Vale S.A. (NYSE:VALE) Q2 2021 Earnings Conference Call July 29, 2021 11:00 AM ET
Eduardo De Salles Bartolomeo - Chief Executive Officer
Luciano Siani Pires - Executive Vice President of Finance & Investor Relations
Marcello Spinelli - Executive Vice President of Iron Ore
Mark Travers - Executive Vice President of Base Metals
Carlos Medeiros - Executive Vice President of Safety & Operational Excellence
Alexandre D'Ambrosio - Executive Vice President of Legal & Tax
Conference Call Participants
Carlos De Alba - Morgan Stanley
Jason Fairclough - Bank of America
Alex Hacking - Citi
Andreas Bokkenheuser - UBS
Amos Fletcher - Barclays
Tyler Broda - RBC
Christian Georges - Societe Generale
Sylvain Brunet - BNP
Good morning, ladies and gentlemen. Welcome to Vale's Conference Call to discuss the Second Quarter of 2021 Results. 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 a time. [Operator Instructions] As a reminder, this conference is being recorded, and the recording will be available on the company's website at vale.com at Investors link.
This conference call is accompanied by a slide presentation, also available at the Investors link at the company's website and is transmitted via Internet as well. The broadcasting via Internet, both the audio and the slide chain has a few second delay in relation to the audio transmitted via phone.
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 comment as a result of macroeconomic conditions, market risks and other factors.
With us today are Mr. Eduardo De Salles Bartolomeo, Chief Executive Officer; Mr. Luciano Siani Pires, Executive Vice President, Finance and Investor Relations; Mr. Marcello Spinelli, Executive Vice President, Iron Ore: Mr. Mark Travers, Executive Vice President, Base Metals; Mr. Carlos Medeiros, Executive Vice President, Safety and Operational Excellence; and Mr. Alexandre D'Ambrosio, Executive Vice President, Legal and Tax. First, Mr. Eduardo Bartolomeo will proceed to the presentation on Vale's second quarter 2021 performance and after that, he will be available for questions and answers.
It's now my pleasure to turn the call over to Mr. Eduardo Bartolomeo. Sir, you may now begin.
Eduardo De Salles Bartolomeo
Okay. Thank you. Good morning, everyone. First of all, I hope you're all doing well.
As we have done since the beginning of the pandemic, we kept our guards up in the second quarter of 2021 with all the safety and prevention procedures for COVID-19. Safety, people and reparation, these words have been our priority since 2019 and continue to inspire our actions.
We have made progress in repairing Brumadinho. We are working with the authorities to implement the 37.7 billion reais integral reparation agreements signed in February this year. While the authorities are structuring the work fronts, Vale continue its actions for social environmental and social economic reparation.
In the second quarter of 2021, among other initiatives, we launched the social strengthening program in 10 municipalities and along the Paraopeba River. And we are completing a new pipeline to supply the metropolitan region of Belo Horizonte. This deliver is a major step forward in ensuring water safety for nearly 6 million people.
The reparation of individual damage also continues to advance. Since 2019, more than 10,700 people have entered in civil or labor compensation agreements with Vale, totaling nearly 2.7 billion reais. As you can see, we are repairing Brumadinho in a quick, fair and agile way.
We have advanced in the safety of our dams as well. In the first semester, we removed the emergency level of four structures and reduce the emergency level of another two. In the upstream dam decharacterization program, we completed the work of the Santo Wind Dam at the Vargem Grande complex. So, since 2019, six upstream structures have been eliminated. We also completed the works of the containment structures downstream of Forquilha and Grupo dam.
Finally, we are also advancing with the works for victory before into two superior dams. Earlier this month, we started activities to remove the tailings with unmanned equipment. In addition, our dam management model also continues to improve. We have appointed an independent Tailing Review Board the ITRB to each of our iron ore corridors. This practice is in line with the global industry standards for tailings management, the GISDM, by the way, we are inline to adhere to GISDM in due time. So we continue to make progress in the quarter transformation towards the safer Vale.
We have also made progress on our ESG commitments. This quarter, we detail our strategy to achieve our 33% reduction targets for scope one and two emissions with an estimated investment between $4 billion to $6 billion. As I said at the last Vale Day, Vale is uniquely positioned to lead the transition to a low carbon mining. We have a high quality portfolio to support steel decarburization. We are a leader in renewable energy with around 90% of our global consumption from clean sources. And we operate sustainably protecting 1 million hectares of forest, about 80% of which in the Amazon rainforest.
For our IESG gap action plan, we closed another gap with the establishment of a formal due diligence methodology for human rights. This process assesses and addresses human rights risks and impacts. It will be implemented across all of our operations and critical projects is starting with 14 operations in Brazil in 2021. As you can see, we remain firm with our ambition to transform Vale into a ESG benchmark.
Well, now talking about the operational performance of our business, our adjusted EBITDA in the second quarter was the all time record at $11.2 billion. Given the increased sales volume of iron ore and good market conditions. We completed another quarter of increased iron ore production, growing 9 million tones compared to the same period of last year.
In the first half, we were 60 million tonne higher than the first half of the last year. We have reached it as well a nano capacity of 335 million tonne and we expect to operate with an average production of 1 million tonnes per day in the second half of the year. We remain confident that we will achieve our production guidance for 2021. Spinelli will give more color on that.
In April, our performance was mainly impacted by stoppage of the Sudbury operations in June. We continue to negotiate a collective labor agreement for the next five years. In copper, we recover part of the performance compared to the first quarter by accelerating the implementation of a new safety and maintenance process in Salobo and Sossego towards a stronger second half.
Despite of this, our portfolio of nickel products has made strides to ensure the continued delivery of quality, responsibly sourced material to the market. In June, we had the first production of the ore from Reid Brook underground mine at the Voisey’s Bay Mine Extension project. We also signed an agreement for the e Bahodopi Nickel Processing Facility in Indonesia with TISCO and Xinhai and the final investment decision is expected in the next six months.
Finally, in Thompson, Manitoba, we are also evaluating investments to extend the mines activities for 10 years. In relation to our cash brinks, we concluded the acquisition of Mitsui stake in the coal and logistics operation in Mozambique. This is an important step for advancement and the order is the conclusion of the ramp up of the Moatize operations. We expect to reach a run rate of 50 million tonnes per year in the second half. And we continue to seek alternatives for responsible divestment in that business.
Talking about capital location, we provided further evidence of our commitment to return value to our shareholders, with the distribution of extraordinary dividends of close to $2.2 billion dollars in June. Summing up, March dividends, Vale returned around $6.2 billion to shareholders in the first half of 2021. In September, we will distribute at least another $5.3 billion according to our policy and based on the results of the first half. The final number, including extraordinary dividends will be defined as usual in September.
And, as I said in the last quarter, without compromising, the continuity of dividends above the minimum policy, we continued with the share buyback program announced in April. So far, the program has disbursed $2.6 billion and is 45% complete. So, disciplined capital allocation is part of the reason and I'm confident that we will deliver on our commitment to maximize returns for our shareholders in the long term.
To conclude, I just want to emphasize that we're still guided by derisking, reshaping and rewriting Vale. We have effectively advanced into derisking. We are repairing Brumadinho fairly and quickly. We are building a culture of safety and operational excellence. We continue to stabilize our operations. Our ESG commitments are fundamental to our strategy. And we continue with an extreme capital discipline, focus on the return to our shareholders.
In reshaping, we establish a good case with the VNC exit and we are so looking for a responsible exit in Mozambique. And the rating will happen as we evolve in our deliveries, which brings us closer to our ambition of being a safer company with more stable and reliable operations, increasing our investors’ perception of Vale. To make that happen, we are working very hard. And I want to thank our 70,000 employees, our contractors, suppliers and customers for their resilience, high guard and commitment to our culture transformation.
Now hand over to Spinelli, who will give more details about the performance in iron ore. Thank you very much.
Thank you, Eduardo. Good afternoon, everyone. Let's start bringing an outlook about the production of this year. We want to reinforce our production guidance is a range between 3.15 in 3.35. We increase as Eduardo said 16 million tons the first half compared to last year, 5% of production. If you don't add any more volumes, the second half you can see that we are in the lower range of the guidance. But what can make us believe that we can deliver more in the second half. My right hand side, I have some talk, I want to share with you.
Firstly, we are in a dry season now, you know our seasonality we've been running our operations 1 million tons a day. Second, East branch, we anticipated a ramp-up of east branch, because the previous plan was for a third quarter. Now we are the full capacity in East branch. Third in spite the limitation to produce more with wet processing in our team in a team work, we could add additional volumes for high silica there, due to the market conditions that we have nowadays. Four, that's new from last week and here not only important, but we can now reduce the risk in have the full capacity. And last but not least, we have a very brand new asset now Maravilhas III since the last Tuesday is right. So we can now bring the wet process in full in Vargem Grande and you're waiting for additional capacity and a couple more weeks with the resume of the conveyor belt the long distance conveyor belt that is over the parking garage is down.
So let's move to the next slide. Now I can give you an update about the resumption plan. Well, since the last conference call, we have several shipments. I want to reconcile the numbers you with you. We left last quarter with 327 million tons of capacity. Sinter, we added, with each range plus two high-silica two plus five. Fábrica: of full capacity since last week it was 4, a matter of industries plus 4. The sum is 342 but we need to decrease the capacity that we lost in Itabira.
We start this year saying that the capacity of Itabira this year should be minus nine. And after hard work in Itabira, handling the materials, we could reduce this impact to minus two. And as I said last conference call with several small delays in older feeds, we have a minus five. So, the net number is 335 of capacity today.
Next slide, please. So, what -- what we expect for the second half. So, as I mentioned, Vargem Grande, we want to unlock the capacity to the end of this quarter plus 6 million tons. And also S11D, we have ABON [ph] Crusher, we already sold one we have another the second one this year, and we'll have the other two for next year. And about Brucutu, in total we announced that in our production report that we are -- we have now another startup for total second half of next year. So [Indiscernible] dam is under construction is going well but we decide to have some extra works to guarantee all the safety standards for that dam. I want to remind you that we need some extra time to have the final permit from our industry that already has the permits. So that's our new forecast.
Again, for that site in Brucutu. We also have more two initiatives to recover capacity, we have the filtration that is under construction and also lowering them if we're not using today, but have a plan to bring back next year. So despite this delay in total, we partially offset the capacity of -- to bringing or five million tons with high silica in Brucutu and also 5 million tons in Itabira as I mentioned that will reduce the problem since the beginning of the year.
To conclude, in our roadmap to 400 million, it's important to say that we are also with projects online. We have the filtration Itabira in Brucutu in the north we have gelato in S11D plus standard S11D 100 million tons.
Eduardo De Salles Bartolomeo
Thank you, Marcello. A few remarks on each of the businesses. As you saw the performance of cost, there was a an important increase on costs before third-party purchases towards $17.8 per ton. We're now expecting at the end of the year between 16, 16.5. There were one-offs in this quarter, most importantly, the merge costs increased a lot because of the repairs in the ship loader in the north and the queue of vessels increase. However, we're now feeling some inflationary pressures, diesel costs have increased a lot, mining parts, we're starting to see some service inflation. But still with the dilution of fixed costs, we expect this decline over the next quarters.
Reminder that Q3 will still be impacted by the carryover of the production, higher cost production from Q2 through inventories. But in Q4, you should see the full at least $1.5 decline compared to current levels. The opportunity is going forward to reduce costs. First and foremost is to unwind all the COVID expenditures, if we continue to progress in controlling the pandemic. Today, iron ore spends about $150 million a year on costs and expenses just on the pandemic measures. On cost alone, this is about $0.30 per turn we expect to start unwinding this soon. We have the normalization of operations team of Timbopeba, Fábrica, those who already reached full capacity should start to post better cost performance in upcoming quarters as well.
And finally, we did have an increase in maintenance expenses related to the catch up that we're doing. We're implementing the VPS, Vale Production System model, requires systematic maintenance to go from the prior levels of 20% or 30% of total maintenance activities towards 70%, 80%. We're getting very close to that. Once we have most of the maintenance being done systematically, we should normalize maintenance costs as well.
On the pallet side, just call your attention to the substantial increase in realized prices from $192 to $255, a reminder that this $255 includes a mix between CFR sales and FOB sales, which deduct the freight rates.
And also that increase should have been even higher, if it wasn't for the fact that an important fraction of the pallet sales, they have -- its prior quarter prices that come in those sales. So therefore, the price increases in the second quarter have not yet gone through the pricing systems for pallets.
Actually, pallet premiums are around $60 for blast furnace pellets and $70 on top of the 65% for direct reduction pellets. So the premiums increased substantially in the quarter. We're now also selling more of direct reduction pallets, which commanded higher premiums. So that explains that very healthy increase in pallet premiums.
And also that highlights the opportunity that we have ahead, because two of our major operations, Itabira and Brucutu, which are performing well below potential, awaiting the filtration works and the tailings dams, the works. These are the ones who produce pellet feed to supply our pellet plants. So, therefore, once they come back, hopefully, we will start to normalize our pellet production and take advantage of these very high premiums.
In base metals, I think we missed consensus by maybe 12%, 15% on base metals EBITDA. Perhaps that was because of the assessment that the market made about the impact of the Sudbury strike. Just a reminder Sudbury is a polymetallic producer, not only nickel production, sulfur but also copper production, byproducts production. So Sudbury does have a very large impact on our operations.
Even if we resolve quickly the strike, we will still have many weeks until we normalize. And also we have some major maintenance program; the regular 18-month scheduled maintenance has to be done over the next few weeks as well in the surface facilities in Sudbury.
Finally, on coal, in June, we started to consolidate the results of the business in the corridor -- the logistics corridor. As a result, EBITDA for the month of June was minus $12 million, a significant improvement. The prior months, in April and May, we were minus $60 million, minus $50 million every month. So already, the benefits for the coal performance are kicking in. And therefore, with the ramp up and the current pricing environment, we do expect to reach positive EBITDA in the second half of this year.
So, let's now move straight to Q&A.
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Mr. Carlos De Alba with Morgan Stanley.
Carlos De Alba
Hi. Good afternoon for you guys in Brazil. And I hope you're doing well. So the question I had first is on money returns to shareholders. What do you see with the potential increase in dividend, Taxes the combination going forward of dividends and share buybacks?
And also you can provide any color on the caps to future dividends, at least in the second half of the year, based on their balance sheet accounts and the capital reserve account and the net profit or retained earnings account that will be very useful.
And then, if I may ask, just on Muatis, Luciano the 12 million negative EBITDA in June versus the 50-50 in prior months, does that already reflect the benefit of the removal of the other financial burden on the project finance?
And the only thing that is then left to capture is the better economics as the ramp of progresses, or there still is some part of the project finance benefits or elimination of the of those costs that should be reflected on top of the improvement to minus 12. Thank you very much.
Luciano Siani Pires
Thank you. Carlos.
Luciano Siani Pires
Let me begin, and Marcello just then you take from me, Okay.
Luciano Siani Pires
I think, as I mentioned in the beginning remarks, Carlos we have been extremely disciplined in the capital allocation, right, both, in buybacks and dividend payments. We did an extraordinary March, i.e. of course, we signed that we have at least 5.3 billion to be paid on September.
This is at least because, we're going to see market conditions and as to define the waters level of extraordinary dividends. As the specifics about the tax reform we were questioned that in the previous call, and we answer the following is that, few still on the make, by the way, is something that should be neutral. That is the plea from both government and legislators that would either increase if there is like, how can I say that, factor of taxation of dividends would be a reduction on the above the line, so it would be neutral.
But anyhow, we won't change our dividend policy because of that. Because dividend policy and philosophy is to the surplus of maintaining our business health and running is going to go as soon as possible to the shareholders. So With that, I think there's a not a specific question about reserves. And I think we can still can explore that as well and give some more color that I've just explained.
Okay. Luciano then you go to Muatis, please?
Luciano Siani Pires
Okay. So Carlos, at current levels of cash flow generation, that there's no competition between buybacks and extraordinary dividends. So we've been doing both. And we'll continue to do both.
The shareholder base is spread all around the world. So different shareholders, they have different tax regimes. So it is even possible that for some of them, that are already taxing their dividends that the current proposal could even be beneficial. We at least hope that it's going to be neutral as it was said for the Brazilian shareholders, but for some foreign shareholders could even be beneficial.
So because of this heterogeneity of the shareholder base, we would rather be not take sides here and continue to do both thinking about the -- because we can do both. And there's clearly appetite for both also in the shareholder base.
As regards the reserves, this is going to be a -- if any, if any, this is going to be a temporary effect, because as you see we are building reserves very quickly. And there will naturally come a point, for example, perhaps in the first quarter that the cash flows will be less than profits generated.
For example, because in January, we have to pay the annual income taxes and it's natural that the free cash flow generated in the first quarter will be well below profit. So any -- if there is any restriction, it should be corrected very quickly.
The other thing that we might do is that we did before is to paste the dividends into quarters instead of just doing it in a in a lump sum. So we're certainly going to pay more than the minimum in September. But there's -- we cannot rule out additional dividends in December as well, based on the profits generated in the third -- third quarter.
On Muatis, yes the benefits of the removal of the project finance have fully kicked in into the minus 12. So now what we have to pursue going forward is the better economics as you mentioned of the ramp up and higher sales to go into positive territory.
Our next question comes from Mr. Jason Fairclough with Bank of America.
Everybody, good day from London. Just a couple quick ones from me. First, can we just talk about Samarco, it appears that some of the involved parties want to renegotiate some of the amounts that had already been agreed. So any color you can provide would be really helpful and if there's any implications for the Brumadinho settlement?
Secondly, just on your guidance, could we just talk about the guidance to return to 400 million tonnes by the end of 2022. I'm trying to understand what benefit you take from guiding from such an aggressive return to nameplate capacity, when the market basically is not rewarding for here, rewarding you for it, any thoughts there?
Eduardo De Salles Bartolomeo
I’ll go ahead on Samarco and then Spinelli and I can talk about the guidance. Why so important to come back to the nameplate capacity? Hello?
Luciano Siani Pires
Okay, I'm sorry, I wasn't mute. Okay, just a reminder here to give some part of the history in Marianna in 2016. In 2016, there was an agreement between the state governments, the justice institutions in Samarco, with support of the shareholders and where 42 programs were defined to ensure full reparation, and compensation amounts were also defined.
In 2018, there was another agreement in which the public prosecutors joined in, and there was a review of the governance of the Renova Foundation, okay, to improve the participation of those affected. And this agreement, 2018, had already a provision that two years after its signing, the party would sit together again to evaluate the effects and the effectiveness and the functioning of the programs. So not of the entire agreement of each of the 42 programs.
What Samarco is doing right now, is precisely that it's renegotiating the programs, the 42 programs as provided by the 2018 agreement. It is not negotiating a new agreement for Mariana. In fact, many of the programs of the agreement are quite advanced and would make no sense to discard the work already done by the Renova Foundation.
So -- and importantly, completely different from Brumadinho, where we were building an agreement from scratch, the mediation underway in the Supreme Court right now. It's aimed at improving execution and governance, respecting the parameters of the valid agreement, which was signed by everyone. And the compensation amounts have already been defined in six.
There are no discussions about values in this mediation, because the programs have already been defined. The cost of the programs are provisioned for and the compensation amounts have already been defined. And everyone agrees on this. There is a letter of principles, which is public that was signed in June, at the beginning of the renegotiation progress, which states exactly that we're reviewing the programs and we're not talking about values. We're not talking about compensation values, which had already been fixed.
Now Spinelli on 400 million guidance?
Eduardo De Salles Bartolomeo
Yes, yes. I want to -- I think Jason has an excellent question, because it's very important to understand why we are focusing on coming back to the nameplate capacity. When you look at the numbers and you drill down on the three systems, the big numbers are coming where from Itabira, from Brucutu and from the North. So we are talking about quantity here and then comes to our value over volume. We are not going to put volume on the market, as your right, if you will be not rewarded for that.
But at the same time we are functioning an efficiently. We're operating half of the Brucutu capacity, not at the total capacity of Itabira and having opportunities to increase operations in the North of Brazil. So, we're not saying that we're going to produce 400 million tonnes. We're going to say that we have the conditions to swing capacity to blend at adequate form. So that's what behind the building back the capacity. And then we use it as we should do in our value over volume, in our commercial strategy.
And I think Spinelli can reiterate that. But that's, I think, a very, very good question, Jason. Thanks for that.
You’re perfect, other rather than that, just to compliment, I think, in the different mode of operational mode, so safer mode using drive processing and have the capacity to use if you need. So that's the available capacity, we will be used with our mantra of managing overwhelm.
Our next question comes from Mr. Alex Hacking with Citi.
Yes, thank you. Good morning. So first question, Spinelli, just to follow-up on the iron ore capacity, how much -- when I look at figure 12? What assumptions in there are on the on the northern system, because that was always designed with, I think 230 million tons of capacity. But when, we look at production today, it still seems like it's operating below 200. So what are you assuming on the ramp up there of the northern system?
And then just to follow-up on your previous comments, so, again, you're talking there about getting to 450 million tonnes of capacity in the future? I mean, are you saying that you would be willing to build up to that capacity level, but operate very significantly below that at 350 million tones, or something like that?
And then just one quick question on Muatis, what's the mix of met and thermal in that 50 million pounds? Thanks.
Thank you, Alex for the question. Well, talking about the figures in the north system, yes, we designed to deliver the 230 million tonnes, we need to have some construction there, the S11D, and also, to deliver the other product. Now we have we had the ramp up of S11D. We learned a lot last years to run a non-flexible system or less flexible system, but very interesting in terms of environment and vicious in terms of costs. But we don't have the same flexibility and open feet operation. So that’s all related to the ramp up is to adjusting the crushers.
And it's important to say that we learned this last quarter, when we have a lot of products, we have the times. So we can have some impact, temporary impact when we are getting some new capacity. And we learn to this and we are going to have in our plan for this in the new future.
And talking about the 450, again, it is about a pipeline of products to offset some setback that you can have, in the mining business very well, we can have difficulties like we have now referred to related to our construction, or our permit, some small delays in six months or even one year, even pipeline to have reliability to deliver all round. If you don't see the necessity in the future, we don't -- just don't trigger the project in this pipeline, but we must have the pipeline of 150 to guarantee that we can have the optionality to deliver the 400 million. So that's the idea of 450.
Eduardo De Salles Bartolomeo
And Spinelli, just to add on you, and I think Alex has a point, 150 is a more medium-term shot. And then comes the swing capacity ability that you just mentioned, okay. That's why we need to build buffers for that and to swing capacity, because we have very expensive minds as well. So that's behind and it's a medium-term, it's not that we're going to use 550 next year or next two years, or what else even next year for the 400. We need to establish our architecture as it was before. And then we define as you said, margin over volume as we always do.
And Luciana could answer about Muatis
Luciano Siani Pires
It's about 55% Medical, 45% Thermal.
Our next question comes from Andreas Bokkenheuser with UBS.
Thank you very much. Just a quick question from me on freight. I know we've talked a little bit about this before, we're obviously, seeing a bit of freight cost inflation. But over the last few months, it's obviously, been talked about new IMO rules on freight and carbon emissions, and so on so forth. Can you just remind us, how does the freight contract reset work for you guys? I mean, I know you have long-term freight contracts, and obviously, freight rates are right now hovering around $27, $28 a time. So I guess the question is, if -- if freight stays at this level, you know, should we just expect even your medium for long-term freight contracts to be reset at that level? Or do you have any kind of fixed freight contracts with some of your ship providers? That is my question. Thank you very much.
Luciano Siani Pires
Andreas, Luciano here. Two points here to address. The first one, is about the market the spot market today. You're right. It's a surprisingly robust in this first half, I can say surprising, because if we can see the small, smaller vessels, Panamax is -- Panamax as they were really under pressure with high demand for the same pattern of the cape size business. But, -- there were a whole market was really robust in this first half, and we still see this market, higher level than then we expect, we don't see these long-term trends, considering the supply demand in this market.
The other part, the other question that you made related to IMO regulations, this is an important point, I am always defining the regulation for some time, we set a goal for 2030 for a reduction of 40% of the lesions. It was related only to new vessels after 2015 now they are extending to system the vessels. What we see in our fleet, we don't -- we don't have any impact in terms of costs, only the first generation of Panamax, is we keep pursuing maximum speed, reduction of 2%, but is very small in factors.
So we don't see an average any problem in our in our fleet. But the spot market, we can have, it's only for 2023. And after that, we have another -- another regulation that you need to keep the efficiencies 2% a year in a rank that you will define [indiscernible] in terms of efficiency of disaster.
So in this case, if you don't comply on that target, you're going have a risk reduction of your of your power. And, again, this can be something that we must track. But at the same time, the business will react to this, bring in technology, I want to emphasize as well that we have our product, our set of product that is called echo shipping. We brought the rotor sailing to a new vessel and we're bringing out the air bubble lubrication. That's another initiative, both of them can help a lot in a vessel to reduce their emissions. And we have a set of products that can make this evolution better and we need to definitely talk to our ship owners to implement these initiatives. But we are really aware about that.
Luciano Siani Pires
Because if I may add, Andreas, we will never ever converge towards spot rates. More than 80% of our fleet has 30-year contracts, which is a costs -- operating costs and a pass-through for fuel. So for example, our second generation Vale markers today are running at rates of $14, $16 per tonne at these bunker prices. At lower prices, they can go as low as $10, $9 per tonne. And that's it.
The reason why we suffer with higher spot rates is because in the second half we usually use spots to transport the excess production from the second half to the first half. But this is not ever going to flow through the existing contracts for 85% of our fleet.
Eduardo De Salles Bartolomeo
Just ready to go to information. We -- our fleet today is 170 ships and we also bring in more meeting waiver Vale maxes in six New Castle maxes this year. So we feel really well protective for this preparations.
Our next question comes from Mr. Amos Fletcher with Barclays.
Yes. Good morning. Good afternoon, gentlemen. Thanks for taking my question. First question was just on the Sudbury strike. How long should we assume this takes to get resolved? And then I want to also ask about financial leverage. I mean, if we look at your pure financial leverage, you're in a net cash position with the business delivering very strong EBITDA prospectively. Could it be possible to take on a bit of modest levels of financial leverage to improve returns to shareholders even more? Thanks so much.
Eduardo De Salles Bartolomeo
Hey, go ahead, Mark.
Okay, so Amos, we've been back at the table in discussions with the USW for about 10, 11 days now. And those talks continue today. So that is a good news to this the story. The fact is that we're at the table and engaged very heavy manner with the USW to try and resolve this.
Discussions are going well. We feel positive. But of course, we can't count on anything until it's concluded but we remain positive that we can hopefully conclude a deal while we're at the table.
Luciano Siani Pires
And Amos, in terms of financial leverage, the answer is yes. We intend to increase our leverage. We had this target of $10 billion of expanded net debt. We raise it after discussion with the Board of Directors to 15. We're going to do this over time. And obviously, in the short-term, we're playing catch up, right, given the very strong cash flow generation just to stand still where we are. We're having to distribute everything that we generate, as we promised before. And -- but in order to re leverage, yes, we will need to distribute more than the free cash flow. And we will do so in the next few quarters.
Our next question comes from Mr. Tyler Broda with RBC.
Great. Thank you. I guess, I just had a question on the third-party volumes. So you had quite a jump in the second quarter, about 2 million tons. Doesn't sound like much, but obviously has a big impact on your costs. Could you just run through where those volumes come from and sort of where we should be looking at for those going forward? Thank you.
Thank you, Tyler. Spinelli, here. We see the purchase of third-party as an opportunity, a way -- all this depends on the -- the impact depends on the index, but it can make money and we do it. In this what happened the second that in -- the first half actually we have spare capacity in our systems to fill the rainy season and the lower production in the mine. So we could improve increase our purchase and take advantage on that.
Second half, I say that it's more related to, what we do usually you can compare to the last year. We are full in our operations now with Parauapebas and also we have the margin financial operations. We don't see so much -- no increase in this purchase comparing to last year. So that be stable -- stable process.
Our next question comes from Mr. Christian Georges with Societe Generale.
Thank you very much. Just to be clear on what you were saying about freight costs. I think you were saying that you're not seeing the current surge as being sustainable in the long term. I mean, what's your take on it. What’s your idea of when we should see the current liability cost reverse. And then he said, because of more capacity coming to market or more because you're seeing less activity on the shipping?
Eduardo De Salles Bartolomeo
Thank you, Christian. Well, I think we have a balanced market in capesize business. We don’t -- the effect of commodities, like soybeans is more related to small vessels not cape sizes. This year they had a -- they sometimes use the cape size for day of business, was not the usual use of the cape size. So that's our view. This market with our -- even with our return to the market, you see some markets like India or CIA are using cape-size to defeat China, they will go back to their domestic markets. So there is some balance rebalance in this something coming from Brazil, but reducing for other parts of the world. So that's our view about this the capesize markets not but again depends on other on other points, like the other part of the -- the total market in other kind of vessels, but our trend is not to sustain long term business level of spot rate.
Our next question comes from Mr. Sylvain Brunet with BNP.
Hi, gentlemen. Two questions for me, please. First on iron ore, sequential cost increases, maybe, Luciano, as you hinted at some spillover effects. What should we expect into Q3? You guide, I guess, towards the later part of the year, but what about freight and fuel costs, lag effects we should expect in Q3?
My second question is on your nickel business, in a complex where NPI production keeps creeping, over 50% of global production, if you take China and Indonesia together. Does that concern you? And would you consider streamlining your portfolio to favor class one exposure and maybe streamline the non class one exposure? Thanks.
Okay. So on iron ore costs, so we've guided for $1.5 reduction on C1 actually at the end of the year. And also, as I mentioned, Q3 will be a middle point from today and end of the year, because of the effects on inventory that there's a pass-through that takes another one or two months in order to unwind the inventory produced at higher costs.
So there's no structural change in the next six months, but for eventually, we -- if we can unwind COVID quicker, due to more progress in the reduction of the number of cases, maybe we can have a positive surprise here.
In terms of freight and fuel for the -- for today's spot prices and oil prices, the freight should stay pretty much the same. Maybe a slight increase, because when we sell more, we have to resort more to support freight, which is going to be definitely the case on the on the third quarter and fourth quarter.
But again, this is at the margin, because most of the freight is constructed in our fleet. So you should not expect significant changes in this variable for Q3 and Q4. Some upward tick, but marginal.
So I'll address the question around NPI production, class one pivoting. So clearly, the supply of NPI coming out of Indonesia is increasing dramatically. Right now, what we are seeing is that the demand for nickel is quite strong. And in fact, we're seeing the market, I would say, more or less in deficit rather than surplus, where we also see and expect Chinese NPI production to continue to decrease.
Although, it is fair to say that the NPI production coming out of Indonesia will continue to lead to increased overall supply in the coming years, as well as some strong -- but we do also have some very strong demand in the stainless steel industry.
There are -- I think it's something that we do need to watch in the future years. But overall, in the coming years, we do expect that it’d not be an oversupplied market. And as you may have seen, Indonesia is looking at potential policy moves to limit its further expansion of NPI to protect the sustainability of the saprolite in the coming decades.
In Vale Base Metals, we do have -- are in a position to play to all three segments in the nickel industry, a high purity, the stainless as well as the chemical to provide to the EV side. We are clearly focusing quite heavily on the high purity and the playing into the energy transition and electric vehicles, in particular, in our Canadian associate.
It's important to note also that, even our Indonesian operations, although, providing a nickel matte, we’re always flowing that through to make a class one product out of our Vale's refinery.
It's also finally I will note that our Onça Puma Ferronickel operation is a very -- is quite a profitable operation. And it provides us with a long life and continued flexibility even to convert that mat and sulfate for us in the class one product. So I think we have lots of options to play the market the way we would like to under our strategy.
This concludes today's question-and-answer session. Mr. Eduardo Bartolomeo at this time, you may proceed with your closing statements.
Eduardo De Salles Bartolomeo
Okay. Thank you. Well, thank you again for your interest and your questions and interest in our business results. And as I -- we said all the quarters, it's a really a marathon that we are experience.
And this marathon requires discipline and persistence. And I think, we've been there, we actively with the narrative of the risking, reshaping and rewriting. We're doing our job in the risk of the company in the safety and operations in ESG.
And of course, in the capital discipline that you're seeing that is extremely rigid. Reshaping has been done. But of course the rewriting is the final is the 42 kilometers is when we are really reliable and safe. And then, when we be rewarded with your confidence again. And I think that's the word that we're doing with our team and our 7,000 employees.
So, thank you again. And I hope to see you in the next call.