There is no getting over the downturn in Brazil's mining industry. Rising inflation, falling GDP, a weakening currency, infrastructure challenges, a major resource scandal; you name it, Brazil has experienced it.

Its fortunes are best seen through the lens of national mega-miner miner, Vale, which accounts for around 70% of the total revenues in Brazil's mining sector. In the three months to the end of March Vale recorded a net loss of US$3.1 billion. This was a turnaround from the net profit of $2.5 billion it posted in the same period a year earlier.

The price Vale received for its iron ore fell precipitously over this time – something the government cannot be held culpable for. What the state can be judged on is inflation though. During this period, Vale's interest payments and debt in US dollar terms increased substantially, contributing heavily to the loss.

While the currency depreciation in Brazil has presented opportunities in terms of merger and acquisitions (M&A), it has also dented the balance sheet of its biggest miner who holds instruments in other currencies. Despite this, Vale is still pushing forward with its iron ore development projects and spent $739 million on its 90Mt/y S11D iron ore project in the March quarter.

This example is not wholly representative. Brazil leads the stakes in niobium production and has a huge global influence on the tantalum, bauxite, iron ore and manganese spaces, but much of its copper, nickel and gold resources are still awaiting development.

Unlocking the code

An issue that would go a long way to bringing in investors to these potential developments is some certainty over the mining code.

The government first raised the possibility of revising the current mining code, which in itself is a piece of legislation from 1967 that has been amended as the years have passed, back in 2009.

Then the country was starting to surf on the waves of a commodities boom. Vale, which can be read as Brazilian iron ore producers in this context, was making money hand over fist, supplying China with massive amounts of iron ore and setting the foundations for a number of huge projects, which would satisfy what appeared to be an enormous, unquenchable appetite for the steel raw material.

Four years later a bill of law was tabled. At this point, iron ore prices were still close to their recent highs and the increased tax burdens the new code was asking for were unwanted, but potentially workable.

Unfortunately – some may read fortunately –, as has been seen throughout the Brazilian legislative space in the past few years, the ruling party deliberated over this code amid some resistance from the miners. Then, with an upcoming election in 2014, talk of making the bill law, was put on the back burner.

This continual pondering does nothing for an investment community intending to put money into long-term assets, which have tens of years of life in them.

"Having a bill of law pending for two years creates a scenario that raises legal insecurity, especially for mining projects, which are long term investments," Pedro Garcia, partner at Rio-based law firm Veirano, told Mining Journal. "Investors need security on what the rules are."

These thoughts were echoed by Pieter Van Dijk, head of mining, Brazil, for accounting firm KPMG.

"Failure to approve a new regulatory framework has created a lot of uncertainty in the mining industry and has greatly discouraged investments in prospection and development. It has also had an impact on mergers and acquisitions, because many questions remain unanswered," he told Mining Journal.

There has been lots of recent talk about an updated code being readied though.

Garcia, who is representing the interests of some mining associations in talks over a revised mining code, said a special commission has recently been formed within Brazil's congress to move the new code through the state system.

A meeting of the commission to give the first parliamentary sign off – it would need several approvals at governmental and parliamentary-level before coming into law – was supposed to take place in May, however for some unknown reason this never occurred.

In June, Garcia said the president of the commission had recently been giving guidance that the code would pass the "first gate" of government in two months' time.

If the commission president's word can be taken as red, the law could start moving through congress before getting final sign off.

Even with this guide, it is hard to gauge exactly how much time the full process could take.

"It will depend on the political interest. Given the labour party is in quite bad shape in terms of public confidence and surveys, if they feel the mining code would be a good [political] move, it could move fast, in say six to eight months.

"But, if it is more of a macroeconomic measure that would not affect public confidence in Brazil as much it could be at least 12-18 months," he said.

This is where the recent Petrobras scandal may actually help the mining sector's push for new reforms.

Yes, it will lead to foreign companies carrying out further due diligence on any Brazilian investments they have, or are intending to make – which will increase expenditure and therefore the barriers to entry –, but the seeming failure to effectively regulate the oil & gas sector could mean the government moves to tighten up the whole resource sector, which includes mining.

"If they [the government] feel the mining code could be regarded by the industry and, even internationally, as a good measure that would boost the economy and shift the focus on the country from the scandals being talked of now to an improved mining sector, I think they would do it," Garcia said.

What to expect

When the new mining code does eventually arrive, it could be quite different to the bill bought to parliament back in 2013.

Van Dijk said: "The new mining code was prepared way back in 2011-12 when commodity prices were very different from the prices of today. You had companies, especially Vale, being extremely profitable, and everyone was very optimistic and buoyant.

"That scenario has now changed. I would expect the new reality would be taken into account and the bill may suffer some amendments to better support companies under this scenario."

Back then, junior explorers said the removal of a first come, first serve system for exploration claims would deter smaller companies from exploring in the South American country.

"In the original bill of law there was a concept that any kind of licence would be subject to tenders. There was a unanimous opinion that this would kill exploration," Garcia said.

The government said such a move was tabled to stop miners from sitting on potentially profitable deposits, with those who have the financial means to actually carry out work being given preferential treatment under the new law.

This policy has been omitted from the latest draft, according to Garcia.

"Priority rights are guaranteed, meaning exploration companies have the incentive to actually explore, look around and try to find new deposits safe in the knowledge they will retain the deposit if they find anything," he said.

"The fact the special commission realised that [the auction proposal] was a huge mistake and returned to the first come, first serve routine is good."

An increase in royalties the government originally mooted in 2013 will likely take place to bring the country up to date with neighbours such as Peru and Chile.

Brazil currently has in place rates ranging from 0.2% to 3%, with iron ore royalties coming in at 2%, while many of its regional peers charge 2-5%. An increase to 0.2-4% is supposedly on the cards, however Garcia said this could be governed outside of the mining code.

"This is one of the aspects where the special commission and the government have no consensus. The government wants to have the flexibility of using decrees for the royalty rates, separate from the mining code. The special commission and the industry players want the rates in the mining code," he said.

Despite this debate, government may judge it cannot pitch the increase at the top end of its original plans, as break-even, not profitability, is the new reality in the sector. The new minister of mines and energy, Eduardo Braga, has already made some encouraging noises on this front, according to Garcia.

"[He] has already stated the government will have to take into account the fact that the economic scenario for the mining sector has changed dramatically while considering the issue on the royalty rates," he said.

There are also other changes being lined up in the new code.

"The revised bill of law is bringing some interesting securities in for the financing of exploration and exploitation, which could have a huge impact on not only Brazil's mining sector, but worldwide," a well-informed Garcia said.

This could involve the issue of "certificates" proving ownership and rights on projects, according to Garcia.

It would require a partnership with Brazil's stock exchange, but Garcia said this was a "good starting point" to develop an instrument for explorers looking to obtain the needed finance to develop projects.

The development of a new mining and exploration registry could also be included within the code.

"It is amazing in Brazil we still don't have a proper registry for registering royalties, options and other types of typical mining contracts. With the revised bill of law the registering of these agreements would also be improved," Garcia said.

Improving infrastructure

While the introduction of a new mining code would certainly bring long-term certainty over governance of the sector, the country still has other hurdles to overcome.

"Infrastructure is a huge issue in Brazil," Van Dijk said. "The road and rail network is precarious and massive [financial] outlays are needed. For mining companies, this is a big issue, given that getting their product to ports in Brazil is often a huge challenge.

"Unless you are lucky enough to have a mine supported by half-decent infrastructure, Brazil's poor performance in the area is a major hurdle. For many companies looking to invest in Brazil in the mining sector, the infrastructure question is extremely relevant and can be a deal breaker."

Van Dijk is right. While companies like Anglo American can spend $8.4 billion building a new mine, slurry pipeline and port to transport valuable iron ore, juniors struggling to make ends meet cannot get their hands on such amounts.

Recent announcements on this front show promise. Last month Brazil's president Dilma Rousseff announced $65 billion would be spent on new concessions for infrastructure.

"These are not announcements directly focused on the mining sector, but...the fact there will be investments in new ports and railways... throughout the country will certainly benefit the mining sector, even if it is indirectly," Garcia said.

The government's plans included selling new concessions to the private sector for the construction and operation of nearly 7,000km of roads, as well as four large airports and a number of ports and railways.

It would offer concessions worth about BRL66 billion (US$21 billion) for roads to connect soya bean growers in the interior to ports, BRL86 billion for railways, BRL37 billion for ports and close to BRL9bn for airports, including for the cities of Salvador, Florianópolis, Fortaleza and Porto Alegre.

It is not just logistic bottlenecks which need to be overcome in Brazil.

Like many countries in South America, parts of Brazil are facing severe water shortages, which could severely impact mining operations in those areas in the future.

"It is not so much of an issue now, but maybe going back four or five months when the water shortage problem was more acute, we had a lot of discussions with companies with respect to contingency plans, because if you have to close your office, or only have water in your office a couple of days a week, the impact is going to be huge," Van Dijk said.

At the Minas-Rio iron ore mine in Minas Gerais state, Anglo American had several initiatives in place to cope with any potential water shortages that arose.

"We are putting in a strategy for reclaiming water from the tailings dam in a large amount to reduce the amount of water needed from the river [Pesce]," plant operations manager Nemer Saib said on a site visit at the start of May.

Saib said the company was reacting to issues as they came along, but also had long-term plans drawn up. "We have this water available here, but we need to think sustainably for the long term," he said.

São Paulo state was where most of the recent headlines came from on water shortages with precipitation in 2014 the lowest on record, but Rio de Janeiro state and Minas Gerais have suffered too. In fact, Carpathian Gold recently had to reduce both its mining and processing activities at the RDM mine in Minas Gerais on the back of water shortages in the state.

Also, considering many states in Brazil rely on water sources for power generation – through hydroelectric power plants – it had a knock on effect, with power outages being experienced at the height of last year's droughts in São Paulo.

Local governments have reacted to these problems.

Rationing was put in place, with discounts offered to consumers using less water, in some states to ensure resources were available, while in Minas Gerais, a potential bill has been introduced to get mining companies to recycle up to 50% of the water used.

China importance

Along with recent infrastructure concession announcements, the government highlighted a pact previously agreed with China to build a $40 billion 'bi-oceanic' railway connecting Brazil with the Pacific through Peru. This just happened to pass through some of Brazil's major iron ore hubs. The latter deal is light on detail, but the government has said it hoped work would start on the project in 2018.

China, Brazil and Peru's agreement highlights the growing importance of the Asian nation on this South American country.

The two have signed a handful of agreements in the past 18 months or so, with the latest $50 billion trade and investment deal rubber stamped in May.

... the government highlighted a pact previously agreed with China to build a $40 billion 'bi-oceanic' railway connecting Brazil with the Pacific through Peru

The importance of China to a company like Vale is made obvious on the Brazilian company's website. At the start of July, the last five stories on its press page all featured the signing of contracts with Chinese companies or institutions.

"From the standpoint of the mining industry, China is far and away the most important economy and country to Brazil. If you look at Vale, I think, more than 50% of its iron ore output is sold to China, so it is of huge importance," Van Dijk said.

He said most of the recent deals China had signed with Brazil were around infrastructure and it was hard to deduce their impact on the mining community, but the fact they were still being signed, despite worries over Brazil's GDP growth, inflation and regulation, showed China is very much buying into Brazil's long-term investment story.

The future

In the current iron ore price market mines like S11D (process plant modules being transported to site, below) and Minas-Rio are not likely to keep getting commissioned in Brazil. Even on the smaller scale, Centaurus Metals was not even able to raise A$2.7 million (US$2.1 million) for a 300,000tpy mine.

This does not mean to say the project pipeline is empty.

The reality is smaller, multi-phase projects outside of iron ore requiring modest initial capital outlay will become the trend, much like they have in other major mining hubs.

In the gold sector, Australian-listed Orinoco Gold has managed to successfully follow this blueprint, taking forward the concept for a small narrow vein gold mine, getting it funded and starting construction.

In May, the company secured an $8 million finance package for its 70%-owned Cascavel gold project in Goias state, part of its bigger Faina Goldfields property.

The financing might have surprised some in the sector in the respect Orinoco raised this cash without a compliant resource. It, instead, relied on bonanza gold grade hits, including 15m at 88g/t Au, "excellent geological information" from its exploration decline and the coarse nature of the ore to move forward.

Managing director Mark Papendieck said the variability of the gold grades over the small area meant resource drilling would be very costly, involving very small drill spacing, hence why Orinoco didn't pursue it.

"In fact, we can develop the deposit and commence mining for about the same cost as what would be required to achieve an indicated resource over a small area of the project," he said.

It decided to use the cash from the recent financing to build a 200m x 250m mine at Cascavel and a 14tph gravity process line at its 100%-owned Sertão asset (28km by road from Cascavel), which it hopes will lead to first production by the end of the year.

Costing A$6.6 billion to build, the company viewed Cascavel as the first step in a much bigger gold operation. Being capitalised at A$16 million, it was not trying to walk before it could run though.

"There is no doubt in our minds that Cascavel can continue to grow and fund further exploration throughout the broader Faina project over the coming years; however, for that to happen the company must maintain a disciplined approach to the development and our cash position.

"For these reasons we continue to seek a larger partner to explore for these large systems across our broader tenement package," he said.

There is a similar, yet slightly larger, story going on in Para state with fellow-Australian listed developer Avanco Resources.

Having acquired Carajás' second largest land tenement (second only to Vale), the copper-focused company has successfully drafted a mine plan at its Antas North project and funded the $60 million build.

This financing was backed by the likes of BlackRock, Appian Natural Resources and Greenstone Resources, pedigree institutions on the lookout for high returns.

Avanco plans to produce 11-12,000t/y of copper concentrate and 7,000oz/y of gold from the mine, with first concentrate planned for March. It also hosts a 6 million tonne resource at an impressive 2.45% copper grade.

As Avanco's land holding would indicate, though, the company could be a lot bigger in the future.

This future potential includes the Pedra Branca underground copper project, which the company acquired from Xstrata back in February 2012. It has already shown off high copper and gold grades from several rounds of drilling with an inferred resource of 560,000t of copper, 500,000oz of gold and 1.04 million ounces of silver being defined.

An updated and upgraded resource was likely to come out shorty, according to managing director Tony Polglase. Then, a scoping study could follow in the December quarter, which could consider a number of options to pursue, he said.

"By the end of the year we would then be in a position to tell the shareholders we have settled on one mining plan and we will continue spending money on it. That will then be fully documented in a prefeasibility study by the end of March," he told Mining Journal.

The publication of such a study could bring about "warp speed change" to the company's market valuation, according to Polglase, suggesting Pedra Branca could be close to three times the size of Antas North.

And there was even more potential for the company beyond this, which it could capitalise on with cash flow from Antas North when it comes into production, Polglase said.

"We're sitting in the best copper region of Brazil and there is a chance that with time we will find a very large copper deposit ourselves," he said.

The company has already discovered mineralisation at Nova Esperança, west of Pedra Branca, an extension to the east of Pedra Branca East (extension) and the Sucurui and Sao Jorge prospects.


Considering the valuation of mines and projects in Brazil has fallen in line with the devaluation of the local currency there has been very little M&A in the sector, bar Vale's divestments over the past few years.

Garcia said there were companies potentially eyeing up deals on the back of these falling valuations waiting for the right time to strike.

"In terms of activity, yes, we are seeing lots of interest. I was talking to one of our private equity clients, who was saying 'the assets are so low [in valuation] and, with these exchange rates, I'm feeling pressure from my investors to look at opportunities in Brazil, as they are so cheap. If I don't do anything, afterwards people will ask me how I lost that opportunity.'"

One thing possibly holding this corporate activity back is rising operating costs, as Polglase explained.

"While the exchange rate has moved very much in our favour, the inflation is eroding some of that away and will continue to erode some of that away," he said.

The wages companies are obliged to pay their workers go up in line with government-officiated inflation figures, so operating costs have gone up.

Polglase did not think this would be a huge issue going forward, though.

"I would say in the long term, the currency will keep depreciating neck and neck with inflation. I don't expect there to be too much of a disadvantage with the inflation," he said.

And, in the long term, juniors may also be able to look to some of Brazil's biggest banks for funding.

Despite raising $60 million in equity for Antas North, Avanco previously looked at a combined equity and debt deal, with a Brazilian bank, Banco Votorantim, previously lined up to take on the debt.

Petrobras' downfall affected the company's pursuit of this debt facility, but Polglase said the company would consider looking to Brazil's financial institutions once again for potential funding of the next stage in the company's development, Pedro Branca.

"As you can imagine, oil and gas and mining fall into the same sector within the banking fraternity. For instance, when the credit committee were looking at our proposed debt it was put in the same basket as the Petrobras issue," he said.

This ended up delaying the proposed debt package, which could have led to Avanco missing its construction window before the rainy season kicked in.

"It was unfortunately just bad timing. That being said, we will certainly go back to them if we do something – and we will – on stage two [Pedra Branca]," he said.

With all the damage of a commodities bust and a national oil and gas scandal, in addition to the need for certainty on the mining code, Brazil still looked like a place to do business.

If it's here in the bust, it will certainly have a presence when the inevitable boom comes back.

Previously published in Mining Journal

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