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Boxed In By Bauxite
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Mention Niyamgiri and Vedanta Resources executives lapse into silence. Ever since 2004, when group company Sterlite Industries signed up with the Orissa government to mine the bauxite-rich hills, protests by environmentalists and the tribal inhabitants have kept the $6.5-billion mineral and metals group on tenterhooks. Executives are under instruction not to do anything that can possibly jeopardise the permission it received in April from the Ministry of Environment and Forests to start mining. Vedanta's future hinges so much on these bauxite reserves in southeast Orissa that the group's 55-year-old Executive Chairman Anil Agarwal is impatiently prodding his team to start mining as soon as October. He has waited five years and he is willing to wait no more.
Mining the bauxite — from which aluminium is extracted — at Niyamgiri is central to Agarwal's big bet on that particular metal. And the success of this operation will also have a bearing on how Agarwal steers his London-headquartered empire of aluminium, copper, zinc and iron ore through the blizzard of global recession and "be a top producer in each of our businesses", as per the group vision. Agarwal himself puts it as ambitiously as he is known to be: "We are looking to be among the Top 10 metal producers of the world in the next few years, if not (then) in 10-15 years."
But first he has to contend with the worst global economic crisis in 80 years, which is roiling the metal market. Metal prices have fallen 27-55 per cent in the past year, shaving off realisations in group companies. For fiscal 2009, Vedanta Resources reported a 20 per cent drop in sales to $6.5 billion and a steeper 55 per cent drop in net profit to $900 million (see ‘Slowdown Effect'). Worse, the London Metal Exchange's (LME) daily price bulletins are alerting the chairman to newer realities as aluminium ($1,706/tonne on 22 July) and refined copper ($5,340/tonne on 22 July) hover dangerously near the group's manufacturing costs. Today, it costs Agarwal $1,702 to produce each tonne of aluminium.
Agarwal needs greater economies of scale and plans to increase capacity in all his businesses. But he has placed his biggest bet on aluminium, where capacity in group companies Bharat Aluminium, Vedanta Aluminium and Madras Aluminium is being raised five times from 0.5 million tonne per annum (mtpa) today to 2.5 mtpa by 2011. Agarwal will spend 69 per cent of his $13.5-billion planned capex (capital expenditure) on this expansion after which aluminium will account for 25 per cent of Vedanta's total operating profit, up from 12 per cent today.
It would propel Agarwal from being the world's 14th largest player to the fourth largest (see ‘Aluminium Ambition' on page 31). Besides, copper capacity — at Sterlite Industries, Konkola Copper Mines (Zambia) — is being raised from 0.5 mtpa to 1 mtpa, zinc (Hindustan Zinc) from 0.8 mtpa to 1 mtpa and iron ore (Sesa Goa and Dempo) from 16 mtpa to 25 mtpa.
Betting heavily on aluminium may be a great plan because the metal's versatility, strength, weight, corrosion resistance and 100 per cent recyclability makes it the metal for the next generation. In just 150 years of its existence, aluminium has grown to be the second-most used metal in the world after steel. Empirical evidence suggests aluminium prices have been the most stable of all metals.
However, analysts are questioning Vedanta's timing of going aluminium-heavy at this point, even if it has access to one of the largest bauxite mines in the world. "The inventory level of aluminium at LME is highest ever, raising concerns over future prices of aluminium," says Reena Walia, analyst with Angel Commodities. While global aluminium output has risen 7 per cent each year since 2001, in 2009 — for the first time in 15 years — world production is projected to shrink 5 per cent as demand from China dries up. According to LME figures, global stockpile is at a record high of 4.5 mt. Prices had climbed to a peak of $3,380 per tonne, but fell to a low of $1,279 per tonne before recovering to around $1,700 per tonne currently. Agarwal's average cost of production ($1,702 per tonne) forced the management to shut down marginal production at Malco (December 2008) and part of Balco Plant 1 (March 2009) when the production costs moved beyond selling costs.
When Vedanta's new capacities go on-stream next year, it will run up against 50 aluminium smelter projects coming up across the world with a total capacity of 20 mtpa. Many of these may never come up, but a capacity of 10 per cent of current production (35 mtpa) is well under construction.
Doesn't Vedanta run the risk of excess global capacity or lower prices? Agarwal does not think so. "We believe global consumption of aluminium will not go below 35 mtpa… aluminium prices would remain in the range of $1,500-1,800 a tonne," he says. "We expect to sell 3 mtpa at $1,200-1,300 per tonne." Vedanta's latest annual report quotes Brookhunt, a research and consulting firm for the industry, which predicts that although demand may remain subdued in 2009 and 2010, it is expected to grow 6 per cent in 2011 and 6.5 per cent in 2012. But S&P's credit analyst Anita Yadav disagrees: "Price outlook for base metals remains soft for the next two-three years." Even commodity gurus Jim Rogers and Marc Faber prefer precious metals such as gold, silver and agricultural commodities over base metals. Actually, the genesis of Agarwal's confidence is in his next statement. "(Soon) we'll be producing at $800-900 per tonne."
The answer to whether Vedanta can achieve the cost target of $800-900 per tonne of aluminium production lies in the controversial Niyamgiri hills. Following the 2004 agreement with the Orissa government, bauxite mined on the plateau atop Niyamgiri was to be transported via conveyor belts to the foothill at Lanjigarh, where Sterlite subsidiary Vedanta Aluminium has set up a 1.4-mtpa refinery. So far, bauxite from its mines in Maharashtra/Gujarat costs $276-300 a tonne at Lanjigarh and that from Chhattisgarh and Jharkhand between $216-240 per tonne — due to high transportation costs. In comparison, Niyamgiri bauxite will cost only $54-60 per tonne due to proximity to the refineries. Agarwal plans to extract 96 per cent of its bauxite requirement from Niyamgiri hills for future aluminium production. But Niyamgiri was not to be a cakewalk.
Environmentalists and tribals protested against deforestation of hill slopes, destruction of the bio-diversity-rich local ecosystems and disruption of water sources. Only this April, Vedanta got the approval from the Ministry of Environment and Forests to start mining operations at Niyamgiri after five years of litigation.
But ActionAid UK, an international non-government organisation, is organising meetings of Kondh tribals with churches in London to apprise them of the environmental damage that mining could cause. It is arranging for the tribals to disrupt Vedanta's annual general meeting (AGM) in London on 27 July to protest, just as they did last year. On the same day, in India, a signed petition will be sent to the Prime Minister. "Investors have the power to halt the mine," says Meredith Alexander, head of trade and corporates, ActionAid UK. "If Vedanta won't make the responsible choice to honour the wishes of the Kondh people, then it is up to investors to force Vedanta's hand. The AGM is an opportunity for them to do so," she says. Two years ago, a Norwegian pension fund divested $14 million worth of shares in Vedanta Resources after the Council of Ethics attested the risk of the fund contributing to environmental damage and human rights violations.
"We will block all roads to the mountain," says a Dongaria Kondh tribesman from the Niyamgiri hills. Agarwal explains that Vedanta is doing its best: "Local people (where we operate) should feel Vedanta belongs to them. We are providing livelihood and education, and undertaking various welfare programmes for 2 million underprivileged children." Company officials say they have spent Rs 200 crore on social activities in the past four years and have a bigger budget of Rs 125 crore this fiscal. Clearly, we have neither heard the last of Niyamgiri nor Vedanta's tussle to fulfil its aluminium ambition.
Agarwal's next big bet is on copper where 8 per cent of his capex is being deployed to double capacity from 0.5 mtpa to 1 mtpa. Even though copper accounts for 22 per cent of the firm's profits, it has traditionally been Vedanta's weak link due to lack of integration in operations. Copper flagship Sterlite has remained a custom smelter, sourcing 92 per cent of its raw materials from third parties, while the rest comes from its own mines in Tasmania. This has meant coping with wild price fluctuations in input costs. Also, Sterlite's Tasmania mines are running out of copper ore and have a mining life of just three-four years more. It has mines at Konkola in Zambia, but high transportation costs mean the ore cannot be shipped to India. Therefore, India may continue to remain a smelter operation.
New smelting operations coming up at Nchanga in Zambia, coupled with ore from Konkola, will make Africa the hub of Vedanta's intergrated operations, producing copper at $2,800 per tonne against current LME price of $5,340 a tonne. Zambia will produce 435,000 tonne by 2012, while the Indian and Australian operations together would produce 400,000 tonne by 2010.
Vedanta, however, may see a turn of fortune in copper if it bags the bankrupt US copper firm Asarco, which will help it gain a global footprint in copper and access to the US market. Yet, it may not be able to make up for the depleting mines of Tasmania, as Asarco would remain largely a stand-alone operation.
Zinc makes up for the group where copper falls short. Vedanta-owned Hindustan Zinc is India's largest zinc producer with a market share of 80 per cent. According to Crisil, the company's zinc capacity "ranks among the first quartile of low-cost operations globally". That makes Hindustan Zinc a cash cow for the group; its current costs of $710 per tonne is less than half the market price of $1,626 per tonne. Vedanta has access to highgrade zinc ore from the captive Rampura Agucha mines in Rajasthan that has a mining life of 25 years.
However, this advantage may be shortlived. "Currently, the mines are 170-metre deep and in next three years we are planning to completely switch from open-cast mining to that of underground mining," says Rajendra Dashora, associate general manager and mines head at Hindustan Zinc. This could spike mining costs by $350 per tonne, according to experts. "The quality of the ore body and the stripping ratio (the ratio of volume of scrap to ore body) decides the economic viability of underground operations," says K.U.M. Rao, professor and former head of department, mining engineering at IIT Kharagpur. Even though the capacity expansion from 0.8 mtpa to 1.06 mtpa will bring greater economies of scale, zinc demand, being closely linked to the galvanised steel industry, will swim and sink with the industry.
While aluminium may stun or sting, copper needs fixing and zinc is delivering value beyond imagination, Vedanta's steel ambition continues to remain under wraps. Speculation over Agarwal's imminent entry into steel has been rampant ever since the group snatched iron ore mining firm Sesa Goa from under the nose of ArcelorMittal and Aditya Birla Group. Currently, it is at a disadvantage vis-a-vis global majors — such as Rio Tinto, BHP Billiton and Vale, which account for 70 per cent of the world market — in bargaining with its customers. On its part, Vedanta has disclosed nothing more than its target of producing 10 per cent of global seaborne trade in iron ore (900 mtpa). Vedanta is still 74 mt short of target, though it has strengthened its position with the acquisition of Goa's Dempo this month, which produces 4 mt of ore.
But Agarwal's steel dream is not likely to stop at iron ore. He is believed to be in discussion with "good friend" L.N. Mittal to set up a joint venture with ArcelorMittal in India.
Vedanta's target is to meet 5 per cent of global silver requirement (silver is a byproduct of zinc-lead refining). It also plans to produce 10 per cent of India's power using coal mines in the Northeast region and Orissa. Power and fuel account for 40 per cent of aluminium manufacturing cost. By building own plants Vedanta plans to source power at Rs 1 per unit (against Rs 4 paid to state utilities). The group is planning to produce 6,600 MW of captive power through Sterlite Energy.
The Trump Card
The ace up Agarwal's sleeve is the enormous cash on Vedanta Resources's balance sheet. In the past five years, the group has raised $8 billion from the market, mostly in equity. Of this, $7 billion is still available. "The most positive aspect is the good cash reserve in nearly all companies," says Ashish Kapur, CEO of Invest Shoppe India. "This gives the group strength when major business groups worldwide are facing cash crunch." So Agarwal is fishing for assets. He bought 9.5 per cent stake in Canada's HudBay Minerals in April this year, which produces zinc and copper.
"The credit crisis has strained mid-market companies, many of which have recently completed acquisitions at very high prices and now need to find creative ways to refinance their heavy debt burdens," says Navin Vohra, partner and national leader, metals and mining at Ernst & Young. But at a debt-equity ratio of 0.65, Vedanta's figures are among the lowest in the industry. "Unlike Tata Steel, Hindalco and ArcelorMittal, no major acquisition was done (by Vedanta) at ridiculously high prices," says Kapur. But equity analysts are keenly watching Vedanta's bidding war with Grupo México over Asarco. Grupo Mexico has already revised its bid five times in the past four months and Agarwal was forced to make a counter offer. Vedanta Resources Jersey, a subsidiary, recently raised $1.25 billion in convertible bond issue. "We are concerned that the higher bid by Grupo México could lead to Vedanta overpaying for the Asarco assets," notes Matt Fearnley, a London-based analyst of GMP Securities in a recent report.
Vedanta Resources has to leverage its strengths to emerge a winner in turbulent times
STRENGTH: Access to Niyamgiri hills with high-grade reserves of 70 million tonne could help reduce costs
STRENGTH: Copper firm Asarco, if bought, could provide access to the US market
STRENGTH: Already second-largest producer of zinc-lead in the world — 600,000 tonne
STRENGTH: Mining in Goa and Orissa costs around $25 per tonne for Sesa Goa against market price of $60 per tonne
Agarwal's aggression is already disconcerting those who are uncomfortable with this high-risk-high-return strategy. "Vedanta's sizeable capex programme and appetite for debt-funded acquisitions in a severe industry downturn increases its risk," says S&P's Yadav. "…capital expenditure pipeline remains sizeable at more than $7.6 billion, which will affect its liquidity during the current period of uncertain internal cash flow generation."
Others feel new assets will get tougher to buy. "More sovereign wealth funds (will acquire) far more substantive assets globally," says the latest mining report from Ernst & Young. "This could put pressure on the economic returns for traditional players," it adds. Countries such as Japan, Korea, Russia and China are already out in the market for resource security. About 22 per cent of mergers and acquisitions in 2008 were done by SWFs. Resource-rich countries are also waking up to the threat. Indonesia and Russia have changed mining regulations, forcing foreign players to hand over mining assets to domestic players. Even Vedanta recently faced the scare of a windfall tax on its Zambian operations.
But Agarwal is keeping tabs as he increasingly juggles his time across Far East in the mornings, Europe in the day and now Americas in the evenings. His 60-day-a-year on his Cessna VT jet (clocking 65,000 miles) a year are spent protecting the group's interest as its patriarch. But factors such as the recession and environmentalists are beyond his control. Lord Krishna-devotee Agarwal says he finds solace in Krishna's advice to Arjun in Mahabharat: "Do your best, but don't wish for the fruits of your labour".
muthukumar (dot) kailasam (at) abp (dot) in