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Will Vale Continue to Reduce Its Iron Cash Costs in 2016?

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Highest ever iron ore production

Vale (VALE) has recorded its highest ever iron ore production of 88.2 million tons for 3Q15, primarily due to increased production at its Carajas mine. The Carajas mine’s iron ore production rose to 33.9 million tons in 3Q15, which is 2.3 million tons higher quarter-over-quarter and 1.7 million tons higher year-over-year. The higher production was driven by increased production from the company’s N4WS and the N5S extension mines.

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Higher sales volume and lower costs boost profits

Vale’s iron ore adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) increased to $1.22 billion, which is 2% higher quarter-over-quarter. This is mainly because of higher sales volumes, lower costs, and lower research and development expenses, partially offset by lower realized prices.

Total C1 (cash cost) at the port for iron ore, which includes mine, plant, railroad, and port, was $868 million after royalties. Cash costs are calculated after deducting iron ore freight costs of $736 million, depreciation of $269 million, iron ore acquired from third parties at $40 million, and one-off effects of $109 million from costs of goods sold (or COGS).

The C1 FOB (free on board) was the lowest in the industry at $12.70 per metric ton in 3Q15, which is 20% lower quarter-over-quarter. The lower cost is primarily due to the depreciation of the Brazilian real. Going forward, the further reduction in cash cost will largely depend on the depreciation of Brazilian currency. If Brazilian currency further depreciates, it will have a positive impact on the iron cash cost. BHP Billiton (BHP) and Rio Tinto (RIO), Vale’s peers, reported cash cost of $17.0 per ton and $16.2 per ton, respectively, in 2Q15.

Iron ore market outlook

The iron ore production is expected to increase globally due to the consistent increase in capacity. Vale’s management has indicated that the iron ore demand is expected to pick up from 2016 onwards. The iron ore growth will be driven by the global steel demand. The steel demand may pick up in 2016, primarily led by developed economies.

The iShares MSCI Brazil Capped ETF (EWZ) invests in large-cap and mid-cap companies in Brazil. Vale forms 2.8% of EWZ ETF holdings. CLF forms 3.3% of the SPDR S&P Metals and Mining ETF (XME) holdings.

In the next article, we’ll discuss the factors that negatively impacted Vale’s realized iron ore prices in 3Q15.

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