Greenfields Research

Blog Header Image

The logic of Vale’s Paranapanema takeover

- By: John P Sykes
Posted in: Blog, Commodities, Mining


Vale has announced it will buy Brazilian copper smelter-refiner, Paranapanema, for BRL2.01 billion (US$1.14 billion). Paranapanema is Brazil’s largest copper smelter-refiner, owning the Caraíba Metais facilities, which also manufacture semi-finished copper products such as rod and wire. Paranpanema also owns CibrafErtil, a phosphate fertiliser plant.

With the copper smelting industry facing the double problem of acquiring copper concentrate raw materials and selling one of its main by-products, sulphuric acid, this acquisition by Vale tells us something about the company’s views of the copper and fertiliser markets, and about the company’s growth strategy.

Double difficulties in copper smelting

A raw materials shortage…

Miners traditionally seek to integrate downstream when commodity prices are poor and they are struggling to place their mine production with buyers. With copper concentrate treatment and refining charges at record lows (due to a shortage of copper concentrates and significant smelter overcapacity) Vale does not need to buy downstream facilities to secure buyers for its concentrates.

One would actually expect to see the reverse of this, with copper smelters looking to buy upstream into copper mines and mine projects, such as the recent tie-up between LS Nikko and Sandfire Resources, a South Korean copper smelter and an Australian copper explorer with considerable potential. Indeed, integrated copper miner-smelters (such as Freeport McMoRan, Xstrata and Southern Copper Co.) will be thinking about restricting copper concentrate supply to their own smelters and selling it on the highly profitable spot market. As such, Vale must be confident it can secure enough concentrates to feed the Paranpanema smelters.

…problems selling your by-product

A shortage of raw materials is not the only problem faced when trying to operate a copper smelter in the current business climate – you also need to sell your product. Whilst the copper market seems to have returned to health, so selling copper cathodes, rod or wire shouldn’t be a problem, the same cannot be said for copper smelting’s major by-product – sulphuric acid. The smelting of copper sulphide copper concentrates generates large amounts of sulphur dioxide, a pollutant, which in most countries cannot be released into the atmosphere, and as such it is usually “scrubbed” and converted into sulphuric acid. Approximately three tonnes of sulphuric acid are produced for each tonne of refined copper, with Caraíba generating upto 500,000 tonnes of sulphuric acid a year.

Most people will instinctively think of sulphuric acid as a pollutant or a problem, however, it is actually a vital industrial commodity. Just over half of annual consumption is for converting into phosphoric acid and eventually into phosphate fertilisers. Sulphuric acid is also used in a variety of other industrial processes, as well as in copper mining itself for leaching copper out copper oxide ores, at mines utililising the Solvent Extraction Electrowinning (SXEW) process – currently about 20% of world copper mine production.

In line with most other commodity prices, sulphuric acid prices spiked in 2008, providing a valuable income stream to the copper smelters, who were benefitting little from the high copper prices, as the shortage in the copper concentrates market and subsequent low treatment and refining charges meant they were transferring most of the value of the copper back to the miners. Indeed at this time, on a profit share basis, most copper smelters were actually sulphuric acid manufacturers.

Sulphuric acid is difficult to transport, so there is, however, only a limited global market. The market generally fractures into regional markets, where the balance of supply and demand may not reflect the statistical global average. As such, prices have a tendency to boom and bust harder than the other commodities. So, whilst sulphuric acid prices outstripped other more traditional commodities in 2008, they beat other commodities to the bottom in late 2008-early 2009. Around this time negative spot prices were reported in big sulphuric acid producing regions, such as China. Negative commodity prices mean you pay someone to take a commodity out of your hands – sulphuric acid had returned to its status as a liability that many would assume it was anyway. One analyst in 2009 described sulphuric acid as going from “hero to zero” for copper smelters.

Where will the copper concentrates come from?

Fierce competition likely in maintaining Chilean supply

At present, Caraíba sources most of its concentrates from Chilean mines, so Vale would be hoping that copper concentrate production increases from there. Indeed, Chile seems most likely to bring on a substantial amount of new copper concentrates capacity in the near to medium term, as multi-national miners pour cash into the mining-friendly country, which already has most of the world’s largest and low cost copper concentrates mines. A brownfield expansion is a lower cost and technically simpler endeavour than building an entirely new mine, so represents a lower risk investment on both a technical and political basis. As such, it seems that Chile still retains a competitive advantage in the race to increase copper mine capacity.

However, much of the copper concentrates capacity in Chile is already linked to Japanese buyers. Indeed, negotiations between Chilean mine owners and Japanese smelters, usually set the global benchmark for annual contract TC/RC (Treatment Charge/Refining Charge) terms, that miners pay smelters to smelt and refine their concentrates. Most of the large mines under capacity expansion have Japanese minority owners – for example, Escondida, Collahuasi and Los Pelambres, whilst even Antofagasta’s new concentrates mine, Esperanza, due to start up in 2011, is part funded by Japanese firm Marubeni. Most of the big miners also own copper smelting operations for which the need to provide copper concentrates. Codelco, Xstrata and Anglo American all have copper smelters in Chile, whilst Rio Tinto, BHP Billiton and Freeport McMoRan Copper & Gold all have smelting operations elsewhere in the world.

Homegrown concentrates

Vale has a number of copper mine projects under development in Brazil including the Salobo, Cristalino and Alemao projects, all in the Brazilian Amazon. The mineralogy of these projects means that they could be developed to produce either a low quality concentrate or, using new, higher risk technology (the CESL process), copper cathodes. The Paranapanema purchase may indicate that Vale has opted to go for the more straightforward option and develop concentrates mines then smelt much of the material itself. This will disappoint many of the world’s custom copper smelters, who would have been hoping to get their hands on this material, particularly those in Europe and North America, who would be able to offer the most competitive freight terms. For example, last year, KGHM (a Polish integrated copper miner-smelter) signed a contract with Vale to take half of the concentrates produced at its Salobo copper project, which is the most advanced of Vale’s potential copper concentrates projects.

An unhappy future for Vale Inco 

Vale has also been diversifying out of Brazil, trying to use its iron ore funds from that country to establish itself as a global mining house with assets around the world, across a variety of commodities. This allows it to spread its corporate risk and grow bigger than it could by staying in Brazil alone. As part of this process, Vale acquired Inco, a Canadian nickel-copper miner in 2006 for around US$17 billion, whose main assets are the Voisey’s Bay nickel-copper mine and half of the Sudbury complex of nickel-copper mines, along with nickel-copper smelting facilities. In theory, the nickel operations dovetail nicely with Vale’s modest home grown nickel operations and massive iron ore operations, whilst the copper production begins to provide a little bit of diversification.

For the last year though Vale has been embroiled in a labour dispute with workers at its Canadian operations, and in the long term Vale may be looking at shutting the smelting facilities in Canada and sending the mines’ nickel-copper concentrates down to Brazil. In 2009, Xstrata twice temporarily shut its nearby Kidd Creek copper smelting operations before making the move permanent as it sought to rationalise its smelter capacity. The higher labour costs in Canada combined with older technology smelters can make these assets uncompetitive.

This would continue a trend across the commodities of BRIC nations moving up the supply chain from just mining into smelting, refining and semi-finished metal products, replacing many of the operations in developed nations, who themselves are trying to scramble further up the supply chain to the high value, but super-competitive end-use products, to keep the rising BRIC economies at bay. Indeed, China and India already have substantial custom copper smelting operations, so it seems logical for Brazil to join them.

What about Africa?

As well as the Inco acquisition, Vale has also acquired a late-stage copper project in the Central African Copperbelt, through a joint venture with African Rainbow Minerals, on the Konkola North project in Zambia. This project, which could be onstream around 2011-3, would also produce copper concentrates and could be shipped to Caraíba, near the Brazilian port of Salvador, fairly competitively. This is especially true if infrastructure developments in Namibia, allowing Walvis Bay, on the east coast of Africa, to become a major commodities exporting port are completed to schedule. The majority of copper raw materials currently leave Africa through the Tanzanian port of Dar es Salaam on the west coast of Africa, or the port of Durban in South Africa, and the continent’s south-western tip.

Vale has also invested in early-stage exploration projects in Indonesia, though these are such a long way off from starting up as to be unlikely to figure in any current strategic plans. Indonesian concentrates would have to be smelted in Indonesia from 2014, anyway.

A transatlantic supply chain

Both the concentrates from Vale’s Brazilian projects and its African projects could be of variable quality, and Vale’s Canadian operations produce complex nickel-copper concentrates, so it is likely the generally higher quality Chilean concentrates will still be required to balance the concentrate mix. By combining diminishing supply from Canada, with new supply from Brazil and Africa, Vale could protect itself from competition over supply from Chile, with a transatlantic copper concentrate supply chain, and potentially gives itself quite a lot of room to expand its Brazilian smelting operations. Its location in Brazil puts Vale in a good position for any increase in copper concentrates production out of Chile, or the rest of South America in general. The journey from Antofagasta port, Chile, to Salvador port, Brazil, is about 6,000km shorter than the journey to Japan and 8,000km shorter than the one to China.

Where will the sulphuric acid go?

Disposing of the sulphuric acid is where Paranapanema’s ownership of the CibrafErtil phosphate fertiliser plant comes into play. Undoubtedly, Paranapanema originally bought its stake in CibrafErtil due to the natural integration of these industries, with Caraíba Metais producing sulphuric acid and CibrafErtil combining it with phosphates, to produce phosphoric acid and ultimately phosphate fertilisers. This protected Caraíba Metais from the problem of not been able to sell its sulphuric acid and provided CibrafErtil with a steady supply of one of its raw materials.

If Vale wants to increase the capacity of the Caraíba Metais copper smelting operations though, to take the potential new sources of concentrates discussed above, it will also need to expand CibrafErtil’s operations so they can take more sulphuric acid. To do this though CibrafErtil will need to be able to secure an increased amount of phosphates.

So where will the phosphates come from then?

Vale has not only been buying copper assets recently. In May this year, Vale bought 58.6% of Fosfertil for US$3 billion and the Brazilian phosphate assets of the Bunge Group for US$1.7 billion. They then topped this off with the start-up of a new phosphate rock mine in July, the Bayóvar mine in Peru. Vale is very keen on phosphates and according to their website plans to increase production capacity to 19.2 million tonnes per year by 2017. Expansions of these operations should ensure there are sufficient supplies of phosphates in the future for CibrafErtil to go with its increased supply of sulphuric acid.

Forming a national champion

Mutual assurance

By integrating the copper and phosphate supply chains Vale his given itself the reassurance it needs to expand what its good at as a mining company – mining commodities such as copper and phosphate rock – but knowing it can always find buyers for at least part of this supply, giving it some protection from the vagaries of commodity prices.

Looking long term

Vale will undoubtedly be aware that whilst conditions are tough for smelters and other downstream fabricators at the moment, as new mining capacity comes on stream the balance will change. Indeed, the nature of this supply, where big mines have the best economies of scale means at some point in the future there is likely to be oversupply from the mine side and many miners struggling to find buyers for their raw materials.

Help at home

This purchase will substantially increase the footprint of Vale in Brazil. Vale’s size and cash generation means that it will be able to provide capital for and expand the Caraíba Metais and the CibrafErtil operations in a way these companies would not have been able to do themselves. From the perspective of the Brazilian government and people this secures and possibly creates more of the high value downstream manufacturing jobs that the industrialising economy needs. Vale, as a former state mining company, still has close ties with the Brazilian government and the Brazilian National Development Bank (BNDES), both of which would be happy to see Vale investing some of its profits in the Brazilian economy. Indeed, this goodwill will be useful when trying to borrow the large amounts of money required to increase its global footprint.