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Morningstar | Vale Eyes Volume Expansions, but Higher Costs Offset the Likely Benefit

We have reviewed some of our long-term assumptions for Vale after the firm’s annual investor day. There were several positives, including plans to increase the proportion of higher-quality iron ore, growing output of higher-value iron ore pellets, increasing longer-term nickel and copper volume, and lowering nickel cash costs as assets ramp up to full capacity. We’ve also increased our long-term assumption for the premium for iron ore pellets to USD 45 per tonne, in line with the 10-year average. Pellet premiums have increased over the last decade as natural suppliers in China have exited the market. It’s likely these somewhat higher pellet premiums will persist to incentivise the supply needed to fill the gap.

The benefits of the positives were offset by increasing our expectations for future costs versus our prior assumptions. Capital expenditure ticks up to about USD 4.5 billion from 2020, versus USD 3.7 billion in 2018, with inflation and expenditure for Vale’s planned growth. The coal division remains high cost, with unit costs around USD 125 per tonne. We had expected higher volume to begin to benefit unit costs in 2018, but improvement has taken longer. Guidance is for volume of 12 million tonnes in 2018, similar to last year, but rising to 20 million tonnes by 2021. Unit costs should improve with volume, but regardless, medium- and longer-term operating costs are likely to be higher than we had forecast.

Relative to its global mining peers, Vale’s earnings and share price have benefited in 2018 from greater premiums for higher-grade iron ore and pellets. However, we expect those premiums to shrink as steel spreads normalise from the high levels seen in 2018. Steel prices and spreads have contracted with the current commodity price correction, but the impact on iron ore and coking coal to date has been limited. If the contraction in steel spreads persists, we would expect an impact on the prices for steelmaking raw materials.