From the headlines, Brazilian miner Vale do Rio Dolce (VALE.NYSE, VALE3.IBOV) should be gaining favor in China at the expense of its principal rivals. Stern Hu, formerly Rio Tinto’s (RTP.NYSE, RIO.LSE, RIO.ASX) senior iron ore trader in China, was recently jailed by a Chinese court for commercial crimes. Meanwhile, BHP Billiton (BHP.NYSE, BLT.LSE, BHP.ASX) angered Beijing by trying to merge with Rio, creating what the government sees as an unfair monopoly.
Vale, on the other hand, is a sponsor of the Brazil pavilion at the World Expo in Shanghai and has been clogging Chinese television with commercials featuring football star Ronaldo thanking Vale’s Chinese customers. Yet in this year’s shake-up in the iron ore pricing system, which now allows prices to be set quarterly, Vale was the loser.
Although the new system is good for the miners, because they are not stuck in inflexible year-long deals for the price-volatile commodity, Vale suffers due to its relatively higher transportation costs. Iron ore prices were previously calculated free-on-board, with the supplier covering the shipping and insurance costs, but BHP has now switched to a landed price, under which freight costs are included in the headline price. Given that Australia is closer to China than Brazil, Vale is at a disadvantage.
"Vale was US$12 to US$17 more expensive per ton for steel, because of transport costs," said Paul Bartholomew, Australian manager at Steel Business Briefing, a consultancy. "Their iron ore is the best in the world so the mills tried to recoup the high transport costs elsewhere. But in this market, where the miners need every margin they can get, the transport costs could affect Vale’s competitiveness."
Vale’s long-term solution is economies of scale. The firm is building a fleet of the largest class of ore carriers that currently exist, which would greatly reduce transportation costs. In August 2008, Vale signed a US$1.6 billion deal with Rongsheng Heavy Industries for 12 ships capable of carrying 400,000 deadweight tons of iron ore. In September 2009, it ordered four more from Daewoo Shipbuilding (042660.SEO).
The recent PR campaign, coming only two years after Vale was chastised by Beijing for reneging on price contracts, might also help convince China to go with Brazil over Australia. But the China Iron and Steel Association, which links the government with the industry, doesn’t have much sway. On the ground, business is more important than politics.
"Even if politics dictate a switch, there aren’t many other options. Those three companies hold about 70 to 75% of the seaborne iron ore market," explained Bartholomew. "It’s not like you are suddenly going to get three more large miners appearing, or another China appearing. They need each other."