Vale Announces Streaming Agreement With Silver Wheaton As Part Of Ongoing Response To Subdued Commodity Prices

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Vale (NYSE:VALE) has announced the signing of an agreement with Silver Wheaton (NYSE:SLW) to sell an additional 25% of the gold by-product stream produced at its Salobo copper mine in Brazil for a period that extends until the end of the mine’s life. [1] Vale already had a streaming agreement in place with Silver Wheaton for the sale of 25% of the gold by-products produced at the Salobo mine. [2] With the signing of the new agreement, Vale will receive an upfront payment of $900 million from Silver Wheaton. In addition, Silver Wheaton will pay Vale the lesser of $400 per ounce (plus a 1% annual inflation adjustment from 2017) or the prevailing market price for gold delivered to it, which is the same as the terms of the previous agreement. [1]

The signing of the additional streaming agreement with Silver Wheaton is a part of Vale’s ongoing response to an environment of low commodity prices, particularly those of iron ore. The upfront cash payment will lessen the burden on Vale to finance its capital expenditure needs, with the company looking to deleverage in order to boost its financial flexibility.

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Iron Ore Prices

Iron ore is an important raw material for the steel industry. Thus, demand for iron ore by the steel industry plays a major role in determining its prices. Benchmark international iron ore prices are largely determined by Chinese demand, since China is the largest consumer of iron ore in the world. It accounts for more than 60% of the seaborne iron ore trade. [3] Chinese steel demand growth is expected to slow to 2.7% in 2015, from 6.1% and 3%, in 2013 and 2014, respectively. [4] Weak demand for steel has indirectly resulted in weak demand for iron ore.

On the supply side, an expansion in production by major iron ore mining companies such as Vale, Rio Tinto, and BHP Billiton has created an oversupply situation. A combination of weak demand and oversupply is likely to result in weak iron ore prices in the near term. [5]  The worldwide surplus of seaborne iron ore supply is expected to rise to 300 million tons in 2017, from an expected surplus of 175 million tons in 2015, and a surplus of 72 million tons and 14 million tons, in 2014 and 2013, respectively. [6] [7] Due to the persisting weak demand and oversupply situation, iron ore prices will remain under pressure in the near term.

The average realized price for Vale’s iron ore fines stood at $75.97 per ton in 2014, nearly 32% lower than the average realized price in 2013, which stood at $112.05 per ton. [8] The sale of iron ore pellets and fines collectively account for around 65% of Vale’s net operating revenues. [8] Thus, the fall in iron ore prices has severely dented Vale’s business prospects.

Funding Capex Through Streaming Agreements

The upfront payment of $900 million will lower the company’s funding needs for its capital expenditure requirements, including the remaining capital expenditure for the expansion of the Salobo mine. The company has $9.6 billion of expansion capital requirements in 2015 and 2016, mostly for the expansion of its iron ore production capacity. [9] Due to the subdued commodity pricing environment, sentiment is negative regarding the mining sector in general. Equity valuations are subdued, which makes issuing stock less desirable as a mode of raising capital. Debt is hard to come by for mining companies, most of which have highly leveraged balance sheets, and are looking to deleverage. In such a scenario, precious metal streaming agreements allow mining companies to raise capital to fund their capital expenditure requirements without taking on additional debt.

Thus, Vale’s streaming agreement with Silver Wheaton, for gold produced at the Salobo mine, fits in well with the company’s ongoing response to the subdued commodity pricing environment. It will allow the company to partially fund its capital expenditure requirements without taking on additional debt.

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Notes:
  1. Vale to sell a portion of the gold by-product stream from its Salobo copper mine, Vale News Release [] []
  2. Silver Wheaton’s 2013 40-F, SEC []
  3. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg []
  4. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association []
  5. BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb []
  6. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg []
  7. Iron Ore Caps 2014 Loss as Morgan Stanley Says Worst Over, Bloomberg []
  8. Vale’s Q4 2014 Earnings Release, SEC [] []
  9. Vale Day 2014 Presentation, Vale Website []