Jun 13, 2012

Infrastructure, permitting issues hinder Brazilian iron ore expansions -S&P

As Brazil rushes to meet global iron ore demand, domestic iron ore companies find their production projects facing delays, particularly in project permitting, S&P observed in a recent report. 

A surge in global iron ore demand has spurred a major expansion in Brazil's mining industry as the country's iron ore exports now account for about 33% of the global seaborne iron ore market, says Standard & Poor's.

However, difficulties in obtaining environmental permits, labor constraints and delays in financing new iron ore projects and expansions will keep a number of these projects from launching on time.

In a June 11 report, Primary Credit Analyst, Rafaela Vitoria, said Brazil's iron ore production is expected to grow beyond the world's largest iron ore mining company, Vale's current and planned capacity. Several other producers are also expanding iron ore mining operations and will boost Brazil's iron ore exports in the next few years.

Anglo American and MMX Mineração e Metalicos have sizable projects under development. Steelmakers such as Usinas Siderurgicas de Minas Gerais, Gerdau, and Companhia Siderurgica Nacional (CSN) are also venturing into iron ore exports.

"We estimate that these expansion projects together will add about 300 million tons per year (tpy) of incremental iron ore exports from Brazil," said Vitoria, "which at current prices would produce some $39 billion in annual revenues for companies operating in this sector."

"Investments to start production in this capital-intensive industry are sizable, particularly for the infrastructure to transport the mined ore to port terminals on the coast," said S&P. "As in other mining sectors, building a cost-competitive infrastructure and obtaining regulatory approvals, including environmental licenses, can be huge obstacles for companies to overcome."

"In Brazil, these challenges have somewhat hampered the iron ore mining sector's ability to expand to meet the surging market demand, especially from Chinese steelmakers."

"We believe market fundamentals remain good for Brazil's iron ore mining sector, but we also recognize that, from a credit standpoint, delaying investments due to these challenges may have the unexpected benefit of reducing exposure to a global economic slump and, possibly, slower growth (and thus less demand from China)," Vitoria advised.

"In addition, amid currently high iron ore prices and the resulting cash flow generation from existing operations, delaying expenditures on these massive projects can also prevent the pressure of higher debt on these companies' credits," Vitoria noted.

China now receives about 60% of traded global iron ore deposit shipments as Chinese crude steel production reaches about 700 million tpy in 2012, "which makes the country the largest steel producer in the world, with a share of 45%," said S&P.

Although an abrupt slowdown in China's economic growth could impact iron ore markets, eventually lowering growth rates of the Chinese steel industry, S&P does not expect prices to weaken significantly in the next few years.

"Given current supply level, Chinese iron ore prices, which market estimates place at around $120/ton, may well be setting the price floor for the commodity in the near time," S&P forecast. "As a result we expect supply demand balance to remain tight over the next several years.'

Vale leads the list of major iron ore projects with its construction of the Serra Sul mine, which is expected to yield 90 million tpy, and its expansion of the Cajaras mine to produce another 40 million tpy. "These two projects alone could drive up the country's exports by 40% compared with the 2011 level," S&P noted.

Nonetheless, S&P advised that no major iron ore projects will come online this year and next, "and we are not optimistic that the projects with plans to start operations in 2014 and 2015 will launch on time." Even expansion projects are experiencing delays.

"The environmental licensing process has been one of the major constraints to iron ore mining projects in Brazil. Companies which estimated it would take six months to one year to obtain the licenses now find it is taking one to two years, "given the government agencies' constraints in processing the licensing," S&P observed.

"Furthermore, most iron ore projects in Brazil involve not only the actual mine sites, which are in the middle of the country, but often the infrastructure to transport the ore to the ports on the countries coast," the credit agency said. "These railroad or pipeline transport systems average 400-500 kilometers in length and typically pass through different states and jurisdictions, thereby increasing the complexity of state approvals."

Nevertheless, S&P believes as long as natural resources are available and iron ore prices remain favorable, companies in the Brazilian iron ore mining sector will continue to plan expansions and new capital expenditures. "However, after construction begins, the impact of budget increases on cash flow and the potential for higher-than-expected debt burdens can become a credit concern for these companies," Vitoria cautioned.