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Shipping Dispute Between China and Vale (NYSE:VALE) Not About Vessels

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China-built ships not allowed in Chinese ports? Like a lot of things having to do with China, there's more to the story.

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Lax sees an additional motive driving the Chinese: Retaliation against Vale, who had been accused of influencing prices to their advantage.

In 2010, Vale, along with its two biggest competitors, Rio Tinto (NYSE:RIO) and Australia's BHP Billiton (NYSE:BHP), made a controversial switch from an annual, fixed pricing system that had been in place for the past 40 years.

"They used to price iron ore once a year," Lax explains, "and that worked well for a very long time because the price of ore hardly changed. It wasn't just the Chinese, but every ore purchasing company loved the fact that they had negotiated contracts the previous year, and were using year-old prices when spot prices began to suddenly skyrocket."

According to Mining.com, the difference between the old, annual price of iron ore and the price of iron ore under the new quarterly pricing system was roughly 20%. Perturbed by what were seen as unfairly higher costs, European and Chinese steel makers began pressuring BHP, Rio, and Vale, who, in December 2011, finally bent and adjusted their pricing system to more accurately reflect the spot price of ore. (Prices are still set quarterly.)

Even with the adjustments, Vale's new pricing scheme gives it an advantage against the Chinese.

"There were a lot of disputes and unhappiness in China because that had the practical effect of ratcheting up their costs almost immediately," says Lax.

China Ban Boosts Vale's Costs

Barred from docking in China, Vale was then forced to divert its incoming Valemax ships to its floating transfer station at Subic Bay, in the Philippines.

Subic Bay is one of the few ports in the world -- including ports in Tubarao and Ponta da Madeira (Brazil), Taranto (Italy), Rotterdam (Netherlands), and Sohar (Oman) -- officially capable of accommodating ships as large as Valemax. There is one other port in direct proximity to China capable of docking Valemax, and that's in OIta, Japan, although getting iron ore from Japan to China becomes problematic, especially in light of recently heightened political tensions between the two countries. In October, the aforementioned Vale Minas Gerais will arrive at the Villanueva port on the island of Mindanao, making it the second port in the Philippines to receive a Valemax ship.

Now only capable of docking nearby and servicing China by transferring iron ore to smaller ships, Vale was seeing its profit margins beginning to narrow.
No positions in stocks mentioned.
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