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Why Vale’s Iron Ore Price Realization Is Expected to Improve

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Iron ore price realization

Vale S.A.’s (VALE) average realized price for iron ore fines decreased by $6.40 per ton from $68 per metric ton in 3Q14 to $61.60 in 4Q14. This $6.40 per ton decrease was lower than the $15.90 per ton decrease in the average Platts Iron Ore Index 62%, which came down from $90.20 per ton (cost and freight China) in 3Q14 to $74.3 per ton in 4Q14.

There are several reasons for this relatively better performance. One is the lower impact of the provisional pricing system in 4Q14 compared to 3Q14. Also, the company is increasing CFR (cost and freight) sales, which usually has a positive impact on realizations.

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Going forward, the premium on iron ore price realization will increase from higher iron ore content and lower humidity. The company plans to accomplish this as better quality begins coming out of the projects, such as higher contribution from the Carajás mine. In two years, with large quantities of the Southern range and S11D coming, the quality premium should go up.

Demand for pellets still high

Vale’s management has commented on how the pellets demand is higher in an overall depressed market. It stated that demand is not only increasing in the direct reduced (or DR) iron ore market but also in the blast furnace market.

Premiums are holding surprisingly high, although there was a small decrease last month. The main reason is that more pellets are going to China. The Chinese government is cracking down on polluting units. Pellets lead to less pollution compared to fines since they charge the material in a way that increases energy efficiency and reduces pollution.

This trend is positive for pellets and overall price realizations. This is why Vale, which produced ~43 million tons of pellets in 2014, is going to increase this figure by 10% to 15% in 2015.

Cliffs Natural Resources (CLF) is also a major North American pellet producer. Rio Tinto (RIO) and BHP Billiton (BHP) also have some pellet operations in North America and Brazil, respectively, through joint ventures and subsidiaries.

BHP Billiton, Rio, and Vale form 31.6% of the iShares MSCI Global Metals & Mining Producers ETF (PICK). The SPDR S&P Metals and Mining ETF (XME) also provides exposure to this space.

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