Industry Trend Analysis - Dam Breach To Hurt BHP & Vale - DEC 2015

BMI View: Samarco's dam burst in Brazil will not significantly impact the country's iron ore production growth over 2016-2019. However, Vale and BHP Billiton will lose investor confidence due to high clean - up costs, expensive fines and social backlash over the damage.

Brazil's iron ore production growth will not be significantly affected by the dam bursting incident at Samarco Mineracao SA's iron ore mine. Parent firms Vale and BHP Billiton will incur net income losses over the coming quarters due to fines and clean-up costs associated with the dam breaks at joint venture Samarco's iron ore mine in early November 2015. The dam failure released two mine-waste ponds of tailings down the Rio Duce, killing a reported seven people and dislocating over 600 in Brazil's Minas Gerais state. Samarco agreed to pay an initial USD262mn for clean-up efforts, and parent firms Vale and BHP paid USD66mn of fines. Vale estimates production loss at a nearby mine to reduce 2016 output by 19.0 million tonnes (mnt) of iron ore. While the government has outlined thorough plans to investigate the incident and hold owners Vale and BHP Billiton fiscally responsible for any wrongdoing for the dam failure, we do not expect any changes to mining regulation significant enough to deter investment in the sector ( see: 'Legislation Shift Won't Affect Sector's Growth' , September 29).

In light of the incident, we have revised down our iron ore production growth forecast for Brazil from 8.0% to 6.0% in 2016. We expect production will grow from 358.9mnt in 2016 to 435.5mnt by 2019. This still represents strong average annual iron ore production growth of 6.5% during 2016-2019. The country's resilient growth in the iron ore sector will continue to be supported by low-cost producers, namely Vale, ramping up production to increase market share in a weak price environment ( see: 'Iron Ore To Be Sector's Growth Bright Spot' , September 17).

Growth To Remain Strong
Brazil - Iron Ore Mine Production & Growth
f = BMI forecast. Source: BMIl, USGS

Burst Comes At High Cost For Vale & BHP

Vale and BHP will see costs continue to rise, as the Brazilian government may go after the larger firms' assets as collateral. Estimates of the total cost of damage range from several hundred million dollars to Deutsche Bank's USD1.0bn figure. BHP will also revaluate its risk-sharing strategy through a review of two other major joint ventures in Colombia and Peru. The firm will question the sustainability of non-operated joint ventures set up as independent companies, as opposed to one of the experienced, large-scale miners operating the mine. Specifically, BHP will look into the Cerrejon coal mine in Colombia, owned along with Anglo American and Glencore, and the Antamina copper mine in Peru, owned in part with Teck, Mitsubishi and Glencore.

Vale will likely experience higher financial costs and further social backlash than partner BHP, due to the company's greater exposure to damage and implications of involvement in the disaster. For instance, the flood from the burst dam damaged equipment at a nearby Vale mine, prompting the aforementioned production forecast downgrade. Furthermore, whereas BHP is responding proactively to the incident, Vale has remained silent surrounding allegations of dumping waste from an additional mine into the Samarco dam, causing overcapacity. The allegations, stemming from Brazilian prosecutors and local officials, leave Vale as the target of community outrage. For instance, on November 16, 2015, protesters gathered at the firm's Rio de Janeiro offices to blame the firm for the contamination of the Rio Duce.

Disaster To Exacerbate Market Weakness
Vale & BHP Billiton US Equities, Rebased
Note: November 2014 = 100. Source: Bloomberg
Brazil - Major Iron Ore Projects
Company Mine Capex (USDmn) Notes
Source: Company announcements
Anglo American Minas Rio 8,800 Project completed October 2014; full capacity expected by Q216
Vale Carajas Serra Sul S11D 8,039 Production to start in 2016
Vale Carajas Serra Sul 490 Expansion
Vale Itabiritos 5,500 Consists of Vargem Grande, Conceicao I & II, and Caue mines