Another Rumble in the Nickel Jungle? -Stan Sudol

Stan Sudol - Executive Speech Writer and Mining ColumnistWith such turmoil on global stock exchanges, one might wonder if Xstrata CEO Mick Davis and Vale CEO Roger Agnelli are trying to perform their proposed merger/takeover – difficult enough at the best of times – on the deck of a financial Titanic.

On Monday, many stock exchanges around the world witnessed the worst single day decline since the terrorist attacks of September 11, 2001. The TSX saw $90 billion evaporate while European exchanges wiped out $300 billion. In total, trillions of dollars in investment value were lost. The U.S. exchanges were closed for a holiday.

The “American contagion” as many are calling this stock market slaughter – due to the U.S. subprime mortgage fiasco and collapsing property values – continued Tuesday morning around the world including American exchanges. However, the U.S. Federal Reserve Board’s significant three-quarters of a percentage point reduction to interest rates helped turn around many of the markets by the end of the day including the Toronto exchange.

So much for the theory that China and other Asian countries have decoupled from the United States economy and would not be affected by an American recession!

Also on Monday, Vale was forced to respond to speculation in two leading Brazilian newspapers that the company was going to bid US$90 billion for Xstrata.

In a press release, the company stated, “In an environment of a global consolidation of the mining industry, VALE has been maintaining a dialogue with Xstrata Plc management. At the moment, these discussions had not produced any material result yet.”

Brazilian Vale is the second largest mining company in the world, the biggest producer of iron ore – the key ingredient for steel – and the number two supplier of nickel as well as producing significant quantities of manganese, aluminum and potash. Swiss-based Xstrata Plc is the fifth biggest miner with major holdings in copper, nickel, coal and zinc.

It was no secret that Davis was putting Xstrata into play and there are not many companies with deep enough pockets to come to the negotiating table. Agnelli has publicly stated many times that he is committed to making Vale into the world’s largest miner. Iron ore prices were supposed to rise about 50 per cent or more this year but current economic upheavals may impact those optimistic projections.

If the hedge fund boys are salivating over another potential bidding war, they may be sadly disappointed. In addition, two of the key potential bidders are occupied. BHP Billiton, the biggest mining company in the world is currently attempting a hostile takeover of Rio Tinto, the third largest miner.

The only other likely candidate is British-based Anglo-American Plc – number four in size –which is in the process of spending $16 billion through to 2017 to expand iron ore production at its Brazilian mines and is also in talks with MMX Mineracao to purchase its Amapa and Minas-Rio iron ore mines, also located in Brazil, for $5.5 billion.

The Vale press release also stated, “VALE considers that the current conditions prevailing in the global financial markets may constrain the realization of a major strategic move.”

Perhaps the Vale-Xstrata talks may just be focused on specific properties or metal groups where significant synergies can be attained. Those synergies are most clearly evident in the Sudbury Basin where Vale Inco and Xstrata Nickel have been operating on adjacent mining properties for decades.

Ontario mining rules dictate that there must be a minimum of 200 feet between adjacent underground operations. This eliminates millions of tonnes of profitable ore Vale Inco has discovered near Xstrata Nickel’s Lindsley Mine site.

Negotiations over major cost savings between the two separate companies that range up to $350 million have been slow and inconclusive. Those synergies are estimated to be about $550 million under one company. Without a doubt, dividing up and putting a value on portions of adjacent ore bodies or allocating cost savings from optimizing feed flows to the two mills located at opposite ends of the basin are bound to be complex.

The ore found in the platinum-rich mines on the northern rim of the Sudbury Basin require slightly different alterations in the milling process than ore found in some of the other mines. To maximize metal extraction one mill should be dedicated to the platinum-rich mines while the other should be focused on the other mines. Enormous savings in transportation costs would also result.

However, local rumours say that Xstrata Nickel has been putting too high a value on their surface operations and that Vale Inco, due to the enormous size of its reserves and clout, can afford to wait them out.

It is well known that Xstrata Nickel is running out of ore in the Sudbury Basin and its local smelter is not operating anywhere near full capacity. This will continue even when their new Nickel Rim mine starts production next year.
In the Sudbury Basin, CVRD Inco has 175 million tons of proven and probable reserves as of 2006. The 2005 figures for measured and indicated resources were about 47 million tons and approximately 48 million tons of inferred resources.
By comparison Xstrata Nickel has seven million tonnes of proven and probable reserves in 2006. Their measured and indicated resources are about 26 million tonnes and 29 tonnes of inferred resources.
Who would want to get into a bidding war to acquire Xstrata Nickel’s problems?

There could also be synergies found in the processing of ore from Xstrata Nickel’s Raglan deposits in northern Quebec and the proposed smelter/refinery that must be built somewhere in Newfoundland in conjunction with Vale Inco’s Voisey’s Bay operations. Why ship ore from northern Quebec to Sudbury when Newfoundland is so much closer? Increasing nickel production in the Sudbury Basin could replace the feed from Raglan.

In addition, there could be some cost savings in New Caledonia as Vale Inco is constructing the Goro nickel laterite project in the south of the south-Pacific island and Xstrata Nickel is working in the northern part on Koniambo. However, these projects have different laterite ore deposits that need unrelated refining techniques.

We are obviously heading into a recession and Davis seems to be more interested in immediate returns than long-term growth. Maybe, if the current economic climate does not allow Vale to affordably take over all of Xstrata, there may be a side agreement in the works with Anglo-American or another company to quickly buy some of the other assets.

Bidding wars occur in rapidly expanding markets. With the tightening of global credit markets, downward turmoil in stock markets and metal prices and a Chinese economy that will be impacted much more severely by an American recession than previously thought, another rumble in the nickel jungle may not happen at all.