* Q4 net falls 21 pct to $4.67 bln, in line with forecasts
* Rising iron ore output cushions lower prices, higher costs
* Record $18 bln investments to start paying off in 2012
* Prices seen weak in 2012, below 2011 average -analysts
By Jeb Blount and Sabrina Lorenzi
RIO DE JANEIRO, Feb 15 (Reuters) - Vale SA, the world's No. 2 mining company, reported a 21 percent fall in fourth-quarter net income, as expected, hit by higher costs and weaker iron ore prices that analysts say could keep earnings under pressure this year.
Vale, which is the world's top iron ore producer and invested a record $18 billion last year, is struggling to replace production as older iron ore mines are depleted and ore quality declines.
This is inflating mining costs just as the average price of iron ore , its principal product, fell 11 percent to $141.80 a tonne in the fourth quarter from a year ago, hit by Europe's debt crisis and China's efforts to cool its economy.
The weaker earnings may in large part reflect a pricing concession by Vale to its Chinese clients in the fourth quarter, when it allowed contracts more closely linked to falling spot rates rather than averaging prices of the previous three months, said Mark Pervan, head of commodity research at Australia and New Zealand Banking Group.
Chinese steel mills demanded changes from miners, including Vale and Australian rival Rio Tinto, after spot prices fell in October to their lowest in more than a year, as slack Chinese demand curbed steel prices, and consequently, output.
ANZ sees iron ore prices averaging $156 a tonne this year, down 8 percent from 2011, and Pervan said that could cut Vale's earnings by 8 to 10 percent.
"We saw exceptionally high iron ore prices in the first half of 2011 and you're not going to see that reprised this year," he said.
"We see prices firming up in the second half but they won't be anywhere near last year's highs, given a still very restricted lending environment in China."
Squeezing more efficiency out of the company as metals prices fall and investment remains high will be a key challenge for Vale and Chief Executive Officer Murilio Ferreira, 58, who took the helm of the company last year.
The Rio de Janeiro-based company said net income in the three months to Dec. 31 was $4.67 billion, compared with $5.92 billion a year earlier.
The result was in line with the average estimate of 11 analysts surveyed by Reuters for a $4.68 billion profit. Compared with the third quarter, it was down 5.3 percent.
Iron ore production jumped 3.5 percent to 80.3 million metric tons in the quarter and reached a record 311.8 million tonnes for the year, or about one-third of world exports. Vale ships most of its output overseas, with around 40 percent bound for China.
"We broke several records despite a challenging economic scenario," Ferreira said in a statement, adding that the company benefited from strong global demand for its products.
The company invested $18 billion in 2011 to build copper, coal and nickel mines, iron-ore pellet plants, ports, ships and hydroelectric dams, which it said would only start showing returns this year.
The spending, while a record, was below an initial ambitious target of doubling spending to $24 billion, curbed by environmental licensing and labor constraints. Petrobras , another Brazilian resource giant, also saw investment spending constrained last year, posting its first drop in eight years as it struggled to secure equipment, technology and services.
Vale's revenue was little changed in the quarter, easing just 1.17 percent from a year earlier to $14.8 billion, as higher volumes made up for lower prices. Compared with the third quarter, revenue fell 11.9 percent, less than the 15.9 percent slide expected by analysts.
Nickel for three month settlement averaged $18,396 a tonne in London in the fourth quarter, 19 percent less than a year earlier and down 17 percent from the third quarter.
Vale has the world's largest nickel mining capacity.
Copper for three month delivery fell 13 percent to an average $7,530 a tonne in the fourth quarter from a year earlier and was down 16 percent from the third quarter.
Higher metals volumes also helped make up for the end of bauxite, alumina and aluminum sales, after the company sold its aluminum assets.
Expanded volumes may be Vale's best hope to keep profit from falling further as iron ore and metals prices are likely to remain below 2011 levels in 2012, according to Edmo Chagas and Antonio Heluany, analysts with BTG Pactual.
Investment in 2011 was heavily focused on Moatize in Mozambique, the Southern Hemisphere's largest coal project, the Onca Puma nickel mine in Brazil's Amazon, Vale's iron ore pellet and distribution facilities in Oman and Brazil's Estreito and Indonesia's Karebbe hydrodams.
All are in ramp-up or completion stages and will start generating value or reducing costs for the company this year, Vale said.