Why Simandou Is Important For Vale

| About: Vale S.A. (VALE)

Summary

A technical committee has recommended the Guinean government to strip Beny Steinmetz Group Resources and its partner Vale of the rights to exploit iron ore deposit in Simandou.

Vale has invested over $1 billion in Guinea.

If the Guinean government accepts the recommendation of the technical committee, then Vale could lose many benefits of investing in this project.

In March 2014, a technical committee recommended the Guinean government to strip Beny Steinmetz Group Resources (or BSGR), and its partner Vale (NYSE:VALE) of the rights to exploit an iron ore deposit in northern part of Simandou mountains. This recommendation was made on the basis that BSGR obtained the project through corrupt practices in 2008. Amidst legal tussle, the Simandou iron ore project is important to Vale for a couple of reasons:

High grade iron ore

Goldman Sachs has forecasted that iron ore prices will fall to $80 per tonne in 2015. Vale incurs cash cost of $23 per tonne of iron ore produced from Carajas mine in Brazil, which contains 65.4% of Fe. The Simandou deposit contains high grade iron ore with Fe content of 66% to 68%, which could lead to lower cash cost. This can enable both Vale and BSGR to maintain good profit margins even if lower iron ore prices persist in the future.

Project investment

In 2010, BSGR sold 51% of its stake in the Simandou iron ore project to Vale for $2.5 billion. Vale has invested over $1 billion in Guinean project. If BSGR resorts to international arbitration, then Vale's investment in the project will get stuck for long time. If both the project partners are made to surrender the blocks, then they will have to write off their investment in Guinea.

Alternate iron ore supply to China

China is looking forward to reduce its reliance on Brazilian and Australian iron ore miners by increasing iron ore imports from Africa. The production capacity of Simandou project is about 50 to 70 million tonnes per annum or mtpa. Vale supplies high grade iron ore to China from its Carajas mine in Brazil with a production capacity of 306 mtpa. Although smaller in production capacity, the Simandou project could become an alternate source for Vale to supply high grade iron ore to China.

Shipment benefit

The phase 1 of Simandou project involves connecting a railway from Zogota to an existing railway in Liberia. The phase 2 of this project involves building an integrated railway and deep sea port south of Buchanan to export 50 mtpa iron ore from Simandou. Transporting iron ore from Liberia will save both time and cost as the distance through Liberia is 350 kilometers by railway, which is half the distance stated by a Guinean railway corridor.

The deep sea waters of Liberia allow the use of very large ore carrier vessels in the range from 2 to 3 kilometers from the Liberian coast, while in Guinea the range is about 15 to 20 kilometers from the coast. This will allow bulk ore carriers to ship iron ore from the Simandou deposits.

Competitor may benefit

In 2008, Rio Tinto (NYSE:RIO) was stripped off the mining rights of the northern part of Simandou because the company had held the exploration rights of these deposits since the late 1990's, and it failed to develop them. The exploration rights of these deposits were awarded to BSGR in December 2008 by the previous regime in Guinea.

Rio Tinto along with Chalco and IFC is developing the iron ore project on the southern part of the Simandou. This project with a full production capacity of 100 mtpa is expected to commence production in 2018. If there is any new tendering process for northern part of Simandou, then Rio Tinto could participate in the process. For Rio Tinto, the major benefit of this process will be retaining the blocks that the company had to surrender in 2008, and thus increase its portfolio of high grade iron ore in Africa.

The technical committee has recommended that VBG, the joint venture between Vale and BSGR, be barred from participating in any new tender process. However Vale may be permitted to participate in this process.

Conclusion

The Guinean government is yet to take a stand on this project. If the Guinean government accepts the recommendations of the technical committee, then it could turn out to be a big loss for Vale.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.