Morning, ladies and gentlemen. Welcome to Vale conference call to discuss the Q2 2018 results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If you should desire to join the call, please press star followed by zero. As a reminder, this conference is being recorded, and the recording will be available on the company's website at vale.com at the investor zone. This conference call and slide presentation are being transmitted via internet as well, also through the company's website. Before proceeding, let me mention that forward-looking statements have been made under the Safe Harbor of the Private Securities Litigation Reform Act of 1995. Actual performance could differ materially from that anticipated in any forward-looking comments due a result of macroeconomic conditions, market risks, and other factors.
With us today are Mr. Fabio Schvartsman, President and CEO, Mr. Luciano Siani Pires, CFO, Mr. Peter Poppinga, Executive Director of Ferrous and Coal, Mr. Eduardo Bartolomeo, Executive Director, Base Metals, Mr. Luiz Eduardo Osorio, Executive Director, Sustainability and Institutional Relations, Mr. Alexandre Pereira, Executive Director, Business Support, Mr. Alexandre D'Ambrosio, General Counsel, and Mrs. Marina Pinto, Director of People. First, Mr. Fabio Schvartsman will proceed to the presentation. After that, we will open for questions and answers. It is now my pleasure to turn the call over to Mr. Fabio Schvartsman. Sir, you may now begin.
Thank you. Good morning to all. It is a special pleasure to have you in this call, in this quarter call. This quarter, it's actually a very special one for us, the management of Vale. The reason being, not only because we had a predicted good result in the quarter, but the quality of these results was very good, as I'm going to explain in detail. It's very important for us to achieve all the aspects of our strategy illustrated during the quarter. First of all, these results that we achieved were achieved even with the reduction in the iron ore spot price that went down BRL 9 in average in comparison to last quarter. In spite of the truck driver strike that basically stopped the whole country for several days.
Vale, in these circumstances, was able to beat records in production of iron ore and sales of iron ore at the port, showing our great flexibility. Meanwhile, the reason why we overcome the price reduction in the quarter is because the realized price of Vale has increased by BRL 7 in this quarter. I would like to emphasize as well the fact that we are thinking cost. We are thinking cost long term, and we are thinking short term and long term as well. Long term in this case, we are talking about this recent announcement of a four-year new ship that we did with our division of Vale. Most importantly, it gives you a benefit essentially straight for Vale of BRL 5 per ton in comparison to the average of freighter Vale as of today.
A third special thing that I would like to emphasize, to put light on, is in technologies. We achieved the investment that we were looking for, close to $10 billion of net debt by the end of the quarter. This gave us the opportunity to start a number of movements that demonstrate very clearly how Vale is approaching technology. First, we transformed a large investment, a potential large investment in Vale into a highly profitable one through screening of projects. This emphasizes the fact that we are open to business. We take some time, investments that are very attractive, and this was the case. Secondly, we have started our dividend payment according to our new policy. For the first time, we are going to pay a little more than $2 billion next September regarding the results of this semester. That's a very good achievement for the company.
Finally, representing the trust that the company will remain performing and delivering, we are announcing a buyback program of $1 billion that represents our ability to invest in stocks of the company that in so far the best asset that the company knows, and that we can buy Vale with that premium in the market. This is a very quick summary of what has happened in the commercial. In an hour we will have Form Q7, that will give a more clear view of how the operation went in the last quarter. Good morning, everyone. I would like to start by addressing our Q1 cash costs.
You saw the very steep depreciation of the Brazilian Real in the quarter, and one would expect, given the exposure of Vale to the Brazilian Real, Q1 cash costs should come down, should have come down by about BRL 1 per ton, and why it didn't happen. Four factors are now recurring in the second quarter and should not be present in the third quarter. In addition to the volume dilution, that underpins our forecast that we are going to be substantially, considerably below BRL 30 per ton in the third quarter already. Talking about these four factors, two of them are directly related to the truck driver strike that Mr. Schvartsman mentioned. BRL 0.30 per ton is a direct effect of increasing costs because of the way we dealt with the strike, and the list of things that we made increase costs.
Another BRL 0.30 per ton increase because of the lack of feed for the direct reduction pellets in our pelletizing plant, we had to reschedule some of the ships, and we paid the demurrage for that. The lack of feed came from the lack of inputs for our processing plants, which could not produce then the necessary feed and the necessary quality to feed our direct reduction in pellet plant. The demurrage cost about BRL 0.30 per ton. There are maintenance costs, which are typical of the second quarter, which is the quarter in which we prepare Vale's operations for the tremendous growth in volume that usually happen in third and fourth quarter. There's a BRL 0.30 increase in maintenance cost. That should come down well.
Finally, now that we have more inventories along the chain, it takes longer for reduced production costs to flow through the proper good sales. That's another $0.30 per ton of carryover from the higher cost of the first quarter towards the second quarter. In the third quarter, in the absence of all of these effects, costs should be, because of this, $1 per ton lower. Because of volume dilution that we expect 9%-10% increase in volumes over the third quarter, another $1 per ton at least reduced. Then we'll see if the exchange rate will continue to provide. Today, as of today, the exchange rate is higher than the average for the second quarter. Base metals cost in coal, certainly you will have the opportunity to discuss with my colleagues. Let me jump to expenses.
I always talk about the pre-operating expenses. They came this quarter at $67 million, my point here is that we should be approaching zero very soon, by the end of the year. S11D pre-operating expenses should come down to zero. Pellets pre-operating expenses should come down to zero given the restart of our pellet plants. The three pellet plants will come back in 2018. Also the Mariana operations, we had maintenance costs because of the conveyor belt was damaged, and now it's coming back as well. This is an expense line that should come to zero. R&D expenses increased. That is expected from a first quarter. However, we'd like to underscore the quality of the R&D expenses. That part of it goes toward digital transformation program, which will bring results very soon.
Part of it is exploration expenditure, especially in the Carajás greenfields , especially to generate and to accelerate the growth options in copper in the region. This is to bring good news also soon. Financial expenses also, compared to a year ago, are decreasing by about 30%, which is the direct effect of the reduction in debt mix. Obviously, we also expect those expenses to come down substantially over the next quarters as we retire more debt. I'm sure you noticed also investment coming at a very low number, $705 million. This shows our commitment to capital discipline. Obviously, it is going to go up, especially sustaining investment, given the approval of, for example, what is the demand expansion. This is a testimony to our commitment, and we should look forward over the next few years to very well-behaved capital expenditures.
Finally, on cash flow, conversion of our guidance to cash was very good without any detractors. There was a $200 million equivalent drop in inventories. As you saw, given the sales lower than production. Nothing remarkable except the good conversion. We had that significant decrease in the first quarter. We are expecting a smaller decrease because most of the cash flow generated in the third quarter will be funding the dividend payment in September. Still, we will approach even more the $10 billion net investment. If prices stay where they are, we should then, and depending on how the buyback goes, we should pierce the $10 billion target in the fourth quarter. Therefore then, we will be in discussions of what to do with these additional excess cash. The dividend we are declaring, $2.45 billion, represents 53% of underlying earnings, this is what we expected.
Although we had a forward complete from EBITDA, our expectation of this is going to be the range of income per operation going forward. Having said that, we should jump into Q&A straight away.
Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you have a question, please press the star key followed by the one key on your touch-tone phone. If at any time you would like to remove yourself from the questions queue, press star two. Please restrict your questions to two at a time. Our first question comes from Mr. Carlos de Alba with Morgan Stanley.
Good afternoon, everyone. Thank you for taking the question and congrats on the very strong dividend and results. The question has to do with Samarco. If you, maybe Fabio, could give us an update as to what are the latest developments for the operation to come back and start producing, also particularly if there is any progress on conversations with BHP to potentially one of the two companies becoming the sole owner of Samarco. If so, if you are in a kind of a possibility and Vale ends up with 100% of Samarco, how would the consolidation of Samarco's debt affect the BRL 10 billion net debt target and the possibility to pay more dividends in next year? The second question that I have has to do with this increase in problems in VNC.
Could you comment a little bit on what we should expect for the remaining of the year and 2019? The joint operation have been delivering quite a good performance with a positive trend. It seems to have been a hiccup last quarter, but I just would like to see if it is something relatively temporary or we should factor in higher cost for everything now. Thank you.
Carlos, thank you for your question. Regarding Samarco, I have to tell you that we have very good progress recently regarding the legal actions against the company and the shareholders of the company. That has eliminated a cloud over the business. That helps for the good behavior of starting up again the operation of Samarco. We are now more than ever 100% focused in bringing Samarco back on stream. For the second of your question regarding BHP, I have to tell you that it is of maximum importance for Vale and I guess for BHP this issue right now. We are 100% focused in what can be done in order to have the return of Samarco. Even if and when a deal regarding BHP and Vale will be made, the point that has to be understood, there is no business benefit here.
If we agree, the purpose is solely on the benefit of returning Samarco. That's the way Vale is looking into it, and I'm pretty sure is the same way that BHP is looking into it. Unfortunately, it's less of a business opportunity and more a social obligation that we are taking into consideration together with BHP. Second, regarding VNC, I would like to give a clear review on where we are. We are now better than we were a year ago. The current cost of VNC has depleted. We are not paying for operating this company. This is a much better situation than we had before. Nevertheless, the fact remains that this is an operation still to be stabilized. It is the most complex operation that Vale owns because the choosing what to do and when to do it is not easy at all.
We are looking to auction, basically because everybody knows that we have to continue this operation in New Caledonia. We have to build a new tailings dam there, and this decision has to be taken till the end of the year. We are going to reach a final decision of how to fund it, and if we are going to make it or not till the end of the year. In that occasion, we will let you know our final idea on the future of VNC.
Okay, thank you.
Our next question comes from Thiago Lofiego with Bradesco BBI.
Hi. Thank you. Just one follow-up question from the question we called, that's a very good capitalization issue. When should we expect Vale to initiate a new growth cycle, even if a more modest one? We understand the company's really focusing on dividends right now. The net debt level is close to the target of BRL 70. Just looking two, three, four years out, when should we expect Vale to start investing in growth projects again? You guys have mentioned about potential projects in copper, potentially energy, which is actually ideal. What's the mindset of the company regarding those at this point? Thank you.
Thiago, thank you for this question. We have a very clear stated policy for dividends in the company. We have been paying dividends in this year according to this policy. It doesn't mean that it will remain all of our cash flow for this payment. For the decision, what we do with the additional will be made in any given moment comparing alternatives. This time, we decided to make a buyback because it was clearly the best option for creating value for shareholders. We are going to continue to do that. Nevertheless, we announced investment in hydrogen. Why? Because we think that the return on investment there is such that we certainly are going to create value for shareholders. There is not such a thing in our mindset. This is a growth season or a dividend season.
Actually, we have a dividend policy, we are going to use the excess cash either to distribute more or in buyback or in both if the returns are deemed adequate. The decision will be made at any given moment.
Okay. That's clear. Thank you, Fabio.
Our next question comes from Jonathan Brandt with HSBC.
Hi, good afternoon, congratulations on the results. I first wanted to ask about the freight rates. There's some new legislation coming in in 2020 that will require lower sulfur content. I know you've to some extent mitigated that with the new freight contracts that you have in your results today. I'm just wondering how exposed you are to this in terms of the current fleet of vessels. Is this something that is still an issue, and what steps you could take to mitigate it? Secondly, for Luciano, I'm just wondering if there's any more to do on the liability management side on how we should think about interest expenses. Obviously, they'll continue to come down in the next quarter or two as you pay down that debt.
Is there anything left to do on the refinancing side or other liability management options that you're considering perhaps buying back the state the MBR or on the debentures? Thank you.
John, thanks for the questions. It is easy. As you pointed out, this is something important structurally shift coming in January 2020, the IMO. Our direction plan is to progressively install scrubbers in order to progressively depend less on the low sulfur oil, because we don't know how fast the refineries will react to this new demand. As a rule of thumb, in a nutshell, you can work with the following equation. There will be an increase in cost, let's say, the low sulfur oil costs $300 more than the high sulfur oil, or the spread, if you believe in that. The average freight cost we have today will be roughly the same, if you take into account the effect of the average freight rate in 2023.
Because what we are going to do, the scrubbers will reduce this delta, this gap to the low sulfur in $1.8. The new Valemax coming, the third generation we just announced, will also reduce it in $1. The Valemax second generation, which is coming on stream now, we already have seven in the fleet. It's also reducing $1.
All this together, the scrubbers, the Valemax, the new, the third generation and the second generation Valemax coming in, will compensate this increase in the spread between the oil categories. It provides, it is always the worst case. If, of course, the refinery react and the spread narrows, we will be much better off.
Thank you.
John, on liability management, we continue to look into and to do liability management. If you look at the statement of cash flow, you see that we actually retired $2.6 billion in debt this quarter, but we issued another $700 million in debt. Some of the capital providers now are coming to us with very cheap and low attractive rates. We continue to extend the duration of our debt. Some of these loans that we made are replacing others that will mature in the short term. Yes, we will continue to do that exercise. We continue to have loans which cost more than they should given the current financial position of Vale.
As regards MBR, it is one of the many options that we have to use our capital, and we will be comparing it to other alternatives that we have in order to make a decision on the MBR space.
Thanks, Peter.
Our next question comes from Alex Hacking with Citi.
Hi, good afternoon. Thank you for the questions. First, I just wanted to follow up on the freight question. I just wanted to clarify, the new ships with 62 million tons of capacity, will that be incremental freight capacity for Vale, or that will be replacing some of the long-term contracts that were rolled off? My second question is just related to the capital allocation. Could you maybe discuss the framework when you're deciding on capital return on buybacks versus dividends? Thank you.
Hi, Alex. No. Yes, you're right. It's the third generation. We just announced the value of ships, which we are calling Valemax. 325 deadweight. That's new capacity coming. We will be replacing, of course, some older contracts or even some Capesizes. These are very large bulk carriers. They come on top of the 18 fleet. Excuse me. Just to clarify your second question is regarding dividends against buyback, right?
I'm sorry. Yes. The question is, when you return capital next year above and beyond the stated policy, how will you decide between buybacks and dividends? What's the framework for that decision? Thank you.
That's a good question. I can explain to you how we reached the decision to pay dividends according to policy and an additional two buyback. The reason in this moment was basically the following. We have just announced this new policy. It was in our interest to demonstrate that this is a policy that is here to stay. We are going to follow this path. Therefore, we thought it would be better in this moment not to have more dividends, but instead to give it back to shareholders through a buyback that it is equally at the benefit of the company. More importantly, it gives a very important sign of how the management sees the future of Vale. Because we are very positive in the return on the investment that we are going to make in this buyback.
What is going to happen in the next year, that this is a flexibility that we are going to hold. It will depend on evaluating the situation in maybe the month . We are going to analyze and see which is the best for the company, to be able to pay more dividends than the policy or should we make more to buybacks again. This will be decided in the coming times.
Thank you.
Our next question comes from Grant Sporre with Macquarie.
Good afternoon, gentlemen. Thank you for my questions, and congratulations on the good results. I have two questions for you. The first one is regarding the coal division. Firstly, can you just give us an outline as to how you see that division sort of improving its performance going forward? When it came to that, if you can give us some guidance on the costs or how we should think about the costs going forward, particularly the carbon tariffs. My second question is just in the iron ore division. Under a scenario, perhaps in the second half or later in the year, if we have, let's say, a slowdown in the market, are you still flexible in being able to take down some things in your processing system, perhaps to support the market or be a bit more market-friendly? Those are my two questions. Thank you.
Okay. Grant, thank you for the question. Specifically, in the iron ore, if there is a slowdown in the market, which we don't see coming so soon, but if there's something typically happen, yes, first thing we would do is to reduce our third-party purchases, which is around 10 million-15 million tons a year. Secondly, in the processing system or in other small mines, we have mines we could reduce or shut down temporarily where we have the lower margins. That's a possibility, but our flexibility. Then we would manage, of course, our contracts through our offshore inventories differently. Regarding the coal, actually, we have had some success. We are thinking about 2018 this year as a year of consolidation, a year of trying to put things in order with the philosophy of the iron ore business.
Iron ore guys helping the coal guys to achieve that. We had already good progress on the commercial front, where the price realization is getting better and better. The OpEx comes down a little bit this quarter. What we are doing is deliberately fixing some problems and deliberately maybe sometimes slowing down some areas. I'll give you an example. We have some late safety issue was behind schedule in some specific areas, we took the decision to recover that situation to normal levels. We are drilling much more out in order to have better planning possibilities. As well as one very important thing which also affect the mix, the use of the metallurgical coal to thermal coal, which is slightly below 50 now.
This is the decision we took to mine out a certain bit called "so the point" where there's some ore still there that we need to mine that out in order to use this pit for the new tailings, in order to avoid to build a new tailings dam. You see there is lots of actions we could mine better, we are deliberately going for a more sustainable preparation for 2019 in order to get more sustainable operations. If you take out the tariffs for the loans, for the finance instruments, if you look down the road, we see OpEx around BRL 60 a ton. The tariffs also have an important fixed cost component, therefore, with increased loans, it should come down. We are expecting it to stabilize between BRL 20 and BRL 25 a ton, which adds then to the 60 exactly.
The return to Vale between BRL 5 to BRL 10. All in, it should be a total cost, as you can see, really is around BRL 80 a ton.
Thank you very much. Just to clarify, the tariff is basically a fixed cost. It is not a variable cost.
It has variable components as well because the logistics also has to pay some obligations of the concession which are variable. You may argue that some of the maintenance costs are variable as well, depending on one, because it pays for everything. It pays for everything. There are two components, but the debt service component is mostly fixed.
Mostly fixed.
Yes, mostly fixed.
Right. Okay. Thank you very much.
Our next question comes from Alfonso Salazar with Scotiabank.
Thank you. My question goes back to future growth. I understand that right now the priority is in dividends and buyback, if the opportunity arises later on to grow through M&A, is there any preference in terms of commodity or any possibility that Vale diversifies away? I understand you want to be less exposed to iron ore in the future. What do you think that could make sense for Vale portfolio? Regarding the logistics and energy, what are your plans to improve that again?
Thank you for your question. Regarding the diversification, it's important to emphasize that we are totally determined that the work that is already being done. We are growing in base metals because this is our real diversification. This is what we've been looking for, is to increase the stake of base metals in our total share generation. Yes, we want to be more diversified, to do diversification has to happen internally through the effort that we already made in the past. We are not looking into any other acquisition that will represent a diversification additional to the company.
Thank you. Regarding the logistics and energy portfolio going.
Actually, of all these people, energy is a very clear one. We want to be self-sufficient in the production of energy because this is huge regarding taxes and transportation costs. It's very efficient return wise when you are self-sufficient, and we are far from that. That means that we have a lot of opportunities to increase our output in energy for the purpose of reducing our CapEx cost in our operations. In logistics, again, we dropped this position. We want to increase our stake in VLI as of today because we think that VLI is a very good operation with fantastic upside. If there is an opportunity, we are going to increase and not decrease our participation in VLI.
Excellent. Thank you very much.
Our next question comes from John Tomasic with John Tomasic Very Independent Research.
Thank you very much. I'm a shareholder, and I couldn't be happier. The production in the first half was below the rates of the Vale Day guided December 6 in each product line. Will the second half catch up? The first half rate was 35% short in coal. What do you think the total coal production will be this year and next year?
Hi, John. Thanks for the question. Peter speaking. Yes, what we think, and we are keeping our guidance of around 390 million tons production in this year. That means in the second half of this year, we are going to produce, in both quarters, we are going to produce over 100 million tons. For your information, in June, we already are close to this pace. Regarding coal, we are really analyzing during this quarter all the actions we have taken in order to recover the production loss. We will probably then analyze it, and if it's the case, we are going to pronounce and talk about the new guidance in the next quarter. Thank you.
Our next question comes from Tyler Broda with RBC.
Thank you. Thank you very much for the call today. Just have a quick question with reference to just on the recent iron ore market. We've seen a big increase in the discounts for elements like phosphorus. Wondering if you could describe, in your view, how much of this is Minas-Rio being out of the market, or is this more just the natural progression now of the changing blast furnace size in China? Just in your view, what will profitability need to get to in China so as to move the market away from the structural frame we've seen recently?
Tyler, thanks for your question. I spoke in the previous call that I do believe this is a structural trend. It has to do with actually three factors. The fact that the Chinese concentrate, which has a very low aluminum silica ratio, dropped and went out of the market substantially in the last years. Vale itself took out some high silica product, which happens to have a low aluminum too. Then there is the whole depletion going on in the river that was not in terms of quantity, but in terms of quality, aluminum wise, phosphorus wise in Australia.
I don't expect this to change so drastically. That explains also why our new product, the flagship that we have, the Premium Blend Fines, which next year will become our biggest volume of sales, why is it so successful? We are achieving premiums of BRL 5 to BRL 7 over the 62 benchmark. We also developed a new product called sinter feed, a low aluminum sinter feed, which comes directly from the trail, and this is achieving actually BRL 10 premium in certain segments. Actually, what we believe is if there is a change in the margin of steel mills or in the coke price, which will actually reinforce the existing trend for connectivity which comes from the supply side performance. We don't see this changing, and it's a tremendous opportunity for Vale to differentiate itself. This is what we are doing.
We first differentiate ourselves with the 65 product premium. Now we are going to differentiate further progressively with the Premium Blend Fines in terms of low impurities. Thank you.
Thank you.
Our next question comes from Aman Barwar with Rystad Energy.
Hi. Thank you for doing the call today. Actually, my question that I had in mind was along the same lines of the previous question. In the second quarter, you had average premium of BRL 7. I just wanted to know what you think are the sustainable premiums. Also, if you can comment on your competitors, we've heard various bits and pieces of news of other players also trying to upgrade their products. You did mention in the Q2 notes that our premium product is [re-rating]. If you can talk about any of the competitors and their strategy and how they might benefit from the detriment of Vale, if any.
Hi, Aman. Thanks for the question. Yes, this is true. Of course, nobody is standing still. What you see is lots of initiatives happening in Australia. FMG announced the Eliwana project, which has a higher iron content. You have others like BHP and Rio announcing South Flank and Koodaideri. You have the Yandi depletion coming looming in the next year. This means the quantities will be there, but the qualities will be different. It may achieve the same premium content, but the impurities will be not the same. It means that the aluminum activity ratio will go up, which helps our premiums. That's where we differentiate ourselves. You mentioned a BRL 10 premium in this quarter. It will go up. In the next, of course, 64 elements will be there, but it will be going up.
For instance, the new BRBF we are selling to the market. We have some contracts where we don't have those premiums, right? We are a company honoring our contracts. Once the market will in the next quarters and years realize that this is a new trend, then it will be priced accordingly. It will benefit everybody. I think we are in a very good moment. Again, we are differentiating ourselves from our competitors through the premium products.
Just to complement what Peter just said. Just to clarify what Peter said. The factors that are going to increase our iron grades and premiums are, first, we have more volumes coming out of S11. Second, we have more product production coming in the next few quarters. Third, we have this BRBF that is being [well-received] that we are going to enter into three contracts and therefore those iron prices will react accordingly to the premium that the markets are seeing today. All in all these movements translate into premiums increasing going forward. We are very at ease with the fact that we are going to see next quarter going into the premium will continue to increase.
Just to finalize, the other fear that the market has that Carajás would have excess volume coming because we are still ramping up in the S11D. That is not a concern for us anymore. We are selling product. We are completely sold out in terms of products for the next year. We are selling product in different segments, like EAF in Europe, like some volumes to India. We are feeding pellet plants into our own pellet plants in order to maximize productivity. In China, there is, in our segment, a big opportunity for us. China is investing very much into the pellet business because of the pollution, because of the decarbonization.
I don't know if you know, but they are investing roughly a capacity of 50 million tons, new capacity of 50 million tons of pellet production capacity in China, with traveling grate technology, which means they can use hematite ore. At least 50 million is the size of the whole Vale of pellet business, is 50 million tons. Where is the feed going to come from for this new capacity? We hope, and we expect that part of this new demand will exactly come from the pellet plants which will be built on the ground, and will therefore be absorbed by this new market opportunity. No excess volume at all anymore in the market for our customers.
Just as a follow-up to that, in terms of investment happening in the Chinese market, we've also heard various reports about them investing in electric arc furnaces and them developing the scrap market, which over the long term would be a threat, I guess, to the iron ore market as a whole and especially to Vale. In the short term, I guess, from what we've heard, it has not taken up as much due to the cost differential of scrap to be higher. Do you think that is a threat that, of course, the market is worried about? Is Vale concerned about the threat from electric arc furnaces taking up market share from blast furnaces in China?
Of course, there is this element structurally there, that China will have more obsolete scrap generated in the next years. This scrap story is a really long-term story. It's roughly 10 years out, and it has to be structured first in China. The physical, the electric arc furnaces, the energy. Energy is another big issue in China, so electric arc furnaces really work with energy. The scrap distribution channels in China are not organized. So of course, there will be some effect, but I don't expect this to be in the short and medium term. It will be in the long term. Also lastly, in the short term, we will need a bigger portion of pellets of high quality for the protection of steel in electrical furnaces, and therefore, the feed for it will mostly come from where it's going to come today, from Vale.
We read all this with all the concern. We are following very closely. Not only it is a long-term concern, but even when it happens, the market will adapt to another structure, as is happening in the U.S., where we are selling more pellets to all the electrical furnaces there.
Thank you.
Our next question comes from Gustavo Bechara with BTG Pactual.
Good morning. I have a quick question regarding the debt. I'm trying to understand here, with the net debt target being right around the corner, should we expect further reduction in gross debt? To that point, where will the company place gross debt reduction in its priority vis-a-vis other capital alternatives, activities such as an extraordinary dividend or the purchase of new shares or even the purchase of new assets?
In the bigger portion that we are reducing net debt, we are basically reducing gross debt. That means that it is a positive rollout. It is being performed this way and will continue to be performed this way.
Okay, thank you.
Our next question comes from Marcos Costa Santos with Itaú BBA.
Hi, good morning, everyone. A quick question to follow up on the BRBF, Peter. The premium on BRBF is quite new to us, and it has varied a lot in the recent months, right? According to the chart you put in the press release. It was below $2 in May and above $10 in July. If you could explain to us the main reasons why it varied so much. What is the sustainable level that you think it should be going forward? The second question for Eduardo. You mentioned in the previous call about the trend of electric cars now becoming a reality. I'd like to hear from you, what is the company's view on the size of the potential market, and where will the growth come from? Thank you.
Thanks for the question. The BRBF is in fact a recent story that it's become so explicit in the market. It was always there. The difference is that we have changed our policy in terms of sales. We are not selling at index anymore. We are selling at fixed price. That means that the BRBF is becoming part more and more of the price formation of the 62 index. Okay. The reason that it's the first time, why it's becoming so clear now, and the reason why it happened two months ago, it's simply the fact that if you look at the stockpiles sitting in China, you see that the Australian material is piling up and the Brazilian material is decreasing. That's not because Brazil is not delivering.
It's all because the demand for Brazilian ore is higher than the demand of the sum of the Australian ores, and that means the premiums. The structure is actually the same on the depletion as I told the aluminum story. There is some fundamental unbalance in the market, which now becomes very explicit. The market will have to react. For the moment, the market is reacting, giving Brazilian blend material higher premiums. We expect them to increase a bit in the future, but then probably stay at those levels. Okay. Marco, just to give you some clarity on the story. I think it is the case that impact battery EV is coming. I think the trend has a lot of potential. The question is always exactly how fast and how big is the trend?
This year, we're talking about a 38,000 ton demand for batteries, for future of batteries . It's almost, I would say relevant, but very, how can I say, not a lot of impact. Looking scenario that we could create on the back of the government decisions that are being taken around the world, it can easily rise from 350,000 to 500,000 tons of nickel. That takes all the excess capacity that we have today in class 1 that will be fed into class 2. We are positive. We always work in a conservative scenario to do our homework here. It has to be done, as we mentioned in the previous call. We need to organize our house to be ready for this growth because growth is coming. Many of you are China addicts. This is a China play.
Although there are initiatives coming from U.S. and Europe is always concerned about the environment, I believe that the true driver behind the growth of EVs is China due to multiple factors. It's relevant for the pollution that is impacting our . We talk all the time. It's relevant for their geopolitics that they're going to build a new industry around EVs. It's relevant for their grid. They're going to have to store all the renewable that they have. For China, it's a no-brainer. They already produce in the range of 1 million cars a year with EVs. It's obviously a game, but it's a game that we are really conservative in how we approach to it. We're really focused on our homework to be ready for that. Giving some numbers to you, now 38, and we believe it's going to be 350,000-500,000 in 2025.
Okay. Thank you.
Perfect. Thank you very much.
This concludes today's question and answer session. Mr. Fabio Schvartsman, at this time you may proceed with your closing statements.
Thank you again once more. It was a pleasure to have all of you in this call, and I hope to have you back in the next one in the next quarter. In order to finalize, I just want to emphasize that the company will continue to perform the same rate as we've been performing. The ability and stability of the company is there. We are hoping to get in the next quarter the same kind of results or even a little better than the results that we have delivered in the former quarters. Thank you so much for all of you, and have a good day. Bye-bye.
That does conclude Vale's conference call for today. Thank you very much for your participation. You may now disconnect.