Valemax Strategy Further Imperilled

BMI View: We expect further complications for Vale 's strategy of increasing its Chinese iron ore market share after China's Transport Ministry reaffirmed a long-standing ban on Valemax ships berthing at Chinese ports. After ordering a review of the policy in August 2013, the Ministry recently announced that only ships up to 250,000 deadweight tons (DWT) could berth at Chinese ports from July 1st, effectively preventing Vale's class of over 30 very large ore carriers (VLOCs) from shipping directly to China. We still expect China to be the top destination for Vale's iron ore, but believe the firm could lose market share to its Australian rivals due to cost competitiveness.

We believe the recent decision by China's Ministry of Transport to ban ships greater than 250,000DWT from docking in Chinese ports is likely to lead to Vale experiencing difficulties in expanding its market share in China and increases the risk it loses out to Australian rivals. The decision effectively solidifies China's ban on the 400,000DWT Valemax fleet, a major blow to Vale which primarily built the fleet to increase iron ore export volumes from Brazil to China, and to do so at a lower per-unit cost. The decision stems from objections by both Chinese steelmakers and shipping companies, who feared allowing the Valemax ships into China would give the Brazilian firm monopolistic control over iron ore supplies, and hence prices. By banning the Valemax fleet from entering Chinese waters, Vale will be unable to extract the cost savings it sought to increase its competitiveness with Australian rivals BHP Billiton (BHP), Rio Tinto (Rio), and Fortescue Metals. Rather, iron ore shipped to China will either need to be loaded onto smaller vessels in Brazil or transhipped through ports in the Philippines or Malaysia. Thus, even with current global shipping costs subdued, Vale still faces the spectre of higher transport costs at a time when iron ore prices are trending lower with the economic slowdown in China.

Going The Distance

Australian Domination To Continue
China - Iron Ore Imports By Country (mnt, 2013)

BMI View: We expect further complications for Vale 's strategy of increasing its Chinese iron ore market share after China's Transport Ministry reaffirmed a long-standing ban on Valemax ships berthing at Chinese ports. After ordering a review of the policy in August 2013, the Ministry recently announced that only ships up to 250,000 deadweight tons (DWT) could berth at Chinese ports from July 1st, effectively preventing Vale's class of over 30 very large ore carriers (VLOCs) from shipping directly to China. We still expect China to be the top destination for Vale's iron ore, but believe the firm could lose market share to its Australian rivals due to cost competitiveness.

We believe the recent decision by China's Ministry of Transport to ban ships greater than 250,000DWT from docking in Chinese ports is likely to lead to Vale experiencing difficulties in expanding its market share in China and increases the risk it loses out to Australian rivals. The decision effectively solidifies China's ban on the 400,000DWT Valemax fleet, a major blow to Vale which primarily built the fleet to increase iron ore export volumes from Brazil to China, and to do so at a lower per-unit cost. The decision stems from objections by both Chinese steelmakers and shipping companies, who feared allowing the Valemax ships into China would give the Brazilian firm monopolistic control over iron ore supplies, and hence prices. By banning the Valemax fleet from entering Chinese waters, Vale will be unable to extract the cost savings it sought to increase its competitiveness with Australian rivals BHP Billiton (BHP), Rio Tinto (Rio), and Fortescue Metals. Rather, iron ore shipped to China will either need to be loaded onto smaller vessels in Brazil or transhipped through ports in the Philippines or Malaysia. Thus, even with current global shipping costs subdued, Vale still faces the spectre of higher transport costs at a time when iron ore prices are trending lower with the economic slowdown in China.

Australian Domination To Continue
China - Iron Ore Imports By Country (mnt, 2013)

Going The Distance

Currently, Vale sells about 40% of its annual iron ore production to China, but is keen to grow this percentage. As the largest primary steel producer in the world, China consumes approximately 70% of total seaborne iron ore, making it by far the largest single market. Australia remains China's largest supplier, with slightly over half of the market, with Brazil remaining second. Vale's main disadvantage vis-à-vis its peers is Brazil's distance from China, with high transport costs hurting its competitiveness. The main Brazil-to-China shipping route, which goes east across the Atlantic and around the southern tip of Africa, takes between three to four times as long to complete compared to the Australia-to-China routes (9-12 days versus approximately 35 days).

Links To Riches In China
Map - Countries & Ports

Indeed, Bloomberg estimates that shipping costs from Australia to China are approximately US$13 less per metric tonne compared to those from Brazil. To mitigate this, Vale placed a major bet on using its Valemax VLOCs, with a capacity of 400,000DWT each, to decrease shipping costs to China by about one-third and thus allowing the firm to be more cost competitive. Vale benefits from an integrated supply chain, which allows relatively low overall costs, but the distance, and hence time, it takes for its iron ore to reach Chinese shores partially lessens that advantage. With the ban in place for the foreseeable future, Vale will have to use a transhipment hub in the Philippines, as well as one in Malaysia (currently under construction and expected to become operational later in 2014), to utilize its Valemax fleet for Chinese iron ore shipments, further increasing already long shipment times. We note that even with global shipping rates subdued due to overcapacity, the Valemax ban still remains an impediment for Vale. The Valemax ship was set to allow Vale to achieve lower per-unit costs than other means of shipping and work towards levellingthe playing field with Australian competitors. Without being able to use the VLOCs to ship directly to China, this advantage will elude Vale.

Despite Low Prices, Chinese Ruling Still A Blow To Vale
Baltic Exchange Capesize Index

Competition To Heat Up

We expect further pressure on Vale in the coming years as its Australian rivals BHP, Rio and Fortescue seek to increase their own Chinese market share. Recent earnings results indicate the former two firms have been particularly successful in expanding output at current iron ore mines in Australia while concurrently reducing operational costs. Indeed, both BHP and Rio reported increased profits in their latest financial releases, with BHP reporting lower unit costs and Rio citing output expansion at a cost of more than US$3bn below previous expectations. This will further push both firms down the cost curve, increasing their competitiveness. Vale too is pursuing operational efficiencies while maximizing production volume, but transport times and costs still put the firm at a disadvantage.

High-Cost Chinese Tonnage At Risk
Global - Iron Ore Cash Costs By Company (US$/tonne & Production As % Capacity)

We also expect further challenges for Vale due to our forecast for falling iron ore prices. We forecast iron ore prices to average US$103/tonne between 2014 and 2017, compared with an average of US$135/tonne in 2013. As growth in Chinese steel consumption slows due to reduced fixed asset investment, and as more Chinese steel production capacity switches to the electric arc furnace (EAF) method, major producers will have to fight even harder for a share in a market past its peak. One upside risk for major iron ore producers is China's crackdown on pollution, which should increase demand for high-grade iron ore that does not need sintering, a process that removes impurities and which produces more pollutants. Both Vale and Rio in particular produce significant quantities of high-grade iron ore, which may lead to increased sales of such ore products to China with the push to curb environmental pollution.

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This article is tagged to:
Sector: Mining, Infrastructure, Freight Transport, Shipping
Geography: Brazil, Australia, China, Malaysia, Philippines
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