As speculated, Vale ( VALE ) has decided to shelve its $5.9 billion Rio Colorado potash project in Argentina after negotiations with the government over tax breaks failed. The company issued a statement saying that the economics of the project are not in line with its current commitment to discipline in capital allocation and value creation. Without tax breaks, the project's costs could soar by 86% to $11 billion. The company sought to keep its options open by further stating that it will continue honoring the commitments related to concessions and look for alternatives that enhance the project economics. The possibility of resumption could be evaluated at a later stage.
Vale had announced an indefinite suspension of the project in January. Operations were halted in December during the holiday break given to workers and did not resume thereafter.
The company had been seeking tax breaks for the project to help compensate for soaring costs related to inflation and exchange rates. Unofficial estimates measured inflation in Argentina at about 25% a year, well above the official rate of 10.8% in 2012. This might well be true since private economists have long discredited the quality of official Argentine data and even the International Monetary Fund ( IMF ) has censured the country for the same.
Mothballing will not have a significant impact on Vale's financials. The company's revenues from the potash business are a relatively minor percentage of its overall revenues. Even with the Rio Colorado project, potash revenues would not be a significant valuation driver for Vale.
The Rio Colorado Project
The Rio Colorado project includes the developing of a potash mine in Mendoza, the renovation of 440 kilometers of railroad tracks and the construction of a 350 kilometer-long railroad line to transport the potash to a terminal in the port of Bahia Blanca for export. The annual production capacity was targeted at 2.4 million tons initially and to go up to 4.3 million tons eventually. Vale stated on February 27 that it had already spent $2.23 billion on the project and completed 45% of the work. The budget for the project was slashed from $1.08 billion to $611 million for 2013.
Why Was The Project Suspended In The First Place?
Vale is heavily dependent on iron ore and prices for the same were very low on average in 2012 due to weak economic conditions in the Eurozone and a slowdown in demand from China. The average realized price in 2012 at $97 per ton was much lower than the price of $136 per ton the previous year. Furthermore, it booked non-cash non-recurring charges of $5.7 billion for 2012. These include a $5.2 billion write-down of nickel, coal and aluminum assets, a $232 million charge to settle a tax dispute with Switzerland and a $254 million charge for back tax payments to Brazil's Minas Gerais state. (( Vale Q4 2012 Results , Vale Press Release))
The suspension of Rio Colorado was a casualty of Vale's slashed investment spending target for 2013 to $16.3 billion, which is at the lowest level in three years. The company aims to slash investments by $1.2 billion this year as it struggles with a slowdown in demand for iron ore. Given the limited capital at the company's disposal for investment, it would be understandably reluctant to absorb a cost increase of 86% on a project which may not give returns till 2015. (( Vale Capex 2013 , Vale Press Release))
Implications Of Mothballing
We think that mothballing of the potash project will not impact Vale's financials much. Revenues from the potash business are a very small portion of the company's business. In 2012, revenues from potash stood at $308 million compared to revenues of $33.2 billion from iron ore and overall revenues of $46.5 billion. The volume of potash sold in 2012 was 581,000 metric tons and the average realized price was approximately $530 per ton. Allowing for modest inflation and taking a price figure of $550 per ton three years later when peak production capacity of 4.3 million tons might be reached, we obtain a revenue figure of $2.4 billion. Compared to overall revenue of $46.5 billion today (which is only expected to rise in the next three years), this figure looks quite modest.
Argentina is already claiming that there are two investors ready to enter the project even if Vale pulls out. We will keep an eye on further developments to see whether this claim is genuine.
We have a Trefis price estimate for Vale of $20.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.