Vale (NYSE:VALE) is replacing trucks with 23 miles of conveyor belts to cut costs at its Serra Sul iron ore project, which is part of the Carajas mining complex in Brazil. This will allow the company to reduce mine-to-port costs at Carajas to about $15 per tonne, which is half of its current operational cost. The use of conveyor belts will eliminate the need for 100 trucks to link ore deposits to the processing plant and cut fuel consumption by approximately 77%. The mine is expected to begin production in 2016 and reach full production in five to six years thereafter. Since iron ore prices are expected to reach their lowest levels around 2018, Vale’s lower costs at Serra Sul will help it capture higher long-term profits as the demand-supply dynamic evens out thereafter. 
This is part of Vale’s larger strategy to become cost-competitive in order to regain lost ground in the global seaborne iron ore trade market. Rivals BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RIO) have surged ahead in the last few years. They have reduced costs by gaining economies of scale with increasing production and deployment of advanced technologies. These companies also enjoy a natural cost advantage over Vale owing to the relatively shorter distances between China and Australia, as compared to between China and Brazil.
The Serra Sul Project
The Serra Sul S11D iron ore project includes planned investments of $8.1 billion in building a mine and $11.4 billion in railway and port spending. The $11.4 billion will be spent on the construction of a rail spur, the expansion of the Northern System railway, the acquisition of wagons and locomotives, and onshore and offshore expansions at the Ponta da Madeira maritime terminal. The project is expected to increase the Northern System logistics capacity to 230 million tonnes per year. It is being built in the southern corner of Carajas – the world’s largest iron-ore complex. Once it reaches full production around the end of this decade, S11D is expected to have an annual production capacity of 90 million tonnes per year. This will represent about 8% of global iron ore exports. To put things in perspective, Vale’s iron ore production in 2012 totaled approximately 303 million tonnes. Vale currently has 7.38 billion metric tonnes of proven and probable iron-ore reserves at Carajas.
According to the company’s latest annual report filed with the SEC, the project is 41% complete and capital expenditure worth $1.8 billion has been incurred so far. 
The Advantage To Vale
Vale has been losing ground to rival miners like Rio Tinto and BHP Billiton. Its market value dropped below Rio’s in October for the first time in four years. Rio is fast catching up with Vale in terms of iron ore production capacity. Iron-ore output at Vale has grown 5.5% since 2007 amid aging mines and environmental licensing constraints, compared with a 37% increase for Rio Tinto and a 43% increase for BHP Billiton, the world’s largest mining company and third-largest iron-ore producer. Rio’s iron ore production is expected to reach 290 million tonnes by the end of 2013 and 360 million tonnes by the end of 2015. Vale’s iron ore production in 2012 stood at 320 million tonnes, a drop of nearly 0.8% from 2011 levels of 322 million tonnes. 
Iron ore prices have started declining after restocking by the Chinese steel mills came to an and in February. Going forward, the growing role of scrap in Chinese steel production and increasing investment in Chinese domestic iron ore production will keep demand growth in check. 
According to the Bureau of Resource and Energy Economics (BREE), the official Australian commodities forecasting agency, iron ore prices will decline going forward and reach its lowest levels around 2018. This is due to a lot of additional production capacity scheduled to come online in this period and a non-commensurate expected rise in demand. Beyond 2018, the balance between demand and supply is likely to be more even. Vale’s cost reduction efforts should thus start bearing fruits in a few years and continue into the next decade. 
We have a Trefis price estimate for Vale of $20.
- Vale’s $20 billion truckless venture key to its revival, MineWeb
- Vale 2012 20-F, SEC
- Vale Q4 2012 Production Report, Vale Website
- The best laid plans of miners and men, Financial Times
- Australia predicts fall in iron ore price, Financial Times
Disclosure: No positions