You can start now, Daniel. Thank you.
Great. Good afternoon and good morning, everybody. This is Daniel Fairclough from the ArcelorMittal Investor Relations team. Thank you very much for joining us today on our conference call to discuss the third quarter 2016 results. In an effort to reduce the length of our call, we have this morning published our results presentation with full speaker notes. After a brief introduction from Mr. Mittal, we will move straight to the Q&A this quarter. The intention is that the whole call should therefore last about 45 minutes. If you do want to register a question, please do press star one on your keypad, and we will take the questions in the order that they are received. With that, I will hand over the call to Mr. Mittal.
Thank you, Daniel. Good day to everyone, and welcome to ArcelorMittal's third quarter 2016 results call. I am joined on this call today by Aditya Mittal, Group CFO and CEO of Europe, as well as Simon Wandke, EVP Mining, Genuino Christino, who is our Head of Finance, and Daniel. Before we move to Q&A, I would like to make some brief introductory remarks. As usual, I will start by commenting on our health and safety performance. Our lost time injury frequency rate for the first nine months of the year was 0.8 times. Safety remains our number one priority, and it was pleasing to be recognized last month by World Steel for our commitment and innovation in pursuit of any injury-free, illness-free, and healthy workplace. Turning to results, this was a solid quarter for ArcelorMittal.
EBITDA was $1.9 billion, a 7% improvement over the second quarter and more than 40% improvement compared with the third quarter of 2015. It is worth noting this is our highest level of quarterly EBITDA since the third quarter of 2014. Encouragingly, we also reported a second consecutive net income of $700 million. Overall, our steel-only EBITDA improved by 5.3% to $1.7 billion in the third quarter, primarily driven by a 7.4% improvement in average steel selling prices, offset by an 8.1% decline in shipment. Performance also improved in our mining business, with EBITDA 25% higher at $204 million, driven by higher seaborne iron ore prices offset in part by lower iron ore marketable shipment volumes. Despite a $600 million investment in operating working capital during the quarter, we had a positive free cash flow of $300 million, contributing to a further net debt reduction to $12.2 billion.
Net debt is now $4.6 billion lower than one year ago, and the lowest level since the ArcelorMittal merger. Looking ahead to the fourth quarter, we expect EBITDA to be lower compared to the third quarter due to lower steel prices in the U.S. and the impact of rapidly rising coking coal prices on steel spreads. Coal prices have spiked unexpectedly in the third quarter due to supply issues, including China's decision to limit coal mining to 276 days per year. Near term, there will be a negative impact on global steel spreads. I'm confident that the steel prices will adjust to these higher raw material costs. We have seen it before. It is just a question of time. I note that over the past month or so, there has been a sharp increase in steel prices globally.
Globally speaking, overcapacity also remains a challenge. A comprehensive trade response across all product categories remains important in order to support fair trade. I am therefore pleased to see the decision by the U.S. Department of Commerce to initiate anti-circumvention investigation on cold rolling products and CORE exports from China through Vietnam. Lastly, the implementation of our Action 2020 plan to improve underlying performance is on track. We remain confident about the potential of this plan to significantly increase EBITDA and free cash flow. Thank you very much. We are happy to take your questions.
Thank you, Mr. Mittal. If I can remind everybody, if you would like to ask a question, do press star one. We have the queue all ready. We will take the first question, please, from Michael Shillaker at Credit Suisse.
Hi. Thanks a lot. I've got three questions, if I may. The first question, just a clarification on the guidance, because I've had a lot of questions on this this morning and some confusion. If I look at your implied guidance, it's the $4.5 billion of cash neutral as per Q1, adding the $1 billion of net working capital build. Then adding around $400 million. That's the $390 of bond redemption payments, which did go into operating free cash. Am I right? Is the math right there, thinking that your implicit guidance is better than $5.9 billion for the year is question number 1. Question number 2, if I may, just on volumes. I think the volumes looked a little bit weak, probably weaker than expected in Q3. There doesn't seem to be any seasonal rebound going on in Q4 either.
Could you talk a little bit about volumes, A, around the regions, because I think Europe was clearly a little bit weaker than seasonality-wise in Q3. What is weak in Q4 that's not giving you a seasonal rebound? Is it a buyer strike? Are you suffering from, or are you seeing any form of real demand problem? Or is there any risk that you're just simply losing market share is question number 2. Question number 3, Mr. Mittal, you talked about steel prices rising to compensate for raw materials. Absolutely, we have seen this before. Can you just talk a little bit more about your vision of the timing of this, and would you expect Q4 as a consequence, given you're seeing steel prices rising to be the trough quarter in the current EBITDA cycle? Thanks a lot.
I think Aditya is going to answer on your guidance and volume. Since the steel prices is in everybody's mind, I will take up this question. Thank you, Michael, first of all. Always there has been a lag in steel price rise versus the cost rise. This I have seen in many cycles before, and that's why I said that I'm confident that the steel prices will rise to pass it on to the customers in view of the cost increase. First of all, this coal price rise has been unexpected, very surprising. We did not expect this to move so fast. Clearly, China undertook this volume or capacity cut. There have been two issues. One is there was a flood issue, then we see that they announced this capacity cut.
Very quickly they moved. They reduced the operating days of the coal mines, and they have shut down some of the coal mines. Clearly, they want to reduce the stress on the financial system because these mines have not been making money, and this would help to reduce the financial stress as well as they want to create a better environment for the coal mines. We see that there is a lag here. We will see the prices moving forward, next quarters and next months and next weeks, as we have seen it before. Aditya.
Okay, great. Michael, in terms of your question, our guidance is the cash flow from operating activities will exceed CapEx. Cash flow from operating activities, as you rightly point out, includes our working capital investment, which is $1 billion, and includes the prepayment cost of retiring debt, which is approximately $400 million. In terms of volumes, let's talk about Q2 to Q3 and then a bit about Q4. In terms of Q2 to Q3, I think the biggest drop in volumes is in Europe, where we've had approximately a 13% decline Q3 to Q2. If you look in the past, roughly, when we have had a proper seasonal impact, that's about 11%. The drop is to about 2% greater. I attribute this to the forced outages that we have had.
Again, that's a short-term issue. Production is being restored, and things should look better. In terms of Q4, as a result, European volumes will be better. I expect there to be a small pickup in volumes in Brazil, in the CIS. The only reason why we're suggesting that overall volumes are flat Q4 to Q3 is because of a buyer strike in the U.S. As you know, when prices fall in the U.S., people get hesitant to buy. If you look at the underlying characteristics of the U.S. marketplace, real demand is good. Appearance steel demand is still good, and we're forecasting positive numbers into 2017. As a result, that's temporary in nature, and I don't expect that to continue. It's not a signal or a sign of anything more significant than that.
In terms of market share, look, market share is good. We're not losing market share. If you were to look at the European numbers, you may wrongly conclude that. You have to recognize that in Europe, we have reduced the level of exports, so our market share in the domestic markets remain the same and domestic shipments are increasing. Also, in Europe, we have changed the operating plan. If you were to compare our European shipments, excluding the changes to the operating dynamic, shipments are actually up year-on-year, even on a nine-month basis. What are the operating changes? As you know, Sestao, which was producing 700,000 to 800,000 tons, is at a level of production which is much lower, approximately 150,000 to 200,000 tons. In the long business, we have idled our wire rod plant, which was a commodity-based facility called Zumárraga.
That change in operating footprint is worth about 600,000 to 700,000 tons on a nine-month basis. Just to conclude, our market share remains healthy. Q4 is just a buyer strike in the U.S., and overall, we are seeing good demand patterns on a global basis.
That's great. Just a quick come back on the met coal situation. What do you think the met coal shortage at the moment is doing for China? It obviously looks like the Chinese are starting to export steel. Do you think there's some degree of constraint going on in the Chinese market at the moment in terms of ability to produce profitably to export? I think just as a follow-up again to the lag, is it fair to say that given raw materials are now on relatively short-term contracts, that the lag will be a lot less than, for example, in 2005 when steel industry went into destocking, but the iron ore price went up on a trailing 12-month contract, which clearly gave a pretty material squeeze for a significant amount of time.
Obviously, the pricing of raw materials now has changed, and therefore, it allows the steel industry to recoup those cost rises a lot quicker. Thanks.
Okay. In terms of China, what we have seen just in the last month, perhaps because of how much coking coal prices have risen, exports have reduced. Clearly, that dynamic is unfolding, and it'll be interesting to watch. We've not seen exports in the last nine months change in spite of the various trade measures that have been put in place in Europe and the U.S. and in other countries. What we're seeing is those trade flows moving towards Southeast Asia. Suddenly in October, we saw exports in China decline. In terms of the lag effect, I don't want to draw too many parallels to 2005. Today, when we look at our business, roughly half of our business is in Europe and in North America is contract-based, and the rest is spot-based. That's how it works in terms of the revenue side.
Did you have any other questions on the lag effect or?
No, I think it's all pretty clear. That's great. Thank you.
Thanks, Mike. We'll move on to the next question, please, from Alain at Morgan Stanley.
Yes, good afternoon, everyone. Just a quick question on the cash needs of the business beyond 2016. Are you able to just qualitatively give us some color on what will be the cash needs next year in terms of CapEx, interest payments, and so on, working capital? Thank you.
Okay, great. The headline is we are expecting marginal changes to the cash requirements of the business. Cash requirements for this year, which were announced in February, is $4.5 billion. That's what we expect for the full year. There'd be a marginal change into next year. We'd give you a specific target in February once we have completed our internal budgeting and strategic work. In terms of what could change, I expect interest expense to be down, simultaneously, we would be investing a bit more in terms of growth opportunities. CapEx would be slightly higher.
Thank you.
Thanks, Alain. We'll move to the next question, please, from Seth at Jefferies.
Good afternoon. Thanks for taking the question. A couple of different questions. First on coking coal, separate on the NAFTA business. On the coking coal front, can you just quickly confirm what your contract structure is by region in terms of annual contracts or quarterly or spot sales? What the scale of inventory backlog is for coking coal and inventory by region. Separately, in your NAFTA business, I know that you recently announced plans to restart Indiana Harbor. Can you give us a bit more color on the logic behind this restart, given the recent weakness in domestic steel prices and a sense of the timeline to hit full capacity, exactly what incremental volumes you'd expect that to bring on over that timeframe? Thank you.
Sure. I will give some color on the regions, but let me begin with the global picture on coking coal. We need about 35 million tons of coking coal a year, out of which we produce about 6-7 million tons. We do about 4.5-5 in Kazakhstan, and the rest in the U.S. That gives you a flavor of where that production is based. When you take the number of about 20 million tons-29 million tons, there's about 5 million tons, which is covered in the annual U.S. benchmark system. That leaves you with about 24 million tons of coking coal. Approximately half of that is on spot or monthly spot, or a bit more than just half, and the rest is on quarterly basis. In addition, we buy about 9 million tons of PCI.
That gives you the complete picture of our coking coal plus PCI requirements. In terms of inventory, on average, we have about two and a half months of inventory on a combined basis. Clearly more inventory in the European environment, less in the CIS regions. That's how it plays out.
Indiana Harbor.
In terms of your restart of Indiana Harbor, I think the idea to restart was to produce slabs for Calvert. It was not to increase the amount of steel that we put into the marketplace. Just starting a furnace doesn't necessarily mean that all of that production comes onto that market because we can also reduce some of the levels of production at some of the other furnaces.
Thank you. Just to follow up on the Indiana Harbor ramp-up, could you give us a sense of when you would expect that plant to hit full capacity? I understand that you just alluded to the fact that other plants could be pulled down slightly. Separately, just to go back to one of the earlier questions on Q4 potentially being a bit of a trough in the cycle. Given your comments on coal inventories, would it be fair to think that Q1 actually would see significantly higher impact of the coal price increase relative to Q4? Thank you.
Yeah. We're not providing specific guidance on when Indiana Harbor will hit full capacity. It's safe to say when the market is pulling more volumes, I think all the furnaces in our facilities would be running a bit harder. In terms of your coking coal question, you're right. Q1, we're going to see more of an impact than in Q4. You have to recognize that the price rise movement is just starting. On a global basis, we have seen significant price rises in the last 30 days. In Europe, we have signaled and announced a price increase four or five weeks ago, which predominantly covers the Q1 contracting environment.
Great. Thank you very much.
Thanks, Seth. We'll move to the next question, please, from Yannis at RBC.
Thank you very much. Just a couple of questions on my side. First, on NAFTA, you suggested that there is some uncertainty around volumes in Q4. We've seen recent price hikes from you and some of your peers, and also inventories are relatively lean. In that environment, I would have expected some modest restocking over the short term. Could you perhaps elaborate on that? The second question, on working capital investment, the additional $500 million you suggested today, could you give a rough split between that of how much comes from higher steel prices and how much from higher raw material prices? When you think about raw material prices, should we really look at the spot prices or, let's say, pricing at the beginning of the quarter as an indication? Thank you.
Okay, great. Thank you. In terms of NAFTA, you're right, things are improving in the U.S. marketplace. We have announced price increases. We see that the inventory levels are low, and this points to a return to more normal level of demand and consumption, which should support shipments. What we're saying is we don't see that necessarily in Q4. In Q4, we're forecasting at this point in time, shipments to be lower than Q3. Clearly, if the market rebounds strongly in the next few weeks, that may change. At this point in time, we're expecting Q4 shipments in NAFTA to be lower than Q3. In terms of inventory, I would say about two-thirds to three-fourths of it is coking coal. That is sitting in inventory, and the remaining is in receivables, and that's your steel prices impact of the $500 million.
In terms of what price levels to think about, I think you are more or less on the right page because our inventory cycle is about two and a half months. Therefore, prices at the beginning of this quarter is what's going to be reflected in inventory. The only thing I'm going to suggest is when you look at the inventory, look at Q4 over Q4 last year, right? That's a delta change. Because actually in Q4 compared to Q3, we'll be releasing some working capital.
That's very helpful. If I could just ask a follow-up question in terms of mining and the impact from Ukraine in terms of volumes. Do you expect to see better volumes from Ukraine in 2017, or should we assume a lower operating level going forward? Thank you.
Yannis, it's Simon. If you go back in the recent history, Ukraine open cuts produced around 10 million tons per annum. This year, you saw the reference in the notes today. Obviously, older mines, more complex, getting access to land in arable areas, and it's taken us time to get that land access for the tailings. It's been achieved in Q2, so it has impacted 2016. We're expecting full-year production of concentrate around 9 million, so about 1 million tons less than 2015. Back in 2017, with the new mine plan, we fully expect to be back on track around the 10 million tons as per history.
Thank you very much.
Thanks, Yannis. We'll move to the next question, please, from Tony at Cowen.
Thanks very much, Daniel, and hello, and thanks for taking my questions. The first one was touched on a little bit, but I'd like to pursue on the demand side of the equation, China. It wasn't long ago that people seemed to be writing off China, and now we've got iron ore at $68 and met coal at $300, and your commentary sounded more positive. I was wondering if you could provide more color as to why you think the demand recovery there is more sustainable.
Okay. I don't think we're suggesting that demand recovery in China is necessarily more stable. Clearly, it has done better than what we had forecasted, slightly better, and that's driven by stronger automotive growth as well as infrastructure investment and real estate. All of these factors, we think infrastructure, real estate supported by rising credit. In terms of what's happening in the global steel industry, clearly we are seeing positive demand evolution in most of the markets in which we operate. For example, in Brazil, we think the worst is behind us. We're seeing positive growth in Europe as well as in North America. The ArcelorMittal PMI, global weighted PMI is above 50. That's always a good sign. I think that is what is underlying our confidence.
Secondly, normally when raw material prices are rising, that's another indicator that generally demand for steel is good, which is another positive indicator. In terms of China, I think in the last 12 to 18 months, we clearly had made a lot of progress. We still have some more progress to be done, but we have made progress. What is the progress? Number one, we have established that the Chinese steel industry cannot survive at a spread which is lower than $130 compared to raw materials, which provides a base in terms of steel pricing compared to raw materials. Number two, we have demonstrated that the Chinese have been dumping their overcapacity problem onto our markets, namely the Europe, U.S., and other markets, and have put inappropriate trade measures in all of these markets. What aspects of the journey remain to be done?
The overcapacity situation in China is unresolved. It needs to be resolved, and there is a path that they are on, and hopefully that arrives at the logical conclusion. The last thing that remains unresolved is we need comprehensive trade reform. We've made progress, but we need to make sure that there is no backdoor entry or no loophole. An example of this is circumvention by Vietnam, and just as you are aware, the DOJ has opened an investigation on that, which is good news. In Europe, we are covering certain products, not all products, in terms of Chinese flat steel. There needs to be some work done at the Europe level. That just provides an overview of our flavor of China's role in the global steel industry and on the positive demand outlook for the global steel industry.
Very helpful. Thanks, Aditya.
Sure.
Thanks, Tony. We'll move to the next question, please, from Jason at Bank of America.
Yep. Good afternoon, gents. Thanks for the call. Just one question from me, which is on dividends. We have seen some other groups who've been going through a similar process of balance sheet repair start to talk about dividends again, and I'm just wondering, could you frame for us how you as a management team think about dividends and when they might be appropriate, and how you might frame a policy on dividends?
As we have said before, that topic of the dividend will be back on the board's agenda once the net debt EBITDA multiple is below 2. However, the board will also look at the sustainability of those earnings and the structural improvement that we have made to free cash flow. Also they will review where we are on the credit rating. Though any decision will not be tied to our credit rating, but clearly our rating will at some point reflect the progress we are making on these factors. We think that our near-term priority for surplus cash is for the deleveraging.
Just to push you on this a little bit, Mr. Mittal. If I look at EBITDA at the moment, it does look like you're already at that 2 times threshold. Does that indicate you've got some concerns on the sustainability of earnings right now?
What we have said that we would like to look at the sustainability in the sense that now we are seeing the volatility in the coal price, and we have to push for the price increase as soon as possible. At the same time, the board should review what is the structural changes which we are bringing to our business, how sustainable is this. I do not think that the dividend will be the priority for the board. More will be the progress on Action 2020 and the structural changes.
Thank you very much. Very clear.
Thanks. We'll move to the next question, please, from Roger at JPMorgan.
Hey, good afternoon, gents. Thanks for taking my questions. I just want to go back onto coking coal. You've mentioned this two and a half months of inventory. Is that the entirety of the lag that we should assume between the price of coking coal that we see on the screen and that coming and hitting the P&L? Or is there then a further lag in terms of the time between producing steel and delivering it? Or is there a lag before you take delivery of it as well between agreeing a price for the coking coal and actually taking it onto your books? Could you give us some more color on what the full lag time is on the high coking coal prices right now on hitting your P&L?
Secondly, just could you give some more color on the dynamics of the annual contracts for coking coal in the U.S.? If you just look at the forward curve for coking coal at the moment compared to where it was this time last year, probably talking about a $120 increase year-on-year. Is that a good starting point to consider for how much your coking coal prices are likely to increase in the U.S., and if not, why not? Also you mentioned in answer to a previous question that you've reduced your level of exports from the EU. Could you explain what's behind that? Are you seeing more competition outside the EU and therefore focusing more on the domestic market?
Okay, great. Thank you. In terms of your question on coking coal, the two and a half months is a good guide. If you're extremely precise, you would argue that there is some inventory in built-in metal stock and finished goods. We should just be careful because this effect is not starting in Q4 only. Some of the coking coal prices began a month before or 45 days before. Maybe if you want to be a bit more precise, you can round it up to three months, including the full impact. That's more or less everything. Yeah. That's more or less everything. That's obviously not the case throughout every region, right? In ACIS, it's shorter, but they also have more exposure to the spot market. Hopefully prices are correcting or improving in that environment faster.
In terms of the annual benchmark in the U.S., look, the annual benchmark in the U.S. is we don't talk about the price levels in that. That's something that we negotiate. Some of those mines have limitations on their ability to export, so I would not necessarily tie the pricing exactly to the export markets. In terms of level of exports for Europe, I think that's not because the export market is weaker. I think we did talk about some changes in the operating footprint, and also production outages that we had in Fos-sur-Mer. Historically, what we have done is we have been pushing our facilities to run full, produce at their maximum output, and excess steel, we tend to export. We still make good contribution margins on those exports.
As the domestic market was growing and our demand patterns were improving, we didn't have that much of metal, we reduced our exports. That's all it is.
Okay, thank you very much.
Sure.
Thanks. We'll move to the next question, please, from Alessandro at Berenberg.
Good afternoon. I have three question. First one related to Brazil, that you're basically saying that the worst is behind you. If you can actually quantify in terms of expectation, how strong can the shipment and probably contribution to an average profit that you can see actually in 2017? The second one is related to an update on Ilva, because last October theoretically was the first deadline for the government to take a look at the environmental plan presented by the bidders. The third one is for Mr. Mittal. You just highlighted the beginning of the conference call that you're confident that you're going to be able to align steel prices to increase raw material cost. Usually, of course, raw material cost in terms of positive demand growth has always been a tailwind.
Stripping out basically Q4, probably part of Q1 when the impact would be quite significant of the P&L, do you see these realignment of steel prices relative to the level of demand and inventory as a potential tailwind, let's say, from mid Q1 or end Q1 onwards throughout 2017? Thank you.
Let me address Brazil first. In terms of Brazil, all we're saying is the bottom is reached. We're not necessarily saying that we're off to the boom time so soon. We have been seeing year-on-year declines in Brazil. As you know, roughly demand is off 30% since 2013. That's a very significant drop in the demand of steel. The bottom has been reached. We see it in the currency, we see it in local sentiment, we see it in the fiscal reforms that have been enacted, and we're forecasting positive GDP growth and positive consumption growth of steel next year. That's a big change compared to this year, where we had negative 12%-14% apparent steel consumption decline. In terms of Ilva, look, at this point in time, there's not much more to add.
I think we're part of the process. The process is going slower than anticipated. I think there is a referendum in Italy in December, I don't think anything will be decided before that referendum.
Great. Thanks. We'll move to the next question. Put a question on the place.
Oh, sorry. Thank you. I believe that since there's such a steep price increase in the coal, it is affecting everyone's cost, and our cost also going up, and we see that basically, the environment is positive in every market segment. We see there's a positive growth in 2017. Inventory levels are not high, and we see that it will be possible for us to pass it on to the customer. I did just walk you through the positive environment in terms of our forecast for 2017. In all the markets, we are seeing that there is a positive growth, even including Brazil, which was minus 12% to 14% negative this year. We will be in positive territory 5%-6%. Russia is also in the negative territory this year. We are forecast flat next year.
All these markets, we are seeing that there's a positive growth in demand. There's a steep increase. Already announcements have been made. The scrap price is going up. All these factors put together, we see as a tailwind. We should be able to get it from the customer.
Thank you very much, Mr. Mittal.
Thank you. We'll move to the next question, please, from Bastian at Deutsche Bank.
Yes, good afternoon, gentlemen. I've got two questions, please. My first question is again on coal. You quantify your exposure on coal with 30 million tons, but that excludes the 30 million tons of coke, which converts into additional 40 million tons of coking coal. Can you please give us some additional color on the terms at which you buy the coke and how coal prices will feed through here? Is this pretty much aligned with your contracts for coal, are you annual in the U.S., quarterly in Europe, or is there any difference here or even longer-term contracts which would give you some more cushion? Then my second question is on demand, where you've increased your outlook despite the reasonably weak third quarter shipment number and just a flat Q4 volume outlook, which is probably a little bit weaker than the normal seasonality would suggest.
When saying the third quarter shipments were weak, we essentially reference it to the first half of this year when global prices were rallying heavily. While this would usually give us some restocking and probably strong volumes in such an environment, volumes in the first half were essentially flat. My question is, are Q3 and Q4 really just temporarily weak, or do you see risks that it's actually been the first half of this year which disappointed in a massively booming price environment, as it may have included some restocking and the actual underlying volume basis is much lower than what we thought it would be? Thank you.
Okay, great. Let me just quickly address your first question, and then we'll move on to volumes and what that means. In terms of coke, we are not net short as a group globally. In some markets we are buying coke, but in Europe we are surplus coke. Really the way to think about it is to just look at the coking coal impact. The 35 million number that I gave you, I think accurately captures the impact on the group on a global basis. In terms of volumes, look, we're not suggesting that there has been a change in the demand pattern. Inventory levels, if you look at it in the U.S. especially, where volumes have been weak or low. Just to quickly go through the points and then talk a little bit about next year.
The third quarter was weaker in Europe, as we shipped out less export tons. We had some production issues. European volumes are up in Q4. Brazilian volumes are up, so are volumes in the CIS business. The only impact we're facing in Q4 is the buyer strike in the U.S., which has led to a temporary weakness or temporary destock of orders in the U.S. We expect that to correct. If you just look at it this year, if you analyze the first half, we did about 3 million tons more in the first half of this year. I would expect that phenomena to also occur in the first half of 2017 or perhaps even a greater amount. That's significant volume we are talking.
That's a positive tailwind to Q1, Q2 results where you would see shipment levels of 1 or 2 million tons more volume per quarter, which is quite significant. You know we have a $200 contribution per extra ton we ship out. If we were to track at the same way we tracked this year, that's 3 million tons more volume in the first half of next year. That's $600 million of EBITDA just in the first half of next year. Yeah, as far as we see, this is very clearly a temporary destock occurring in the U.S. The real demand picture is very constructive on a global basis.
Very clear. Thank you. Just to follow up briefly on the point on coal. Essentially you say the 30 million tons of coke which you require, this is essentially what you also sell externally. Your net exposure to coal is really just flat? To coke, sorry.
Coke, I have not given you a number on coke production, but roughly it will mirror what we do on coking coal, right? Coking coal, just so no one else is confused on the call, we need about 35 million tons of coking coal, of which we have about 6 million-7 million tons of our own. Overall, global coke consumption. Yes, we're neutral on global coke consumption.
Basically the coal, which you have been giving us, that's already what you would be using in your coke making process?
Yeah, exactly.
Understood. Okay, thanks.
Sure.
Great. Thanks, Bastian. We'll move to the next question, please, from Carsten at UBS.
Thank you very much. Most of my questions have been answered. One just for the understanding. Maybe you can help me to reconcile the NAFTA third quarter results, because I'm still struggling a little bit. Shipments were down only 1%, production 1%-2%. Sales was significantly up sales per ton, but we still have only seen quarter-over-quarter a small increase in EBITDA. What cost position actually led to the increase in your costs here? Because it can't be coking coal, because you mentioned the two and a half months of inventories.
Yeah. As I was saying, this is the Calvert effect. If you look at Calvert. Calvert slabs come in on a lag effect. We have higher cost slabs in the third quarter, that should help reconcile your numbers. When you move into fourth quarter, we will also have the same cost of slabs, prices will fall in Calvert.
Okay. That helps. Thank you.
Thanks, Carsten. We'll move to the next question, please, from Rochus at Kepler.
Yes, thanks for taking the question. Just one follow-up on Carsten questions on the NAFTA region. When I look at this Calvert effect, is that purely the higher cost you mentioned for the slabs? So let's say maybe on a 4-month lag it's about $100 and then multiply the volumes. Or do I need to consider also that the incoming slabs are now not probably being squeezed with the lower market price? Is there any inventory write down included in your third quarter result? That's the first question. The second one, can you comment a little bit why the long product side in NAFTA was so weak in the third quarter, so 40% down quarter-on-quarter? Any color you can provide on that? The other question is on your net debt guidance.
I guess you have come close to what you wanted to achieve by the end of the year.
Looking at your working capital guidance, the kind of $600 million-ish negative inventory build will widely revert in the fourth quarter, so you should be able to generate minimum the same free cash flow in Q4 as you did in Q3. Any color on that is also appreciated. Can you also give us a sense how the ACIS volumes were impacted by all these effects from relining Saldanha, the issues in Vanderbijlpark, and the other problems in the Ukraine? That would be of help.
Okay. We'll have to go back to your third question because I was not clear what your question was, and maybe Daniel is.
It was the effect from the relines, operational issues, production outages in South Africa and Ukraine, how much had that impacted volumes?
Okay, fine. In terms of NRVs, we did not have any NRVs in the U.S. business in the third quarter. The way to think about it is exactly what you mentioned. You take the slab price, and then you multiply the slab tons, then you multiply the price delta change. That's the cost. That's not all the cost increase, but that's the most significant cost increase that we have in the third quarter because we did have some inventory. In terms of long products in the U.S., we had weaker shipments out of Mexico, and we should just be careful that we have adjusted for scope changes. In terms of South Africa, I think there was a loss of about 67,000 tons, primarily. 67,000 tons was lost due to reline in Saldanha and a total loss of 110,000. In Ukraine, it's also similar number.
Both those facilities are doing better in Q4.
Net debt?
What was the question on net debt? Maybe that was the question I missed.
Yeah. I was keen to get a bit of an update on your net debt guidance. I think you got close to where you wanted to be in terms of net debt by the end of the year, already in the third quarter. Looking at your working capital guidance for the whole year, you will have a positive release from working capital in the first quarter, and you probably should be in a position to have a higher free cash flow in Q4 than you had in Q3. Can you give us a bit of a sense how much further down you expect the debt by the end of the year?
Okay. Look, we're not providing net debt guidance. I think we have provided a lot of information which allows you to create your own framework on what that number is. I think the missing plug is really EBITDA. We've provided what the factors are, which are going to impact the EBITDA into Q4. We've talked extensively about the cash requirements of the business. That should be quite clear to you.
Okay. No problem. Maybe a follow-up on Liberia. I think production obviously is running at the 2 million ton run rate now. I guess previously you scaled the business down to more of a 3 million ton operation. Any update? What's driving that kind of lower level of output?
If you read the notes we've issued today, we've actually taken the production down to 2 million tons. The key driver is that we're working on the final feasibility engineering work for potential expansion to a brownfield area called Gangra, which is about 14 kilometers away from Tokadeh. It's a DSO. It's a higher grade than the Tokadeh deposit. It's a lower strip ratio. It will be very competitive, it is in the final stages of engineering, and that would not be potentially ready to come on stream till mid 2017. At this point, the issue is around making sure that we extend the life of the Tokadeh deposit to take us through to that inflection point. 2 million tons is the current run rate, and we would expect to see, all going well, an approval of the project.
If that goes ahead, you will see higher production from Liberia in 2017 calendar year.
Okay. Very clear. Understood.
Thanks, Rochus. We'll move to the next question from Luc at Exane.
Hi, gentlemen. A couple of questions, if I may. First of all, with regards to the coking coal questions, maybe a follow-up. If I understood right, you have a part of your contracts which are labeled on the spot or monthly basis. Or at least I understood this was something a bit new. Could you maybe elaborate on that one? Secondly, with regards to the 2020 cost savings initiatives, could you help us maybe work out how much has been captured already? Last, on the CapEx side, could you maybe elaborate a bit on your automotive strategy, high-strength steel, and how much CapEx should we run going forward for the steel division growth-wise, quality-wise? Thank you.
Okay. In terms of coking coal, I know there's been a lot of discussion on coking coal, but I wouldn't get too nervous about it. I think the 50/50 that I spoke about also mirrors the order book that we have, and that is how we contract. It's slightly more than 50/50, as I mentioned earlier. Just to repeat, net of U.S., net of our own coking coal, take approximately 24 million tons of coking coal that we buy. Roughly more than half is spot monthly, and that's roughly how much of the steel we sell on spot monthly basis. It's designed that way so there's no squeeze either way. The same way that there are some revenue lags in our business, there are cost lags in the coking coal.
Over a period of time, all of that should neutralize, and as we mentioned earlier, we're very focused on passing on the cost increase in terms of prices on a global basis. In terms of 2020 action plan, I think we're making excellent progress. I can give you a lot of headlines on that, but I'll try and be as succinct as possible. In terms of the U.S. AOP, that's ongoing. We have taken down a hot strip mill, and first half of next year, we'll take down another steel shop. Calvert is progressing well. Output is greater this year than last year. We're making very good progress in getting auto into the order book at Calvert. NAFTA is doing great. In terms of Brazil, we talked about how the bottom has been reached, which is good news.
We can now accelerate what we're doing in terms of the value plan that we had in Brazil, focus more on the domestic market, increase domestic market shipments, which creates further EBITDA, and continue to focus on reducing our cost base. In terms of Europe, our transformation program is running well. If you look at what we're doing in the European environment, we have changed the operating structures. Cost is down. Our yields are better. Cost is better. Moving on to the CIS, I think a turnaround has been affected. Shipments are going to be significantly higher than last year. Profitability has been restored, clearly helped by the devaluation in Kazakhstan. We can see that the CIS turnaround plan is also in shape. We've also addressed our portfolio. We have shut down Trinidad facility. We have sold our U.S. Long business.
We have sold a facility in Europe as well. Mining cost is also doing well. Mining cost is on track to be down 10% year on year. Those are all the headlines, and they demonstrate, and at least the feeling or flavor inside is that we are ahead of where we want to be in terms of Action 2020. What we're going to do is in February, we will detail that more on a numerical basis so you can see what impacts it has had on the EBITDA by region. The last question was on automotive strategy. You may not be aware, but roughly a few hours ago, we issued a press release just talking about how we have expanded our global portfolio of automotive steel. This basically is part of the Action 2020 plan as well. There are numerous steels that we have introduced.
You can go to our website and find the press release, we were developing Usibor 2000 for a long time. Now Usibor 2000 has been released, Ductibor 1000, Fortiform in a range of up to 1050, and various other products. As we mentioned earlier, we rank number 1 among 22 out of 23 global OEMs in technology capability. We continue to expand our R&D efforts, I think we're making very good progress in finding the right solution for the automotive universe.
Thank you.
Great. Thanks, Luc. We'll take the next question, please, from Charles at Bradford Research.
Hi, good morning, or I guess good afternoon. With your iron ore contract in North America, I believe there's an adjustment clause that indexes the price somewhat to the price of hot rolled coils, which have clearly come down from over $600 a short ton to under $500. First of all, is that clause in your contract? What size of it, is it relative to the total impact on pricing, and what is the time lag of the calculation?
Yeah. Hi. That's a great question. The Cliffs agreement is confidential. I cannot get into any details. This is an annual contract environment. That's the only thing I can say.
Okay. Cliffs also says that there aren't any sinter plants operating in the U.S. I thought you had two operating. Are they still?
I believe in Burns Harbor, we still have a sinter plant operation, but we will verify that and come back to you.
Thanks. See you.
Thanks, Charles. We move to the next question from Christian at SocGen.
Thank you. I have just two questions, to be quick. One is, in Brazil, I think you have some charcoal there. You got some eucalyptus left. Is that somewhat reducing your coking coal pricing pressure there? The second one is on your EBITDA breakdown. There seem to be a growing amount of negative internal amount, especially this quarter. Could you just explain why this amount is increasing in recent quarters? Thank you.
It's a good question on charcoal eucalyptus. Yes, that's right. That exists in our Brazilian operations. It's not as significant as you may think, it comes out in rounding errors at the end of the day. It's about 260,000 tons but does provide a cost benefit to our Brazilian operations, namely the [Ustraforos] facility. In terms of your other question. This is because of rising iron ore costs. As iron ore costs rise, the EBITDA that we generate in the mining business is sitting in the inventory of our steel facilities, we have to net that off. That's why you have the other impact, which is greater in Q3 than other quarters.
Okay. Thank you very much.
Sure. Thanks, Christian. We'll move to the last couple of questions, first from Brett at Loop Capital.
Hey, guys. We've seen a good run-up in both iron ore and in met coal, and all the prices. You guys are backward integrated enough to know when capacity is coming on. There's been a lot of capacity that came off as prices were heading down. Just give a rough sense of sorts. We've heard some news about capacity coming back on again. Do you think things get back to an equilibrium in iron ore or met coal at lower pricing levels anytime soon?
Brett, I think if you're talking seaborne, at the moment, we're seeing a sort of a surge in additional demand in China, and you could argue that that's somewhat offset by declining production domestically in China. Those iron units are in demand. I think at the other side of it, we're seeing latent capacity maintained by a number of producers in the industry. Greenfields are pretty well all gone that were promised. Brownfield expansions are quite minimal, and there's only a couple of new players, so to speak, due in the industry in any small tonnage, and it's in the 30 or 40 million tons, as you see into calendar 2017. We don't see a dramatic change in that supply balance. A lot of this rests back on the early conversation around the health of the Chinese steel industry and the spreads.
All right. You don't see a lot of restarted capacity coming on in iron ore or met coal in the near term?
Not if you believe in the capital cost per ton that needs to be put into Greenfield projects. I think you're more likely to see people look at Brownfield. If you step back, and if you're a person midpoint on the cost curve, and you're realistic with your view of the world, you look at who owns the latent capacity on the cost curve. It's first quartile players. It has to be quite a brave person that's going to enter significant capital entry into the iron ore game green, and similarly for brown. I think, what you're seeing is more tonnages coming from capacity utilization, productivity improvements, small brownfields. We're not seeing the brave decisions that were discussed about in the last seven to 10 years.
The last one is manganese. I hear it's running up a lot. What's going on there? What's going on in South Africa? Is there any way of kind of keeping a cap on these prices? It's obviously an alloying agent that most people use, and just wondering about what you're seeing in supply and demand in manganese.
Again, it's not a commodity we're directly in. We are an alloy consumer as a company. The index price has moved up heavily. It's obviously connected with other raw material inputs and health of steel on the consumption end for the alloy plants. Supply is still on the heavy side, i.e., there is a lot of latent capacity in the sector, and we're certainly seeing it fly up for a reason driven by the market dynamics. I think if you went and looked at the supply-demand numbers right now, you'd find excess, like latent excess capacity, which is not currently turned on in the industry.
Thanks very much, guys.
Thanks. We'll move to the last question, please, from Phil at KeyBanc.
Thanks very much for taking my question. Aditya, can you update us on where we are in the automotive contract discussions for NAFTA at this point?
As you know, we don't comment specifically on pricing attributes on automotive. Clearly, the demand picture is favorable. We have seen good growth in the automotive environment in 2016 and are forecasting NAFTA a stable environment. Europe has been marginally stronger in 2016, and we expect the same into 2017. Our focus with our automotive clients has been to push our advanced high-strength steels. They have higher margins, and we're expecting the penetration of higher strength steels to grow as the years pass.
I appreciate that. Follow-up here would be on the Mexican automotive market and how you're currently participating in that market and how you plan on participating over the next couple of years.
That's a good question. At this point in time, our participation in Mexico is primarily through Calvert. We have the advantage of bringing in slabs from Mexico, processing them at Calvert, and then shipping it back into Mexico. The advantage of that is under a system called Maquila, where we don't have to pay Mexican duties. Clearly, Calvert's capabilities are second to none, and that helps us improve our presence in the automotive universe in Mexico.
Thanks very much.
This concludes our earnings call today, thank you very much for participating, look forward to be talking to you soon next quarter. Thank you. Have a good day.