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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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The Valemax fleet was intended as a very expensive, strategic weapon against Rio Tinto, and especially BHP, whose mines are located a short eight-and-a-half day trip from Chinese ports. This is opposed to the 36 days it takes a tanker traveling from Brazil to China at a speed of 15 knots. (Thanks to Ports.com for this approximate data.)

Vale was looking to capitalize on a very simple idea: Bigger ships mean more iron ore per ship, and more iron ore traveling to China per a trip.

"They have these tremendous economies of scale," Lax says, "so the idea was to build this super fleet, bigger than anything that exists...and eliminate the costs discrepancy the Brazilians have shipping iron ore to Brazilian customers."

He goes on to say, "The problem that Vale found itself in was that they basically were using these ships for one customer, " -- China -- "and if that one customer says it's not going to take those ships anymore, [Vale is] really exposing themselves and giving [that customer] a big point of leverage to use against them."

Hence, Vale's current predicament.

"And this idea that they need permission to dredge the port further in order to land these ships is probably not a very likely explanation. The Chinese are trying to apply pressure to one their biggest supplier of this critical commodity, and it's had some effect."

Brazil, which accounts for one-third of the world's iron ore exports, shipped over half of its raw iron ore (its single largest export) to China in 2010.

Facing potential loss, Vale was forced to call an audible.

In August, Vale finalized a $600 million agreement to sell 10 Valemax to the South Korean freight shipper Polaris Shipping Co. The move, as noted in Bloomberg, was a signal to many investors that Vale had sunk far too much capital into the fleet during an era of declining freight rates.

The same article gave a revised estimate for the cost of the 35-ship fleet, originally reported to be $4.2 billion. More than one source now places Vale's final spending at $8 billion. With the fleet's price tag now nearly twice the original amount, that $600 million -- regardless of being far above the market value of the 10 ships -- was far less of a share of Vale's total costs than originally thought.
No positions in stocks mentioned.
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