. Vale’s 2013 20-F, SEC [] []
  3. Vale’s 2013 Production Report, Vale Website []
  4. Vale’s Q2 2014 Earnings Release, SEC []
  5. Vale’s Q3 2014 Production Report, Vale Website []
  6. Vale Day 2013 Presentation, Vale Website []
  7. LME Copper Prices, LME [] []
  8. Goldman Sachs cuts China growth forecast sharply, Market Watch []
  9. China Manufacturing PMI, Trading Economics []
  10. Copper miners forecast years of surplus, Financial Times []
  11. Sharp fall in copper stocks points to rally, Financial Times []
  12. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg []