Vale's nerves of steel

As BHP switches the amber light on commodity prices, Vale is selling the idea of a major iron ore recovery in the second half of 2012.

The BHP Billiton caution about iron ore and other commodity prices is not matched by the world’s largest iron ore producer, Brazil’s Vale group.

And if the speculation of another US Quantitative Easing, which drove Wall Street higher last night, is right, then in the short term Vale’s optimism may be helped by a wave of commodity speculation. When the US prints money traders move in and boost commodity prices (and the Australian dollar). While the the traders concentrate on metals like copper the effect spreads.

BHP has been unmistakably more cautious as commodity prices cool due to the slowdown in China and the uncertainty in Europe. Iron ore is of particular concern. Its planned outer harbour expansion at Port Hedland is in jeopardy (Sun setting on iron's golden age, June 14).

By contrast, three weeks before BHP switched on the amber light Vale was selling the idea of a major iron ore recovery in the second half of 2012.

The Brazilian giant is expecting iron ore to rise from current levels of around $130 a tonne to as high as $US180 a tonne between now and the end of the year. Vale says iron ore has an effective floor price of around $US120/130 a tonne, because expensive Chinese producers can’t compete at those levels. About one third of Chinese production is low grade, with cash costs as high as $US130 a tonne or the current price. Vale believes that when prices hit the Chinese cash cost their production eases or ceases, which pushes up the price.

Vale perhaps needs to be more optimistic for the iron ore price because three-quarters of its profits come from the steelmaking ingredient – more than rivals BHP and Rio Tinto.

And the company is at a disadvantage to the Australian miners because it’s based in Brazil, which is further away from its most important customer, China.

Vale’s strategy to bridge the geographical gap is two-pronged: focus on economies of scale and invest closer to your buyer. But Vale has not had an easy time.

Vale last year postponed its $8 billion Carajas Serra Sul iron ore expansion because of environmental permit issues, higher costs and labour shortages. Vale’s iron ore production is expected to fall in the next three years.

In an attempt to lower shipping costs, Vale’s ambitious former chief executive Roger Agnelli purchased a fleet of Valemax vessels, which can ship up to a third more than the usual carriers.

But Vale is now being forced to send the mega-carriers to a $52 million facility in the Philippines to be unloaded onto smaller vessels because China banned the larger ones from docking. The Brazilians just recently commissioned a second unloading facility.

China blocked the large carriers on safety concerns, which were given great impetus by the leaks in the very first vessel Vale got its hands on.

However, there has been a steady stream of stories indicating that Chinese shipbuilders, who are struggling at the moment, objected to the notion of Beijing accepting commodities in ships that were large enough to undermine them.

China in effect had to choose between its shipbuilders and its steelmakers. Beijing probably pressured Brazil to provide assurances that some of the cost savings involved in the large carriers be passed on in exchange for approving the arrival of the Valemax fleet – provided that reliability was also assured.

However, it seems the ship builders won, so the Brazilians have been forced into a second iron ore transfer station.

The combination of its Brazilian expansion problems and its carrier costs has caused Vale to make Africa a clear priority. Producing from African nations would lower Vale’s shipping costs.

While Rio agreed last year to hand over 35 per cent of its Simandou project to the government of Guinea, Vale is still weighing up the viability of a project. A decision is expected at the end of this year.

In effect, the high costs of mining in both Australia and Brazil means that all three major miners see Africa as the next iron ore boom region.

Interestingly, it’s been the smaller Australian miners that have found some common ground with Vale. Sundance Resources recently secured crucial agreements with the Mbalam iron ore mine and rail project that straddles the border of the Republic of Congo and Cameroon. Now the miner has to wait on whether promised funds from – you guessed it – China will come through.

InvestSMART FORUM: Come and meet the team

We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles