A Closer Look At Vale’s Salobo Mine
Vale (NYSE:VALE) is a diversified mining company and the world’s largest iron ore producer. Though iron ore sales account for a majority of the company’s revenues, Vale also has interests in the mining of base metals, particularly copper and nickel. The Salobo copper mine is perhaps Vale’s most valuable base metal mining asset, which not only accounts for the bulk of the company’s copper ore reserves, but is also a source of additional revenues for the company through Vale’s streaming agreement with Silver Wheaton for the gold by-product produced at the mine. In this article, we will take a closer look at why the Salobo mine is one of Vale’s most valuable base metal assets.
The Salobo Mine
Located in Brazil’s Pará state, the Salobo copper mine represents the largest copper deposit ever found in Brazil. The Salobo mine accounts for roughly 80% of Vale’s proven and probable copper reserves of approximately 1.45 billion tons. [1] The mine, which began operating in May 2012, accounted for around 26% of the company’s 380,000 tons of copper production in 2014. [1] Vale finished phase II expansion of the processing facilities at the Salobo mine in 2014, which doubled the mine’s production capacity to 200,000 tons per year. [1] The ramp up of production to full capacity at the Salobo mine will account for most of the increase in Vale’s copper shipments over 2015 and 2016.
Given that supply side constraints could boost copper prices over the next few years, the rise in copper output from the Salobo mine could be extremely well timed.
Copper Supply Side Constraints
Copper is a metal with wide industrial applications. Copper prices have weakened considerably over the past year due to weak global economic conditions, particularly slowing economic growth in China. Weak economic conditions have dampened the demand for the metal, resulting in a subdued copper pricing environment . London Metal Exchange (LME) copper prices averaged roughly $5,800 per ton in Q1 2015, as compared to approximately $7,100 per ton in Q1 2014. [2]
Copper Prices
(Source: London Metal Exchange)
Despite the fall in prices over the past year, copper prices have recently been boosted by expectations of the tightening of copper supply. [3] As a result of the prevailing weakness in prices over the course of the last year, large copper mining companies have put on hold several new projects. In addition, given the adverse pricing environment, funding has become hard to come by, especially for smaller copper mining companies. [3] Furthermore, declining ore grades have negatively impacted copper output for many copper miners globally. ((Copper producers position for price recovery, Financial Times)) As a result of these supply side constraints, copper output is expected to decline in the future, which is likely to translate into a more favorable demand-supply equation. However, the exact impact of these supply side constraints on the demand-supply equation remains to be seen. As per estimates by Citi, demand for copper will exceed supply by 61,000 tons by 2016. [3] Though this represents less than 1% of global production, the extent of this supply shortage could increase going forward, particularly if global economic growth recovers faster than expected. [4] This would boost copper prices and the prospects of copper producers such as Vale.
If supply side constraints do boost copper prices over the next couple of years, the expansion in output at Vale could be extremely well timed.
Streaming Agreements with Silver Wheaton
Apart from providing a sharp boost to Vale’s copper production, the Salobo mine is also the subject of a precious metal streaming agreement between Vale and Silver Wheaton. In 2013, Silver Wheaton entered into an agreement with Vale to purchase 25% of the life of mine gold production from the Salobo mine. Silver Wheaton made an upfront cash payment of $1.33 billion in order to secure rights to the streaming agreement. [5] Earlier on in 2015, Silver Wheaton acquired rights to purchase an additional 25% of the life of mine gold production for an additional $900 million. [6] Under the terms of the streaming deal, Silver Wheaton pays Vale the lesser of the prevailing market price or $400 for each ounce of gold purchased, subject to a 1% annual inflation adjustment starting in 2016. [7]
The upfront payments under the streaming agreements help Vale lower its 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. [8]
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 agreements with Silver Wheaton fit in well with the company’s ongoing response to the subdued commodity pricing environment. These streaming agreements will allow the company to partially fund its capital expenditure requirements while minimizing additions to its debt burden.
Thus, not only will the Salobo mine be primarily responsible for the increase in Vale’s copper shipments over this year and the next, streaming agreements pertaining to the Salobo mine will also partially fund the company’s capital expenditure requirements. Thus, the Salobo mine is important to Vale in more ways than one.
View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research
- Vale’s 2014 20-F, SEC [↩] [↩] [↩]
- LME Copper Prices, LME [↩]
- Copper producers position for price recovery, Financial Times [↩] [↩] [↩]
- Global Copper Production, U.S. Geological Survey [↩]
- Silver Wheaton’s 2013 40-F, SEC [↩]
- Vale to sell a portion of the gold by-product stream from its Salobo copper mine, Vale News Release [↩]
- Salobo Mine, Silver Wheaton Website [↩]
- Vale Day 2014 Presentation, Vale Website [↩]