Vale SA's Latest Move Won't Help Coal Producers

Vale closes its cost-inefficient coal operations, but this decision will not help coal prices.

May 30, 2014 at 10:18AM

Coal prices remain under significant pressure, and producers have finally started to cut production. Vale (NYSE:VALE) is the latest player to join the recently formed trend. The company announced it was closing its Integra Mine Complex in Australia due to economic problems. Vale follows the example of other miners like Walter Energy (NASDAQOTH:WLTGQ), which decided to close its Canadian operations back in April. Even BHP Billiton (NYSE:BHP), which was steadily growing its coal production, has been selective this year and closed its higher-cost Saraji mine in Australia.

Vale's decision might not impact the market
Vale's situation is much different from Walter Energy's, for which the closure of poor performing operations is a question of survival. Vale got just 1.4% of its total revenue from its coal operations in the first quarter, with most of this revenue coming from met coal operations.

While the sole fact of another production cut is positive for the market, one should not expect any significant impact on pricing. Vale is not a major player on the met coal front. The company's first-quarter met coal sales were down 40% from the first quarter of 2013 and totaled 0.88 million tons. In comparison, Walter Energy sold 2.6 million tons of met coal in the first quarter, while BHP Billiton shipped 11.5 million tons.

To produce any effect on the market, Vale should decide to get rid of all its coal operations. There could be rationale behind such a decision, as coal was the sole segment that scored negative adjusted EBITDA for Vale in the first quarter. However, this is a very unlikely scenario, as Vale has continued to invest in its coal operations. In fact, Vale dedicated 24.6% of its investment spending to its coal operations in the first quarter. This number is disproportionately bigger than the share of coal in Vale's revenue mix and indicates that while Vale is ready to slash cost-inefficient operations, it will continue its presence in coal.

Met coal pricing continues to pressure Vale's shares
Meanwhile, iron ore pricing, which is much more important for Vale, remains tough. Iron ore prices have recently reached 20-month lows on continued concerns over slowdown in China. Vale is primarily an iron ore producer, which got 71.7% of its first-quarter revenue from its ferrous minerals segment. The drop in iron ore prices will continue to pressure Vale's bottom line and its shares.

While Vale's costs are low enough to continue operating profitably in current conditions, the drop in prices hurts the company's earnings. Vale's first-quarter earnings were 19% lower than in the first quarter of 2013. Going forward, nickel, which had a boost in price in the second quarter because of tensions over Ukraine, could help Vale's earnings. The company got 9.6% of its total revenue from nickel in the first quarter, and this number will likely increase. However, if pressure on iron ore prices persists, it could offset increased revenue from nickel operations because of the much bigger share of the ferrous minerals segment in Vale's revenue mix.

Bottom line
While Vale took a step to curb its higher-cost coal production, the company continues with investments in this segment. Given the size of the curtailed operations, Vale's move is unlikely to impact the market. However, this move highlights the growing trend of production cuts. Hopefully for anyone in the met coal field, this trend will grow and support pricing in the future.

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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