derailed: why vale isn’t on track in the west african iron ore scramble

simandou—estimated to contain 2.25 billion tons of high grade iron ore—could possibly be the largest integrated iron ore and infrastructure projects in africa. jp morgan recently estimated that vale-controlled blocks could produce 50 million tons of ore by 2020, a project which would put simandou on the same level of south africa’s kumba iron ore. jp’s optimism, however, overlooks a number of risks investors should consider when looking at vale’s position in simandou.

a brief historical overview. under the autocratic regime of lansana conté, rio tinto acquired all exploration licenses for simandou’s four blocks in 1997, and converted them in to mining concessions in 2006 while conté was still in power. right before conté died in 2008, former mines minister mahmoud thiam, announced that the northern portion of simandou (blocks 1 and 2) would be taken from rio tinto—accused of taking too long to develop the mine—and given to bsg resources ltd. (bsgr), a company whose biggest shareholder, beny steinmetz, has strong links to a number of politically-sensitive mining deals across africa. the military juntas in control of guinea between conté’s death and current president alpha condé’s election in december 2010 refused to grant bsgr complete legal rights to the concession. as a result, bsgr sold its majority stake in blocks 1 and 2 to vale up front for $500 million, with billions more payable as the project reached completion.

condé has brought relative stability to guinea since his election in 2010, and is beginning to overhaul the mining industry. condé has purged the ministry of all vestiges of thiam (who profited from bsgr’s sale to vale), weakened the power of the ministry, and has appointed a new coterie of advisers loyal to him. a new mining code was passed last fall, which states that upon issuance of a mining title, the state is automatically granted at no cost a 15%, non-dilutable interest in the share capital of the title holder, with an option to buy an extra 20% in to projects at market prices. while the new law does not change the ownership or validity of mining titles or agreements that were negotiated prior to the new code’s adoption, the government has closely scrutinized the largest and most lucrative deals opaquely signed during the 2008–2010 political transition. in order to wash their hands of any wrongdoing during the messy political transition, rio tinto paid a $700 million bonus payment to the government and negotiated a series of staged buy-in options over 20 years up to the 35% cap before the passage of the new code. vale pursued no such strategy on the eve of the new code’s passage. as such, vale’s tarnished  image—which the guinean government didn’t believe followed the law through its association with bsgr—in the eyes of the guinean government has put the company on the defensive.

the promise to invest in infrastructure—ports, railroads, and roads—is the variable that could change how the condé regime views rio tinto and vale. the global quest for iron ore has spurred renewed talks on refurbishing west africa’s decrepit rail system. rio tinto has pledged $1.1 billion to conduct feasibility studies to construct a 650 km railway (trans-guinean railway) from their part of the mine to the coast, as well as build four-berth port that could export approximately 100 million tons of ore a year. it has also proposed to begin transporting iron ore on a 900km road from simandou beginning in 2015, while it waits for the construction of a railway so as to honor delivery contracts. further, rio tinto is waiting for final regulatory approval for its joint venture with chinalco from the government, which when finalized, will trigger an earn-in payment of $1.35 billion. i believe this will likely be earmarked for railway construction. due to budget constraints in the government, it is likely that the government will not be able to pay for its proposed 51% stake in the railroad, and thus rio tinto could be forced to construct the line through a build, operate and transfer program.

in order to change how the condé administration views vale, the brazilian mining conglomerate needs to invest much more in infrastructure projects than they already have. an increasingly bullish iron ore market for 2012 that favors larger miners is positive, but rising operational costs and an unresolved commercial dispute with china over the company’s valemaxes, suggests to me that vale’s financial will to invest billions long-term in infrastructure projects in guinea is waning. outside of sharing infrastructure with rio, the most cost-effective way for the company to show its commitment on infrastructure development will be to export their portion of iron ore from simandou through liberia. vale will need to work with bhp billiton (which is eyeing mt. nimba iron ore on the guinea-liberia border) to construct a 15 kilometer spur line to yekepa, liberia, and then rehabilitate the old liberian-american-swedish minerals company, a 275 kilometer railway between yekepa and buchanan. the construction of this line is all contingent on whether the guinean government can  agree with liberia over how much would be lost in taxes and transport fees if a railway runs through liberia. recent negotiations in paris have shown that the guinean government is more open to this idea than previously hinted.

in the event that vale pulls out of simandou—as it has suggested it could possibly do by the end of this year—chinese companies could decide to bid for the vale’s majority stake. china hasn’t been entirely successful in the west african iron ore scramble as evidenced in gabon’s belinga deposit. bsgr was very close to selling vale’s present stake in simandou to chinalco when it was initially on the market, and it is very likely that if vale were to relinquish (or lose) its position, chinalco or another company (such as baosteel or wuhan, already operating in liberia) could easily pick up vale’s pieces. china has already committed to funding four-fifths of guinea’s largest power project (the kaleta dam), in a move that possibly foreshadows a new resource-for-infrastructure deal between guinea and china.

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