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Vale S.A. (NYSE:VALE)

Q2 2010 Earnings Call Transcript

July 30, 2010 10:00 am ET

Executives

Guilherme Perboyre Cavalcanti – CFO

Roger Agnelli – President and CEO

José Carlos Martins – Executive Officer of Sales, Marketing, and Strategy

Eduardo Bartolomeo – Executive Officer of Integrated Operations

Tito Martins – Executive Officer of Basic Materials Operations

Analysts

Felipe Hirai – Merrill Lynch

Ivan Fadel – Credit Suisse

Rodrigo Barros – Deutsche Bank

Leonardo Correa – Barclays Bank

Rodolfo De Angele – J.P. Morgan

Tony Rizzuto – Dahlman Rose

Marcos Assumpção – Itau Corretora

Rene Kleyweg – UBS

Operator

Good morning, ladies and gentlemen. Thank you for standing by, and welcome to Vale's conference call to discuss second quarter 2010 results. If you do not have a copy of the relevant press release, it is available at the company's Web site at www.vale.com at the Investors link. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded.

To access the replay, please dial 5511-4688-6312, access code 47095. The file will also be available at the company's Web site at www.vale.com at the Investors section. This conference and the slide presentation are being transmitted via Internet as well. You can the webcast by logging on to the company's Web site, www.vale.com, Investors section, or at www.prnewswire.com.br.

Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. Actual performance could differ materially from that anticipated in any forward-looking comments as a result of macroeconomic conditions, market risks, and other factors.

With us today are Mr. Roger Agnelli, president and chief executive officer; Mr. Guilherme Perboyre Cavalcanti, chief financial officer; Mr. José Carlos Martins, executive officer of marketing, sales, and strategy; Mr. Tito Martins, executive officer of basic materials operations; and, Mr. Eduardo Bartolomeo, executive officer of integrated operations.

First, Mr. Cavalcanti will proceed to the presentation. And after that, we will open for questions and answers. It is now my pleasure to turn the call over to Mr. Cavalcanti. Sir, you may now begin.

Guilherme Perboyre Cavalcanti

Thank you. Good morning to you all. We will have a brief presentation about results in perspective. And then, we'll go to our Q&A session.

We believe that we delivered an outstanding performance in the second quarter of 2010, reaching operating revenues of almost $10 billion, EBIT margin of almost 48% and EBITDA of $5.6 billion, and net earnings of $3.7 billion; all significant increases from the previous quarters, and also a very significant increase compared to the same previous – same period of last year.

On the cost side, we presented savings in two quarters in a row summing up $500 million. Adjusted EBITDA almost doubled, being driven by strong demand for minerals and reflected on the price valuation. And we presented a decrease on the revenue ratio from 2.4 to 1.8 gross debt to EBITDA and to 1.3 times net debt to EBITDA. Our powerful cash generation also allowed us to increase our investment to 88% from $5.2 billion to almost $10 billion on the first half of 2010.

Now, talking about short term outlook, it appeared that financial markets were predicting leases that did not happen. This trend was reflected on the commodity prices that now appear to be recovering as you can see on page 12. In four countries of Europe, recovery also remains strong. And on page 14, following the history of US industrial production, we can see a pattern of moderate growth after strong recoveries.

On page 15, you can see China continues to grow at high rates, although lower than previous quarters, we believe it is a more sustainable pace.

On page 16, we can see global carbon steel output return into peak reached before the crisis. Despite short term volatility, demand for iron ore remains strong. The quarterly pricing system is being consolidated with all our clients. Nickel investors have been dropping, while prices are hovering around $20,000. Therefore, we believe that the market's already priced at the end of the strike. While stainless steel output weakens due to seasonal factors, we believe the demand for nickel to non-stainless steel applications will remain strong. Our constraints to asset utilization and sales growth are being removed, for example, at the end of the strike in Sudbury and our gradual recovery of PDM at the end of shipment iron ore capacity.

Now, talking about growth opportunities, we've nearly delivered three projects already, additional 20 million tons of iron ore, CSA steel mill, Bayóvar phospate rock mine. And we have four projects to be delivered until the end of this year, Oman pelletizing plant, Onça Puma nickel mine, Tres Valles copper mine, and Estreito hydroelectric power generation. Those projects amounted to $7.7 billion in investments that now will start to generate value to our shareholders. And there are many more to come from an exciting pipeline, and moreover, many growth options to see in the pipeline in the future as we can see on page 23 and 24.

On July 25, we have a summary of the Bayóvar phosphate project that came on stream on time and on budget. And as you know, we announced yesterday a public re-auction to acquire 100% of Paranapanema Corporation (inaudible), which can reach an investment of $1.1 million – $1.1 billion, representing our belief in the Brazilian internal market and also a strategic speed to our copper mines.

With that, I will turn now to the Q&A session please.

Sorry, I'll turn now to our president and CEO, Mr. Roger Agnelli.

Roger Agnelli

I wasn't supposed to speak, but I think it's good to say something about the results. First of all, good morning, everybody. It's a pleasure to be with you today. And it is – I was very happy to see that you (inaudible) we call in Brazil (inaudible) or hot seat because of using – the slide presentation is showing very good results for the – in the second quarter.

What I would like to say is that everything is going well. The trend is very good. In terms of revenues, in terms of costs, in terms of perspective, we are very happy that we are in a very nice and very good year for VALE. We have several projects that we are finalizing right now. As you know, we have been investing heavily in the last three or four years. And we have almost $15 billion, $16 billion in capital allocated to those investments without any revenue. And now, we are going to see some returns on those investments.

And I think the most important thing is that the major parts of the projects are Greenfields projects. And we have already prepared those projects due – from field expansion. And we are going straight in almost everything. In Bayóvar, we are going to inaugurate that in the 5th – August the 5th. And we are going to announce that we are going straight for the expansion. We are going to finalize Mozambique. And again, we are going straight for the expansion. We finalized already the CSA. Maybe at the end of the year, we are going to decide if we are going to expand the project again or not.

Other projects that we are finalizing next year, also we are going straight to the expansion, for example, Salobo. So of course, the Greenfields projects in the very beginning are – the return is slower. But when we add additional capacity, we are going to speed up. We are going to increase the return on those investments. So I think we have several options of growth – organic growth. As you said – as you saw in the presentation, we have several other projects that we are, right now, finalizing the strategic plan, but our intention is to go ahead with those projects.

We are confident that there are markets for all the new capacity that we are adding to our systems. In different areas, we are not concerned about that because all these projects, they are very, very competitive, all of them, big resources, big reserves. And we know that we can really be in the first or the second quartile of costs in all those projects. After the expansion, we will be in the first quartile. So we are very, very confident that we are going to bring a lot of returns to our shareholders.

What we are focused today – or at least I'm really focused today, is innovation. Innovation is something very important for the company. As you know, any project will run for at least 20 years. And the world is changing. Everybody, the society – the global society is concerned about the environment, is concerned about social development.

You know that we are, right now, investing heavily in Africa. Africa is a place that we needed to pay attention about social development. We have to pay attention to sustainability. They need that. They deserve that. And that's what we are creating, some opportunities for the local people. It's really important for a mining company like us to be really very sensitive to this kind of issue. And we understand that Africa, everybody thinks it's a risky continent, but we understand very well the need that they have, the – how we have to carry the investments there in Africa. So we don't see any problem there. We are very happy in Mozambique. We are very happy in Zambia, in Kenya. Everywhere that we are developing our projects, we are happy.

Of course, we needed to learn. They needed to learn. It's a matter of get-together and see – and show that we are a company – that we are going to respect the sustainability of our projects. Of course, the issue is to create the mining of the future. And we are working in all projects, considering that in 10 years, nobody will accept the same ratio of water consumption that we have today. Nobody will accept the CO2 emissions that we have today. Everybody will ask for clean energy much better than we have today. So in every single new project, we are delivering those projects and we are completing those projects as a much more clean, much more sustainable project. So this is a challenge for the next (inaudible) of the industry.

Mainly, after the issue that the United States is facing in the Gulf of Mexico that is polluting everything. So we have to really be careful with the projects. We needed to bring today the mentality that we are going to face in 10 years. So it's really very important to be innovative, to be concerned about the environment, see how we can help the local governments to develop their communities, their social (inaudible) in every single country that we are operating in.

I'm very confident that VALE is ahead of the other companies – of the other mining companies in terms of sustainability. I'm very confident. And I'm very proud for the work that we are developing today in VALE. As I said, the trend is good. We are prepared to take advantage of the very good moment in the global economy.

Of course, there are some questions about the near future. But again, we are here to look forward to the next 20 years, not for the next quarter or the next year. We are confident that the market will be very strong, will be good for everybody, and will be good for our operations in order to sell whatever we are going to produce. Again, we are in a very strong position. I should say that we are in the best moment today in our history. We are in the best moment of our history.

We adjusted the company last year heavily. In terms of costs, we trained our people. We developed our assets a lot in terms of maintenance. We are facing some issues – day-by-day issues, every year we face them. And we overcome all the difficulties that we have. That's what I would like to say to you. I'm very confident that the trend is positive. The trend is really positive. Thank you very much.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. We kindly ask to please restrict your questions to two at a time. (Operator Instructions) Again, please restrict your questions to two at a time. Our first question comes from Mr. Felipe Hirai from Merrill Lynch.

Felipe Hirai – Merrill Lynch

Hi. Good morning, everyone. Guilherme, good luck on your new role at VALE. So I have two questions here related to iron ore. So my first one is regarding prices, so if you could just give us some explanation of what happened to the realized prices, according to the formula, we were expecting prices closer or above $100 a ton. The average price came at $92. Maybe if you could talk on what happened with prices in May and June? And also on that topic, if you could talk a little bit on where you expect to see prices in the third quarter? Again, according to the formula, we would expect to see prices going up by $30 in the third quarter. So that's my first question. Thank you.

José Carlos Martins

Okay, Felipe, Martins speaking. As far as the price system, it's rolling out very well. In the first quarter, there was no problem to apply the new price system because, as you know, spot market at that time was going below the formal price, and in this quarter, the opposite. But the system is going all very well also. We shipped every ton in this first month. And we had all the vessels nominated for the next month. And we don't believe we're going to have any kind of problems. So customers are fulfilling their obligations as far as the price system, also as far as the quantity. So the system in itself is doing very well.

The difference you see on the price realizations in the second quarter against your forecast, based on the market situation, probably you did that looking at the average of the market and you make your assessment. We have three points that put our price a little bit down. The first was the carryover because, as you know, we faced some problems in delivering our volumes in the first quarter. So we have the rain and all the issues that we already talked about last time. So we had the carryover volumes that we had to deliver with the former price. This is a contractual obligation. That's the way we work. And we never change what we agree with our customers if it is in our contract. So we have to face the situation and we delivered nearly 10 million tons in the third – in the second quarter based on the price of the first quarter. So that is one of the problems.

Another issue you have to consider is that we sell part of our sales in the domestic market. And for domestic markets, we take out the logistics that we don't use. So for the sales in domestic price, the price is a little bit because it's not FOB a day longer on the port, on the ship. So then, there is a small discount based on it because we spend this money on the logistics so we don't charge the customers.

And the third point is that, probably, you assumed 66% all over our sales. And it's not true because 66% is only in Carajás. So in the south system, we have something around 65% and the south system is around 64%. So if you take all of those effects, that's the reason we have the difference in price.

Going forward, we'll know the index, how much the price will increase in this quarter and that going on also. But I also needed to make this point that some carryover we had from the second quarter to the third quarter. So we expect, in this quarter, to finish all the carryover because operation is performing better now. We don't have the effect the rain. So the third quarter also is the best quarter in our track record. You should look at all the quarters in the past to see that the third is always the best. So we believe that we can finish the carryover.

So as price is concerned, things are moving very well and we are very optimistic about the new system and the market is following up the same system. So I think it was a case of success and again it's a good demonstration of VALE as the leader in this market. So I do not see any kind of problems going forward. But even with this big strength this quarter, based on the spot was much lower than the average we are using for contracts. Costumers are committed and they are behaving like we expected. So that's the point. I hope I was able to explain your question.

Felipe Hirai – Merrill Lynch

Okay. Thank you, Martins. My second question is related to the production and the logistic issues that you had in the first and second quarters. Can you just explain to us what is going on now at Ponta da Madeira and the other ports? How – when do you think that you're going to be able to resume your full production if those issues have been solved? And then how should we think about production and shipments for the next two quarters? Thank you.

José Carlos Martins

First, Eduardo will talk about it. And I think we made a big change in our structure. And I hope now that you have the mine's railway and port under the same direction, I think we're going to have a much more smooth operation because those areas will be much more together and I think that will bring a lot of improvement in the performance as far as the integration between mine and railway and port. And so, Eduardo will talk about it at this point.

Eduardo Bartolomeo

Okay, Felipe. First of all, we should try to separate what is from behind. Behind, we had the (inaudible) on top of the fourth line in Ponta da Madeira. Starting November with the fourth dumper, then it's really catching up, the number of the yards, the reclaimer, the stackers. And now it's all finished, I think. Just look at June, for instance, we did the best year – the best month this year and we are looking very positive.

You can say, as Martins already mentioned, during the first semester added to the normal problems that we face in day-to-day operations in quality of equipment. Of course, they heard it a little bit more up in Ponta da Madeira. But our technicians worked very well. It's already solved. So we have the rainy season that, in the case of the north, goes a little bit further than through June. But anyhow, if you look at the second semester, the ramping up of the fourth line is already ongoing and is doing well.

The rainy season, of course, is well over, as Martins already mentioned. So we're looking – and the normal problems that we have in day-to-day operations, we've been tackling them and solving them. And we're very, very close and near to our budgets. I mean I'm very optimistic about the second semester.

Roger Agnelli

And Felipe, this is Roger. Of course, it's very important to mention that we are preparing all these systems – all these systems in the company for the coming production. So you know that we are expanding production in the north system, in the south system and we needed to prepare the ports for this new capacity requirement.

So Eduardo mentioned about the north – the Ponta da Madeira. I consider that nothing – it's not a problem. It's something that you have to face in a one-part phase. And as you know, 2007, 2008, 2009 equipment – all the equipment that were produced in this time, some of them faced some quality issues. So everybody is facing this kind of thing. So the one part, instead of taking three months, it took three-and-a-half, four months. But this is natural. You are going to see, in the third quarter, that the Guaiba Port here in Sepetiba Bay was stopped before for two – three weeks just to prepare the port to receive the new car dumper.

Eduardo Bartolomeo

The new ship loader.

Roger Agnelli

The new ship loader, sorry, the new ship loader. So what we are doing is the work that is necessary to do to prepare the system to increase capacity in the near term.

Eduardo Bartolomeo

And to consume all the iron ore that is produced in the mines. That's the most important thing. So we're going to move it through the ships.

José Carlos Martins

And Felipe, as far as the price issue is concerned, I would like to add another point that I forgot before – forgot to say. When you make your calculations and you use our deliveries, which in wet basis and the pricing system is in the dry basis. So this brings something like $5 or $6 difference, okay, because you calculated our volumes on wet basis and the price on a dry basis. So this is another point that you have to consider when you assess the average price that we are realizing.

Roger Agnelli

In the first and the second quarter, the ore was really wet. It was raining a lot.

Operator

Excuse me. Again, please restrict your questions to two at a time. Our next question comes from Mr. Ivan Fadel from Credit Suisse.

Ivan Fadel – Credit Suisse

Good morning, everyone. Good morning, Roger, Guilherme, Martins, Tito, Bartolomeo. My first question is regarding the projects, the CapEx. When I compared the CapEx budget in the first and second quarter releases, I noticed some changes in Carajás plus-30 project, also in Vargem Grande Itabiritos, Tubarão VIII, Moatize, and Tres Valles. Could you go over them briefly to explain why the CapEx increased in most of them? And why, particularly in Carajás plus-30, you have now a lower budget for – specifically for 2010? Carajás

And my second question would be related to VALE's growth prospects and M&A. So VALE is to generate very strong cash flows in the next few quarters and, perhaps, years on very high iron ore price expected. And every once in a while, I noticed that there are concerns from market participants, from investors, that VALE might undergo large acquisitions in the future, perhaps taking lower returns. How do you see this going forward? Is it something that VALE's planning for larger acquisitions given that you get very strong cash flows ahead? Or do you keep discipline and perhaps focus on organic growth? Thank you.

José Carlos Martins

Thank you, Ivan. Beginning with the second question, first of all remember that VALE is the only mining company who can double the capacity only with organic investments. So our focus is really organic growth. So there's a lot to do in this sense. And again, big acquisitions have also, today, not only for VALE, but also for the mining industry as a whole, restricted from the financing capacity of the banking system today. So that's not our focus today.

Eduardo Bartolomeo

If I can go over the process. When you look at the south – sorry, the Carajás plus-30 that you asked, it's because of moving targets of the startup date because due to environmental license that we faced problems to take them for presentation, et cetera. When you look at specifically to one of the projects, like Moatize, Moatize added some logistics on the – so we had to readjust the budget. So taking that into account, we may – we're going to move to truck access. We're going to have to make a solution on the beta ports. So that's basically just as normal – just on the budget.

José (inaudible) those things, as José has already mentioned, are being challenged and discussed as to how is the investment that we have now. But they're normal, just as – as we have with all of the projects.

José Carlos Martins

Ivan, this is José. How long have you been working with this across – covering the valley.

Ivan Fadel – Credit Suisse

Sorry, say it again.

José Carlos Martins

How long have you been working covering the valley?

Ivan Fadel – Credit Suisse

Eight years, eight years.

José Carlos Martins

Eight years, okay.

Ivan Fadel – Credit Suisse

Yes.

José Carlos Martins

So you know very well that in the last 10 years, they are following strictly this truck – this plan that we are now there back in 2001 as soon as I – before the – same year. Everything that we made in terms of M&A was opportunistic approach. And of course, there are some actors that we expect to hold – minimize to acquire. But they are not at our (inaudible), so if they somewhat decide to sell, we are prepared to buy. If it fits to our strategy strength, our position in the market, this will bring a lot of synergies for our company.

I don't believe that much in synergies, et cetera. The issue is quality. If the asset is very good, we are going to acquire that. That's the reality. It seems (inaudible) that we are going to spend the money. We have our commitment to grow the company if we speed up the implementation of some projects or we can delay some projects. So we cannot just cover CapEx as we wanted to address all (inaudible) here. Like here, we postponed some projects because we said, "Well, we are analyzing a little bit more of how we're going to be the – the concerned with the environment in the world." And so we saw that was good. Okay. Let's just start this business. And that's what we are doing.

Regarding (inaudible) Paranapanema, these assets we were discussing and looking around, therefore, more – we haven't been there for more than three years right now. And there is an opportunity. And we feel that we are going strongly in copper. Copper, as we mentioned many, many times, we still think that we believe that it's going to be very good. And the market is good. We are bullish about copper. And we are going – we are going to double or triple our concentrate production. So we're starting to have expansion, or here (inaudible) in other places in the world, why not? It's just to manage risks.

And another point is that (inaudible) is that important. We believe that Brazil is an economy that will perform very well in the next – in the following – in the coming years. So we would like to increase our exposure to Brazil market – to the Brazilian market. Why not? So Paranapanema's good. So you could say whatever you want to say, but VALE has been disciplined. And I hate debt. I hate debt. But sometimes we have to have some debt just to optimize the return on equity.

Ivan Fadel – Credit Suisse

José, that was very clear. And I fully agree with you. And I think that continues reinforcement of that is very important for investors to understand because that's why we basically have VALE as our top pick. And I believe fully that VALE has enough organic growth to boost exposed patterns throughout this high cycle. And I think it was very clear to basically mitigate this risk that every once in a while I see some investors raising concerns. So I was really looking for just reinforcements, which I think was something to expect anyway. So thank you very much for your clear and very straight to the point answer. Thank you, José.

José Carlos Martins

Thank you, Ivan.

Operator

Excuse me. Our next question comes from Mr. Rodrigo Barros from Deutsche Bank.

Rodrigo Barros – Deutsche Bank

Good morning, everyone. Congratulations on the very good results, in particular when we consider the non-recurring effect of the delayed shipments. I have some questions, the first one on the VALE news. We note that although iron ore prices came down from almost $190 per ton to $120 per ton, at the same time the value was increased from $4.5 to $6 per ton now. I would like to know if you have any explanation why the value was increasing despite the falling iron ore prices. This is the first question.

José Carlos Martins

First of all, you needed to understand that the new price formula was built exactly to get this because in the former price system, it's only in the iron ore content. If you have iron ore that reached $58 or $66, the price – the percent of iron ore would be the same. So that was observed for a while. And so, because that situation would allow us to correct the price from – to correct the iron ore from August without getting the value used for it.

So exactly what's going on is the price goes down. And you have more quality ore available, the more you'll need the high quality ore. So in order that the customers to get advantage of the low quality ore, they had opportunity to buy more good quality ore. And they have to pay for it. So I think it's – and that's the beauty of the new system for VALE because now, we really have value for our quality. And the market is recognizing it. And that's more beautiful because the market is recognizing and paying it.

So if the Australians have the freight differential, we have the quality differential. So I think both can be happy. I think Australians can be happy with the freight differential. And we are happy with the quality differential. And customers will also be happy because they can take advantage of proximity, and can take advantage of quality. And they can make their ordering according to their best calculation.

So I think the market is proving our (inaudible) – long term (inaudible) that we always told you about. And people are paying. So if people pay, that's the reality. So I don't think we need to explain too much why because as long as the market is paying, it's because the market is recognizing it. And if the market becomes stronger, probably the VRU [ph] will be lower. Because when the market is very strong, what the market needs is iron units more than quality because if they don't have iron units, they cannot produce steel.

So in a very, very strong market, the VRU decreases, and in a weak market, the VRU increases, that's the way the market is recognizing it. And it makes sense when you look at logically inside the system, inside the blast furnace burned, how the people use the ore, and all of those things. So we are very happy with the new system. And we believe that as time goes by, they will be stronger. And everybody recognized they are designed to (inaudible).

Rodrigo Barros – Deutsche Bank

Perfect. Thank you for your answer. My second question, regarding the Rio (inaudible) assets that's VALE, that's just recently. And we all know that these are extremely high quality assets, which naturally would commend very good value news for VALE. I wonder if you could share with us what your plans are for developing that asset.

José Carlos Martins

Well, Cordoba asset is the best in that part of the world. It's a big – this mine is our biggest producer of lumps, and has a very, very high quality similar to Carajás lump, so that is an additional value, which is when you have the lump you don't need to (inaudible) your ore. So there is an additional advantage besides the quality – the sizing is also better.

This resource has had a big challenge, which is logistics. The mine is 2,000 kilometers from the sea. Whatever side you look, it takes 2,000 kilometers to get to the sea. So we are developing a fleet of barges for bringing it to the port – (inaudible) – to the Prata [ph], so down to the sea. And it's not only the issue because that place is not suitable for big vessels. So we needed to make trans-shipment. So there is a lot of logistics. I think it's not a mining issue to develop those costs. But logistically speaking, the challenge is very big.

We are moving to produce 6 million tons there. We made some investments. And we are developing, as I told you, the barges for it. But we believe that we can raise $15 million tons by 2012 and 2013. But that will always depend on the price of the ore in the market because logistics-wise, it's very expensive to do it. And that was the reason that this mine was never fully developed.

But if the price of iron ore probably stays above $100 per ton long term, we believe that we can get full potential from this mine by 2012 and 2013 in the raising of 15 million tons per year.

Roger Agnelli

This is our second coal reserve.

Operator

Excuse me. Our next question comes from Mr. Leonardo Correa from Barclays Bank.

Leonardo Correa – Barclays Bank

Yes. Good morning. Thank you very much for the call. My first question is regarding the iron ore quarter pricing mechanism. The question is for Martins, please. We have been recently hearing of high resistance levels out of the industry on the quarterly pricing mechanism and this is basically given the time the disclosures are made generous. Just to hear from Martins, if I was contemplating to change the system to a monthly pricing system going forward, just to get your views on that.

And the second question is regarding – also for Martins, is regarding the outlook on iron ore demand for Europe, given that the restocking is now close to complete. What type of demand levels are you seeing for Europe during your coming quarters? Those are the questions, please.

José Carlos Martins

Well, as far as the price system is concerned, we have just come from a price that was established for a period of one year to a system that the price is established for quarters. So it was a big improvement from one system to the other. I think the answer for your question is you'll be dealing by the market because as long as volatility stays too high and probably there would be a need for some adjustment.

But I believe that after this overshooting this year in these two quarters, and you see now that the iron ore price is stabilizing in the – in the spot market in China, I believe that this activity will be reduced going forward. And maybe we don't need to change it. But the answer will be given by the market. So as we told you before, we need a system that can cope with the volatility. And I believe the quarterly price can cope with that and will help to reduce volatility.

And to reduce volatility, you have also a kind of dent that will keep the prices stable if the variations are under the same level. Long term, I believe that we can have a more stable price. The price is established. But probably, the price could be kept for a year or two if the volatility's not so big. So I think volatility and customers will have an answer on that.

For the time being, customers are committing themselves with the new price system. It was a big change for them. They come from a one-year price system to acquire, so they have their relationship with their customers. So this is a big challenge. It's a really big challenge. And we needed to arrive to that – how customers will behave under this system, have an option for this to stay or not.

One thing is for sure, if you look at oil prices, oil price is a commodity much bigger than iron ore, much important than iron ore worldwide. And the prices are established daily. And the market agrees with that. I don't think that will – these talks about iron ore price moving every quarter is not good or it's bad. I think it's only a question to be used to that. And as time goes by, people – you adapt to it. And I think also volatility can be much lower under a system that can self-adjust quarterly. So I believe the quarterly system will stay.

The second question about Europe, the European market recovered faster than any other. There was a big recovery, very fast, also put a lot of pressure on that because of the de-levers, because they all discussed for most part of putting more order – almost just in time in asking for more ore, and so and so. And I think that was the history during the first half. Now, the market naturalized [ph] a little bit. And that's normal because we have vacations in Europe because every year, it was the same. So I think it's a natural movement.

One thing that you'll look [ph] is that the performance in Europe is (inaudible). The countries have a different behavior, being Germany practically coming back to the same level of prices as far as production and I don't know – Chinese concerns. But some countries are lagging. And Europe as a whole, even after this recovery, on average, is 15% below pre-prices level. So I believe that there is a space from some growth ahead because the 15% decrease is too much for Europe. So I think, in the fourth quarter, we are going to see some recovery in Europe.

Operator

Excuse me. Our next question comes from Mr. Rodolfo De Angele from J.P. Morgan.

Rodolfo De Angele – J.P. Morgan

Hi. Good morning. My first question is about the Chinese iron ore industry. I wondered perhaps if you could comment on there specifically, if you have a view on what's the marginal cost of production, and if there're any changes on going on, such as consolidation, anything on those lines.

José Carlos Martins

The performance of Chinese iron ore production was very good in the last three months. I think they operate near their full capacity. That's one of the reasons that brought some stability for the spot market also because after the winter, they come and produce almost at full capacity. And this has a brought a lot the ore at the market. And it brought some stability for the iron ore price, which is not bad.

But looking forward, they don't have too much space to grow. And when you look at Estreito, the largest mines in China can produce 10 million tons per year. So the majority of their mines are below 2 million tons per year. So their cost structure is very high. Another issue is that 30% of their production is underground, and you can imagine how expensive it can be to bring iron ore from–

Roger Agnelli

The ratio.

José Carlos Martins

The (inaudible) ratio is that big. So then, their cost structure is very, very different. For some mines, it can be as low as $50, open pit and dig mines. But for some mines, it can be near $140, $150. And those mines, when the spot price will go down like it did, the tenants, they get out.

On average, their cost is around $80 to $90 per ton. And that's the reason, I believe, the long term for iron ore will be not below this level because that was the cost structure. As long as China continues to grow their economy and their steel industry, they will need iron ore. And their cost structure for their local mines can be a flaw for the iron ore price. So I don't – also, quality is another point we talk to. Today, to look at $66 iron ore from China, and a 58% iron ore from India, you have almost a $30 difference between both. So it's a huge difference for quality – for iron ore quality.

So long term, I believe that this price will not go below $100. We had that problem in 2008. But in 2008, you had a slowdown all over the world, Europe have mostly disappeared. And everybody dumped the Chinese market with iron ore. And their market at that time was not so good also. So there were so many factors put together. And then, the price went down as low as $60. But I don't believe that will happen again. And I believe that the iron ore price will be sustainable in the range of $90, $100 per ton long term.

Rodolfo De Angele – J.P. Morgan

Thank you very much.

Operator

Excuse me. Our next question comes from Mr. Tony Rizzuto from Dahlman Rose.

Tony Rizzuto – Dahlman Rose

Thank you very much. I wanted to confirm something I thought I heard, and then also ask a question about pricing for iron ore. And I think I heard earlier that, Martins, when you were mentioning about the carryover tonnage in the second quarter, I think I heard a figure of 10 million tons, if you could confirm that for me. And if you could give us–

José Carlos Martins

Yes, 10 million tons.

Tony Rizzuto – Dahlman Rose

All right. Thank you. And did I hear you say that that would be behind you or a little bit further in 3Q as well.

José Carlos Martins

We have some carryover for this quarter, and more than that, for sure. And I think we can finish all carryover by the end of this quarter, so I want to enter the fourth quarter without any carryover.

Tony Rizzuto – Dahlman Rose

All right. Thank you for that. And then the second question is, when I think about the realization, obviously, there have been a lot of discussion about that so far. But would it be unreasonable – I mean when we think about the pricing mechanism now and as this – the carryover tonnage dissipates somewhat, you're operating at better levels that the Board issues, et cetera. Are we likely to see a pricing increase that could be closer to 40% or 50% sequentially?

José Carlos Martins

We have a problem. We cannot hear your question. And there was an interruption in your line.

Tony Rizzuto – Dahlman Rose

Can you hear me now?

José Carlos Martins

Okay. Let me repeat that. And I apologize. I don't know what's going on. If we think about the pricing mechanism with your operational issues behind you at the port, a little bit dissipation in terms of the carryover further behind you. Is it unreasonable to think about a sequential price increase for iron ore that could be 40% to 50% in the third quarter?

José Carlos Martins

Sorry. But it continues to interrupt, so I cannot understand your full question. I know you talked about the carryover, about the price realization. But I was not able to get what your question was.

Tony Rizzuto – Dahlman Rose

All right. Let me maybe take–

José Carlos Martins

What is interrupting?

Unidentified Participant

(Inaudible, microphone inaccessible).

Tony Rizzuto – Dahlman Rose

Maybe one final shot. Can you hear me now?

José Carlos Martins

Yes.

Tony Rizzuto – Dahlman Rose

All right. I'm just trying to get a better handle on the third quarter price realization for iron ore. With these issues moving behind you, is it likely that we could see an increase maybe on the order of magnitude of 40% to 50% in the third quarter on your realization?

José Carlos Martins

Well, I think that this situation in the third quarter will be positively affected by – because the price went up, we have – if we look to the average, the spot went up. So that's the information you have. And also, you have some improvement in the point you raised about the carryover. But I asked you to be very, very conscious about it because I told you before that you are calculations on a wet basis, and the price system is on a dry basis. So then, you have $6 – $5, $6 difference on that.

Another point is the sales that we have in the domestic market. VALE's sales are much more than our competitors in the domestic market. Brazilian domestic market is a big market for iron ore. So if all those sales are done, a price that is lower than FOB-based price because we have the logistics that cannot be considered. So the price will go up because of the – because of the average that increased in the spot in China, and also because the carryover will be lower.

But you have the other factors that will be present anyway. Then you might – you have to be very careful when you make your assessment. And as you know, we cannot make any kind of forecast about what or where the price will be. The system is there. You know about the price. I told you what the points are that would influence this average price. But it'll be up to you to draw what the number will be. Sorry for that, but I cannot elaborate more about this.

Operator

Excuse me. Our next question comes from Mr. Marcos Assumpção from Itau Corretora.

Marcos Assumpção – Itau Corretora

Hi. Good morning, everyone. Congratulations for the results. My first question is regarding iron ore volumes seen in the third quarter. I understand that shipping operations are – will be running at much more normalized levels in the quarter. But I'd like to understand if – from a market perspective, did VALE – is VALE suffering or facing a little bit shorter – short term demand on the back on the cool down on the Chinese property market during this period, and also the seasonally slowdown in Europe?

José Carlos Martins

Eduardo told you before that production's running very well. So we are going to have – sure, a better performance this quarter for many reasons. And as far as market, we are delivering every ton that we are able to produce and ship. So I've told you before that July, the sales were completely normal, no problems, no problems to deliver. For the August, we have the ships already nominated. And for the time, maybe I do not see any problems arising from this slowdown in the property sector in China. And I think a good practice for analyzing this is the – the iron ore spot price, that's moving up in China in the last two or three weeks.

Marcos Assumpção – Itau Corretora

Perfect. My second question is regarding the nickel business. When do you expect volumes to return to more normalized levels on this business, and given the end of the strike recently in Sudbury?

Tito Martins

Hello. This is Tito speaking. Thank you for the question, by the way. I was sleeping here. We are already bringing back all the employees. Of course, we need some time to train them again. So we should be back on full capacity by September. It's good to remind you that we were already operating with the 50% capacity, so that's why we – the temp's going to be fast. If we were not operating before, it probably would take us much more time, probably three months, to come back to the full operation.

It's important to address that we are still on strike in Voisey's Bay, Labrador. But it's starting to interfere with the operations because even if they are – we aren't operating in 100%, we managed to bring in – to work with the staff and replacement workers, so Canadian operations should be in full capacity by the end of September.

Operator

Excuse me. Our next question comes from Rene Kleyweg from UBS.

Rene Kleyweg – UBS

Good morning, gentlemen. A couple of questions, one on Simandou, could you just give us an indication of when – or what hurdles need to be met for the payment to be made to BSMG? And what potential capital commitments would be made prior to that next installment?

And secondly, Roger mentioned the challenges facing the industry in terms of water consumption, et cetera. There, earlier, has been mention for the possibility of a dry beneficiation process system for it. Hello?

José Carlos Martins

Yes.

Rene Kleyweg – UBS

José, it appears to be the mention of a possibility of a dry beneficiation process system for the 30 million ton expansion at Carajás. Is that still under review? I see you've got the – the da estratégia e implementação. But I was just wondering if you could update us on the potential dry process there.

José Carlos Martins

Well, Martins speaking. As far as Simandou, we are committing our – near $200 million for the project – for developing the project, for the mine and for the logistics. And the next fragment – the next statement will be done after some benchmarks achieved as we get to the full license to bring ore to – to Liberia, and also after we have this feasibility study on place. So that what is what we are committing now is this $200 million for a feasibility study, basic engineering, and also the – the project – for the railways that we needed to revamp it, the railways for – for (inaudible) that we needed to revamp it. So with that (inaudible), for one-year-and-a-half, we are not going to have probably any other payment as far as Simandou is concerned.

As far as dry processing, we are now processing almost 50% of the ore in Carajás by dry processing. The new 20 million ton-plus is dry processing system. And even in the former system, we are processing almost 40% in a dry way. So the 30 million tons project – plus 30 million will be dry processing. And also, the big Serra Sul project will be dry processing.

Our target from now on is to move the Carajás to be 100% dry processing, which will be very much environmentally friendly. Not only are we working on this dry processing, but we are working also in truck level operations. So we intend to reduce a lot the use of trucks in the mining. And we believe that we can get 70% the carbon emission reduction by doing that. So we have a lot of initiatives in Carajás, with the new technologies, with the new process system to make it a much more environmentally-friendly operation.

And only to give additional flavor about it, when we move the iron ore through our big ships, 400,000-ton ships throughout Asia, we reduced 35% carbon emissions. So one of our main targets is to produce iron ore in a much more environmentally-friendly way. So we have a lot of initiatives on this way that – not only bring more environmental concerns, but also can reduce costs. So we can get both lower costs and lower environment effect – it can affect less environment carbon in the end. So it's a very good combination.

Operator

Excuse. Ladies and gentlemen, this concludes today's question-and-answer session. Mr. Cavalcanti, at this time, you may proceed with your closing statements, sir.

Guilherme Perboyre Cavalcanti

Thank you very much everybody for attending this call. And see you next quarter.

Operator

Thank you. That just concludes our VALE's second quarter 2010 results conference call for today. Thank you very much for your participation. And have a good day.

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Source: Vale S.A. Q2 2010 Earnings Call Transcript
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