Good morning, ladies and gentlemen. Welcome to Vale's conference call to discuss second quarter 2019 results. At this time, all participants are in a listen only mode. Later, we'll conduct a question and answer session. Instructions will be given at that time. If you should require assistance during the call, please press the star followed by zero. As a reminder, this conference is being recorded. The recording will be available on the company's website at vale.com, at the investors link. This conference call is accompanied by a slide presentation, also available at the investors link at the company's website. It is transmitted via internet as well. The broadcasting via internet, both the audio and the slides changes, has a few seconds delay in relation to the audio transmitted via phone.
Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. Actual performance could differ materially from that anticipated in any forward-looking comments as a result of macroeconomic conditions, market risks and other factors. Today with us are Mr. Eduardo de Sales Bartolomeo, President and CEO. Mr. Luciano Siani Pires, CFO. Mr. Marcelo Spinelli, Executive Officer for Ferrous Minerals. Mr. Mark Travers, Acting Executive Officer for Base Metals. Mr. Marcos Medeiros, Executive Officer de Segurança e Excelência Operacional. Mr. Luiz Eduardo Osorio, Executive Officer for Sustainability and Institutional Relations. Mr. Alexandre Pereira, Executive Officer for Business Support. Mr. Alexandre D'Ambrosio, General Counsel. Mr. Juarez Saliba, Director of Coal, Strategy and Mineral Exploration. Mrs. Marina Quental, Director of People.
First, Mr. Eduardo Bartolomeo will proceed to the presentation on Vale's second quarter 2019 performance, and after that, he'll be available for questions and answers. It is now my pleasure to turn the call over to Mr. Eduardo Bartolomeo. Sir, you may now begin.
Thank you. Good morning, everyone. I would like to begin by expressing our respect for the families that have been suffering since the dam breach in Brumadinho. I want to thank once more our employees, the authorities, the firefighters, the civil defense, and the volunteers, all of them deeply engaged to provide support and comfort through such tragedy. Safety, people, and reparation. These three words will continue to be our priorities and define our actions since I took on the responsibility of leading Vale. The safety of the people who work in our operations, the people from our communities. This is our obsession. This is what moves us to transform the company. It will be the safety of our assets and our processes that will ensure the safety of the people in our operations. Please, next slide. Vale is totally committed to repairing damage.
Over the past six months, we have made progress with countless measures to ensure the safety of the people and to repair the impacts caused. The special department for recovery and development, coordinated by Marcel, has been working with agility and flexibility with the objective of alleviating the suffering of the families, as well repairing the losses, interacting directly with communities and authorities. Caring for people is fundamental. Increasing the financial security of the families is only a part of that. On this front, we have advanced with individual agreements with those who reach for us. At the same time, we have opened a dialogue with all the authorities involved with the reparation efforts. We can build together a fair and quick solution through collective agreements.
An example is the agreement established in July with the Public Ministry of Labor of the State of Minas Gerais, which had the participation of workers' unions and already had legal approval. On the environmental front, we have submitted a tailings contained plan to the authorities. We have completed several structures in the Ferro-Carvão stream water station to ensure that no more tailings are carried from the dam's breakpoint toward the Paraopeba River. For a quick repair of the damaged infrastructure, a package of work is underway and includes, among other projects, the maintenance and improvement of some 700 km of roads in Brumadinho and region. Lastly, we continue to give transparency to the investigations into the causes of the tragedy. The two investigations started internally, one conducted by a panel of specialists and the other by an an independent committee, are also ongoing. Please, next slide.
Our safety and risk management is being reinforced. We are on a journey to transform Vale into the safest and most reliable mining company in the world. The new Safety and Operational Excellence Executive Office is independent from operation and reports directly to me. This structure strengthens our strategic pillar and aligns our safety and risk management governance with the best benchmarks in the world. Carlos Medeiros, with us in the call, with solid experience in managing large transformational projects, will be an important leader on this front. We focus on safety and operational excellence at Vale. We are continuing to search for best ways to raise the safety level of our assets. We have been working to accelerate the de-characterization of nine upstream dams in Minas Gerais, and we expect to deliver the first two complete decommissioned dams, Fernandinho and 8B, in the first half of 2020.
In June, we were able to increase the safety level of the Vargem Grande dam. Thus, people were able to return to their homes. This is the result of a series of improvements that Vale has been implementing in the structure since January, such as lowering the reservoir water level and cleaning the drainage channels. Please, next one. Well, we are also advancing in our strategy. As we said at the end of the first quarter, Vale's strategic agenda will also be one of continued focus on the three strategic pillars established in 2018. Strong discipline in capital allocation, maximizing the flight to quality in iron ore, and turnaround of base metals. We have made progress in this quarter. It's still a transitional quarter for Vale, which has a premise of reducing risks in our business.
With the appointment of Marcelo Spinelli as Executive Director of Ferrous, and with Juarez Saliba taking the leadership coal business, we have taken important steps towards the stabilization of production and the reliable and sustainable development of both business. In iron ore, we have made substantial progress. As mentioned in our last call, expectation of resuming operations at the Brucutu Iron Ore mine was confirmed in June. We have also partially resumed dry processing production at the Vargem Grande Complex, and we are having conversations with the National Mining Agency to restart other dry processing operations as well. Maximizing the flight to quality in iron ore remains one of our top priorities. Accordingly, I would like to confirm today the conclusion of Ferrous acquisition, which was announced in December last year and recently approved by CADE, the Brazilian antitrust agency.
This acquisition will increase Vale's production with high-quality pellet feed at competitive costs. Our effort to transform Base Metals are ongoing. In this quarter, we performed strongly at the Sudbury mines in Canada. In New Caledonia, we have the biggest challenge of the Base Metals business. Our approach in VNC has been the full transformation of the management system. One example in this regard is the preventive maintenance plan under implementation. Our expectation for Base Metals, as previously stated, is to see the first results of these transformations starting from the fourth quarter. As for coal, we are working to stabilize production and overcome the operational challenges that have impacted our performance. We are developing our knowledge of the deposit, which will allow us to be more assertive about levels. Finally, all of our actions must support our new pact with society.
We want to restore society's trust in our ability to operate with safety while creating shared value, fostering sustainable economic development in the territories which we operate. We are committed to the redefinition of mining in Brazil and around the world. Please, next one. It's important to reinforce that we are going towards great reliability. The second quarter reflects a transitional period. We had great pressure on volume and costs, which are already starting to show a positive trend for the coming quarters. The reduction of uncertainties in our business is in progress. With actions to improve safety and risk management, with actions to stabilize production in all lines, and with greater predictability of expenses with Brumadinho and others. Resuming operations in Brucutu and part of the direct processing of the Vargem Grande Complex is an important step to restore in iron ore.
On the financial and operational perspectives, we have had a strong cash generation, which will help us honor our commitments to society and strengthen our balance sheet further. Luciano will give more color on these points later. We believe we are on the way to a fair and quick reparation and to the rebirth of Brumadinho in the medium term. We continue to work tirelessly to increase our safety, support the people, and repair the damage caused. I'm confident that this ongoing change will transform Vale into a safer, more sustainable, and even more human company. A better company. Thank all you for your time today, I'll now pass the word for Luciano to make the comments on the financial results.
Good morning and good afternoon. I will start going through the provisions. As you saw, we provisioned about $1.2 billion of a total of $1.5 billion for environmental reparation this quarter. The key message here is that now we have a comprehensive level of provisioning to all the scopes that we believe will be the subject of our reparation. Any changes to those provisions will come from a refinement of the numbers going forward as we get more information about how the programs will develop. You should not expect any additional scope to be included in the provisions. How did we get to those $1.2 billion in environmental provisions? We based ourselves on the agreements already signed that we already know what we need to do on this topic.
We based ourselves in the agreements which are under negotiation, for which we already have a clear view of what the final scope will be. We're also including compensation measures. We already have also indications about what kinds of compensation the authorities will demand for the environment. For example, these provisions include tailings removals, dredging of the river, recovery of fountainheads, recovery of degraded areas, and even sanitation compensation efforts, water supply security for some of the cities, water sourcing alternatives, water treatment stations. This is very comprehensive. In total, we have already booked in our balance sheet $5.7 billion, including not only the environmental, socioeconomic, but also the provisions for decommissioning of dams. Relating to the business now, going to iron ore. On the volumes, just to make a simple calculation for you.
Of the 400 million nameplate capacity that Vale has, at one point in time, we had 90 million tons stopped. Plus 9 million tons of the Córrego do Feijão mine in Brumadinho, which will never come back. Therefore, our production capacity bottomed at 300 million tons. Now we have about 30 million back of Brucutu and 12 million of dry process in Vargem Grande. Therefore, as we speak, we have a total production capacity between 340 million-345 million tons annualized. Additional comebacks of operations will add to that number. In terms of costs, as you saw, there was an important increase in costs from the first to the second quarter. Three main drivers for that. Demurrage costs, which we underestimated when we spoke to you on the last call. This is completely normalized now. The line of vessels is back to normal levels.
There's the iron ore prices, which impact the purchase of feed from third parties, and that's good news, right? It has impact on costs. There's the cost carryovers because of the 45-60 days which takes from production costs to flow through inventories and then to be sold. If you take this, you have approximately $160 million of excess demurrage and the lack of cost. If you add on top of that, the $351 million of stoppage and other expenses related to Brumadinho, of which $225, and you find all those numbers in the release, relates to stoppage expenses themselves, and $126 to logistics extraordinary expenses. When you add all of this, you get to approximately $500 million of ongoing recurring effects on the business related to the stoppages and to the consequences of the Brumadinho dam breach.
What we're telling you is we have addressed the reparation cost fully to our best knowledge on the balance sheet. However, we have $500 million of recurring business impact, of which we expect a reduction going forward. What reduction? We expect a $2.50 per ton reduction on C1 because of the elimination of the demurrage effect, cost dilutions, and the reduction of the carryover effects on costs. We expect $1.50 per ton of reduction in expenses related to the comeback of some which naturally reduce the stoppage expenses. When you add those 2.5 plus 1.5 multiplied by production, we expect of those $500 million recurring impact on the iron ore business, $300 million will be out of the financial statements next quarter. That's the size of the improvement we're expecting going forward. Another topic important in iron ore is freight.
You saw the very steep increase in spot rates in the month of July, reaching $27 per ton from Brazil to China. This will not meaningfully impact Vale on the third quarter. We expect a very small marginal increase in our average freight rates. The main reason for this is because of the smaller production, our exposure to the spot market today is minimal. On the fourth quarter, if you want to discuss, we can do later. We will start to see some effects of the new IMO regulations, which will then be mitigated over 2020 and 2021. The freight rates on a relative basis, the freight rates for Vale will remain very competitive even in this environment of increased freight rates. Talking about the other businesses, just very briefly, I would like to stress the very strong performance for copper. We will reach our guidance this year.
Why is this important? Because part of the copper production comes from the Canadian mines. The Canadian mines are performing very well. The mines, the mill, the smelter. You're not seeing this in the nickel numbers because of specific problems we had with the refineries. The copper production doesn't flow through the refineries. It is proof that with the turnaround of base metal going to bear fruit in Canada, that we are increasing by more than 30% the copper production from Ontario this year, and we're gonna reach our guidance. It's gonna be very strong, Q3 and Q4. In nickel, Q3 will post an improvement, although because of the scheduled mine maintenances, not as strong as what we'll see in Q4, which will then be very strong. Do not expect improvements yet in New Caledonia in the second half. We may discuss this in the Q&A.
You saw a little bit of increase in financing costs because of the additional debt that we took over to buffer up our cash resources in the first quarter. This additional debt has been repaid, so financing costs will come down over the next quarters. When you look at net income, we had also non-cash impacts that go beyond Brumadinho. Most importantly, the Germano dam, which is a dam at Samarco, will be decommissioned as well. We have an estimate of over $500 million to be decommissioning, so Vale share was provisioned. We also had an update on the indemnification expenses through the Renova Foundation in Samarco and Vale share, $383 million was also provisioned. Investments came in low, but they will recover on the second half, so we still expect to reach over $4 billion in investments this year.
You saw the very strong cash flow numbers, which will naturally improve into Q3 and Q4. In summary, what we expect for the second half of the year is marginal variations in the provisionings on the balance sheet related to Brumadinho, decreasing costs and higher production volumes with the recovery of the operations, some already announced and some that we expect.
Excuse me. I'd like to make a correction. The name of the Executive Officer of Safety and Operational Excellence is Carlos Medeiros, and not Marcos, as I said before. 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 now. If at any time you would like to remove yourself from the queue, press star two. Please restrict to two questions at a time. The first question comes from Carlos de Alba, Morgan Stanley.
Good afternoon, gentlemen. First question would be on what are the next steps on concluding the agreement or the framework related to the Brumadinho event. When do you expect, or when can we expect perhaps to have the sign-off of the prosecutors and the other authorities in Brazil so that we can, or the company and the market can close this tragic event, and start focusing on actual reparations and indemnifications, which I understand you have already started. My second question is regarding the restart of the 20 million dry operations that I see in the slide that you presented. What I read in the release is that by year-end, they should be restarting.
Does that mean that only at the beginning of next year they will start producing, or can we expect a gradual ramp-up throughout the second half of the year, therefore by the beginning of next year, the 20 million run rate will be already achieved? Thank you for the clarifications.
Carlos, like in the case of Samarco, where you had one single agreement to address all the topics of the civil lawsuits. We've been addressing specific matters of the civil lawsuits one by one. We have already 15 agreements which have been already settled, which means that the scope of the remaining agreements to be signed keeps reducing. There will come a point when the authorities feel that all the relevant topics of the lawsuits have been addressed, that yes, there can be a suspension of those lawsuits. Through the progress that we've been making, we expect this to happen until the end of the year. What is important to notice is that you talked about closing this tragic event. From a perspective of estimating the total financial impact, given all the negotiations that are ongoing, we expect this to be a quarter of closure.
From a legal standpoint, obviously, we need to see the agreements be signed one by one. One concrete example of that is that we, in the first quarter, we made a provision for the reparation of our employees and of the families of the deceased employees. We finalized, from a legal perspective, the agreement this quarter, and we actually eliminated the civil lawsuit. The difference between the final agreement and the original provision was small. That's the dynamics that we expect going forward. There will be perhaps some differences in the actual numbers and the provision numbers up or down. From a scoping perspective, everything that we know and that's on the table being negotiated with the authorities is being taken care of, and we have an expectation that until the perhaps we will address all the issues from a formal perspective.
Carlos, this is Marcelo Spinelli. Thank you for your question. It's a pleasure to talk to you. It's my first time here. Regarding the production, we already have our one-third that we are already talk about the dry operation. Just reinforce, already have the return of the peak of production in Vargem Grande. Just to answer, that's a gradual return. Just to have in your mind what is based on, we need to prove and talk to the National Mining Agency that we don't have any impact in the dams. That we call a seasonal impact. We need to check with engineer tests to guarantee that we can return, step by step, the operation. We are committed to have this return in the next 6 months.
Just to reinforce what you said, we expect to have the run rate operation in the next year, but to recover partially the operations during the next semester.
The next question comes from Timna Tanners, Bank of America Merrill Lynch.
Yeah. Hey, good morning, thanks for all the great detail. I wanted to take a step back and ask if you could give us some detail on the expansion plans in the northern system and remind us about your progress or your projections there, timing wise, and also the necessary infrastructure involved to get to the increased production targets. My second question was really hoping for more detail on nickel, also a bit high level. I know in the past you've talked about potentially consolidating or divesting some of the underperforming assets, but there's also been some headlines about some potential big investments there. Just wondering if you can clarify how you're thinking about that business over the medium term. Thanks very much.
Timna, thanks for the question. I will here. I think the process undergoing there is an operational turnaround. We need to structure the business to be able to whatever route we can. I think, as Luciano mentioned, we've been doing progress very well in Canada, and we're struggling with New Caledonia, as we already said. For that sense, we keep our strategy to catch the upside of the electric vehicles for the nickel. As I think some announcements that have been made in Indonesia are around the joint ventures that will be created internally funded by PTVI, by the way, very important. Sorry, just a minute. No, I'm fine. Keep going. Sorry, Timna. They'll be self-funded from PTVI. Basically, nickel is focused on transforming the business, on transforming the operation, having the assets on a condition that they're supposed to be.
Most importantly, as I already pinpoint, is VNC, that is really underperforming. I think nickel is up to capture the upside from electrical vehicles. I think the expense plans for the north, I'll pass the word for Marcelo Spinelli.
Eduardo, before you go on, perhaps you should comment on Indonesia, because that was perhaps the headlines that were mentioned by Timna.
Yeah. I mentioned Indonesia. I think that was exactly when we had the problem with the phone. Those headlines, they related to the investment that has to be done in Indonesia for the resource. They will do on a joint venture basis and fundamentally through the financing of the PTVI. It's going to be an equity finance. The exposure of risk and finance is being discussed. It's nothing approved, by the way. It's just a matter of the development of the resources in Indonesia.
Hi, Timna. Thank you for the question. It's a pleasure to talk to you. Just let's divide this in three steps. First one is about the ramp-up of the S11D. It's going really well. We're going to run rate this quarter of 230 million tons. We expect to expand the system, the northern system, to 240 on the second half of 2022. We're already planning. We don't have yet conclude the project. We're planning to expand the S11D to 150 million tons. We're going to have further information about this expansion when we get the final details of the engineering.
The next question comes from Chris Terry, Deutsche Bank.
Hi Eduardo and Luciano. Thanks for taking my questions. The first one is on the pellet market. You have guidance set this year at around the 45 million ton level. Does this include the acquisition of the 4 million tons? I don't think it does. Can you just talk about your pathway back to 60 million tons and above? Also just some thoughts on how Samarco might fit into your medium-term pellet guidance. Thank you.
Well, thank you, Chris, for your question. Regarding pellet market, well, we have the constraints in production. We now have the number of 45 million tons of production this year. This depends on the pellet feed production that we are out of product in the southern system. Regarding the production today, we are full in Tubarão and the north system and also Oman. To recover about 11 to 15 million tons of production in the southern system, we need to recover the production of pellet feed that we still have to wait for the return of the wet production in the southern system. Gradually we're going to return this production, in this case, end up more mid to long term view in almost two years.
We can feed these plants, Fábrica and also Vargem Grande using some product from Ferrous, but we still don't have the total capacity to return these plants. We plan to recover this in the few months, but we need to guarantee the pellet feed production to have this.
With regards to Samarco, the expected restart for Samarco is second half of 2020, but Samarco will restart with only a third of its capacity, so 10 million tons. Still this third will be subject to a ramp up. To add a second concentrator to Samarco depends on additional work towards tailings systems. Samarco had a plan to restart a second concentrator soon thereafter the first concentrator, but these plans were jeopardized because of the new regulations following Brumadinho. It's currently working on adjustments to its business plan to see when the second concentrator should restart. A third concentrator, even in the original business plans, would be dependent on the permitting of a brand-new structure, be it probably a new tailings dam, which becomes even more of a constraint in the much medium to long-term future.
Do not expect Samarco to make a meaningful contribution to seaborne pellet markets in the short term.
Our next question comes from Amos Fletcher, Barclays.
Hi, good afternoon, gentlemen. Just one question really. I just wanted to ask about the 20 million tons of dry processing you're potentially gonna bring back. I just wanted to ask, given how quickly the Vargem Grande capacity was restarted, could we expect that the next 20 million tons of dry processing could restart sooner than the year end? Could you also give some clarity on how that dry processing output will influence your product mix? Thank you.
As I told, it depends on negotiation and also studies in engineering designed to test actually the impact of the regular production, the dry production in the dams. Actually, we need to do this side by side with the National Mining Agency. They have a line to progress this analysis and return step by step. The first one was Pico in the Vargem Grande production. We're waiting to recover Abóboras, Timbopeba, Alegria, Fábrica. Step by step, we are expecting to do this in the next six months. The recovery is gradual, and we're waiting the first quarter next year to have a run rate production of the other 20 million tons. Regarding product mix, it is important to say this product will feed our BRBF, the Brazilian fine blends that we blend with the Carajás fines.
It's a very important product to guarantee that we have the total use of the Carajás and the important product to the market. This will all feed the BRBF.
Carajás fines cannot be mixed with other lower quality ores to make BRBF because the specific product from the south, the dry processing from Vargem Grande, for example, has very low alumina. A key feature of the BRBF is low alumina. Whenever you bring Vargem Grande back, for example, you do more BRBF, which you couldn't do otherwise.
The next question comes from Grant Sporre, Macquarie.
Hi. Good afternoon, gentlemen. Thanks for hosting the call. Just two questions on my part. Just a small sort of technical one. The Viga mine, just which system will those tons be reported under? A very simple question. The second one is it too soon to be restoring the old dividend policy, just given that you now have more clarity on provisions, your debt has come down, and the cash generation in Q2 was very strong? Thank you.
Hello, Grant. It's a pleasure to talk to you. Well, the Ferrous production will be connected to the south complex. We can use to feed our plants of Fábrica, the pelletization operation. We still have contracts in place that we need to finish. We're going to keep these contracts to the end of the year. We have a decrease of these contracts. After this end of the year, we can use the product to feed the production in the south system.
Okay, Grant, thanks for your question. Just to be very clear, we're not discussing dividends now. Our focus is totally on the reparation and restoring our risk profile of the company. Okay, thank you for your question.
The next question comes from Tyler Broda, RBC.
Great. Thanks very much for the call today, everybody. My question actually, just gonna ask a similar question to Grant. I guess, while I'm on the line, have you seen with any of the falling Chinese steel margins, have you seen any change in the behavior of your customers yet?
Well, Tyler, thank you for your question. The margins of the steel market in China, well, depends on the production and to keep the strength of the market there. We really believe in three components that are still pushing the sales and the production. First one is about the property market that we think that slowing down, but not really something that we need to be worried. The Politburo is not reinforcing the stimulus. On the other hand, we have the manufacturing, the production of future investment that can recover. Considering this part of the balance of supply-demand, on the supply mode, we see the pressure. We still have the recovery of Vale and the other majors, Australian majors, but we still have a gap in the stocks. This is a gradual process to rebalance the demand and the supply.
The price is too high. They are pressured by the raw materials cost. We still see a constraint and a narrow margin for this market.
Okay. Just for coming back to Grant's question, sorry, Tyler's question about dividends. Being very clear that we have other options to do. Luciano will explore a little bit where our minds are in the short term. As I mentioned, focus on repairing. In due time, we will come back to discuss that. There are other options that we can discuss as well.
We are very mindful of the needs of our shareholders, and no one more than us would like to get back to normal so we can resume dividend distribution. In the meantime, the way we're thinking about the balance sheet is, you saw that with the releases of funds, our pro forma net debt is about $8 billion today. There's another $1.8 billion of leases in the balance sheet, IFRS leases. Those $5.7 billion that were provisioned, they will need to be disbursed at some point in time. One should think perhaps of these $5.7 also as a liability when you think about capital structure. It's also true that if the cash flow generation was strong in the second quarter, it will be even stronger in the third and fourth quarter.
If you think about our $10 billion target net debt, when you put this all together, we're not there yet. On the other hand, once the cash starts coming in, there is no alternative use for it in projects or whatever, rather than manage the balance sheet and perhaps make a nest egg for future distributions. In terms of use on the balance sheet, we can, yes, address part of those leases, which today consume financial expenses. There are other liabilities on the balance sheet. For example, minorities still have shares in MBR, one of our subsidiaries. There are others that may be addressed on the second half. If eventually the balance sheet becomes under-levered, this will be fixed when, let's say, the social license to pay dividends comes back. We will likely re-lever the balance sheet in order to do the proper distributions going forward.
This is, I'd say, a medium-term concern of management. Shorter term, as Eduardo underscored, we are not discussing because we are very mindful of what the homework we need to do first.
The next question comes from Alex Hacking, Citi.
Hi, and thank you for the call. I have two questions related to iron ore. First question, could you discuss your inventory strategy in the second half of this year? Second question, once Vale is back to 400 million tons in two or three years' time, should we think about your cost structure being back where it was historically, or will there be some long-term effects from Brumadinho in terms of operating costs? Thank you.
Hello, Alex. Thank you for your question. This is Spinelli here. Talking about inventory, the first half we used about 6 million tons of our stocks to guarantee the sales. Actually it was a trend in the market. In China, we could see a decrease of 30 million tons half. What we see is the supply-demand is more in the trend to recover balance. We don't see for a market this fast recovery of the inventory, but it's a midterm process to recover the inventory. That's what we expect with the decrease of the inventories in the whole China for the whole suppliers.
For all practical purposes, we believe the cost structure will return to the 2018 levels. From a strategic perspective, perhaps, obviously, Vale will spend more, for example, on dry stacking. We will accelerate our plans through New Steel to do dry concentration, the impacts on the cost structure will be marginal in longer term and more than compensated by the ongoing cost reduction initiatives, digital transformation, operational excellence, and cost cutting. Well reminded. Just a note for you. In May of this year, so two months ago, S11D reached the nameplate business case cost performance of less than $8 per ton. We reached $7.7 per ton at S11D. As the S11D proportion, the overall of Vale increases, you're not seeing it today because of all that noise around the cost structure. Structurally, you could have a lower cost structure because of the larger share of S11D.
The next question comes from Sergey Donskoy, Societe Generale.
Yes. Thank you very much. I have one question. Apologies if it will be a simplistic one. Just trying to understand your production performance in iron ore and put this into context of your guidance. In Q2, iron ore production outside of Northern system was in annualized terms roughly 90 million tons. In Q2 last year, it was around 200 million tons. The average over the last three, four years was also around 200 million tons. We're talking about roughly a decline of a magnitude of about 110 million tons. How can this be reconciled with 93 million tons, which, as you show in the presentation, was the effect of those stoppages? What was the additional impact in Q2 that led to stronger decline? Thank you.
Well, that's a hard question. I would guess that we are talking about typical variations, and we may have had a weaker quarter in some operations in the south, but I'm quite sure that Actually, when we talk about 90 million, it's 93 million. This is the loss of production. Every operation has some long-term trends towards production. Sometimes, for example, the production within Mariana has been coming down slightly over the years. Our production in Itabira had a great jump in 2015 and 2016 and now was coming down recently. You can be pretty sure that the bottom of the production capacity of Vale was 300 million tons, when we had 93 million tons stopped plus 9 million. Oh, that's a good point. One piece which is missing is the 9 million tons of Brumadinho itself, which will never come back.
When we say that we have 93 stopped, the actual total loss was 102 because it's the 93, which may eventually come back, plus nine that will never return. That accounts to half of your difference. I'm pretty sure that the other half is small variations amongst the different operations. As a consequence, which is implicit in your reasoning, is that the northern system is increasing and compensating part of this larger loss in the south. Today, the total, when we talk about 400 million tons of capacity within Vale, people should think more of 220 to 230 in the north and 180 to 170 in the south. That's what we need to do, is to try to recover this 180 production in the south and the southeast.
Our next question comes from Alfonso Salazar, Scotiabank.
Good morning or afternoon, and thank you for the call. I have two questions. The first one is regarding demand, iron ore demand outside China, because what we have seen the first half of the year is very strong crude steel production in China, but not so in the rest of the world. If you can make comment on that, and also keep in mind that there is an increase on ferrous scrap use in the past year. How do you see that evolving in time? The second question is on the new pact with society that is one of your new strategies. If you can comment on something specific on the timing, how do you plan to implement that? Certainly, public opinion and investors need to understand that Vale is working under stricter and safety standards from now on.
If you can give some details on this as well. Thank you.
Thank you for your question. This is Spinelli speaking here. Well, as you said, China is pushing a lot of pressure on the demand, actually making the price higher. We expect a 5% increase in the production and the demand there. Ex-China, we are confident in the lower growth, it's 1%. We have some pressures in some markets regarding the problem of the high price. This is specific for China, but they are the price setter of the market. We have in Europe some productions that are slower with lower growth than we expect in the beginning of the year. They are keeping the growth in 1.5%. That's what we are working on in our forecast.
Alfonso, thanks for your question. I'll try to be brief. This pact, it starts with the fundamental thing that society has to trust that we can operate safely. That is a broader discussion, has to be done with society, has to be done with the regulators, with the associations. In Brazil, we are talking with IBRAM, with CNI, for instance, on that sense. In the world, we're talking ICMM, as you know, is developing new standards for mining. First of all, safety is the key issue here. Second, we have to expand development to where we operate. Brumadinho is a good example because you stop the mines, suddenly you have to restore economic development there. You should prepare when that happens in the sense of Itabira, is something that's coming. You need to prepare the new phase after mining is gone.
Developing the territory is a very important element in that. Thirdly, we are going to start discussing a lot, it has to do even with the scrap that you just mentioned. We need to create an environmental benefit for society. As miners, we have to look at the chain. We have to go beyond Scope 1 and 2, we have to look at Scope 3. Redefining our carbon footprint, we announced last year in a Vale Day our ODS, sorry, I'm translating to English. ODS with ONU, we're going to expand that. We're going to come even more aggressive on our strategic plan. In sum, it's operate safe.
Help the territory, develop the territory, and build a sustainable future for society. I hope I answered you well. Thanks for your question.
The next question comes from Peter Gurchenko, Barclays.
Hi, good morning. Thanks for taking my question. I wanted to follow up a little bit more on the debt reduction plan. Can you maybe be a little more specific on what you're contemplating with respect to debt reductions? Do you think the company could resume tendering for the bonds as you did in the past, or you're more targeting the loans and bank debt? If you consider tendering, maybe you can provide some color on how you're thinking on any particular tranche or reduction across the curve. Any details would be helpful.
Peter, this level of detail we cannot disclose. If you just do the math, it's pretty clear that we will need to attack everything at the same time. It's not that we have so many alternatives. What I indicated in my previous analysis of the balance sheet is that also beyond loans and borrowings, there are other liabilities that we may present opportunities for balance sheet optimization. Leases were an example. Minorities was another example. There are others. That will be the main source use of funds for the cash surplus until we resume paying dividends.
This concludes today's question and answer session. Mr. Eduardo Bartolomeo, at this time you may proceed with your closing statements.
Thank you for your participation and questions. I'd just like to reinforce, as we've been doing the call, it's a transition quarter. We are really moving towards a greater reliability. We are improving our safety, our risk management. We are resuming production. We increased predictability of the expense in Brumadinho. That's very well said. I just want to conclude my speech with the three words that are guiding our work inside Vale: reparation, safety, and people. Once again, thank you for your participation. Have a good day.
That does conclude Vale's conference for today. Thank you very much for your participation. You may now disconnect.