Shipping Dispute Between China and Vale (NYSE:VALE) Not About Vessels
China-built ships not allowed in Chinese ports? Like a lot of things having to do with China, there's more to the story.
The world’s second largest port has a big problem: It’s too small.
Or, more specifically, China’s Ningbo-Zhoushan Port says it lacks the facilities and the channel depth to accommodate a new class of super-ships owned by Brazilian iron ore miner Vale SA (NYSE:VALE). With a single vessel capacity ranging from 380,000 tons to 400,000 tons, the ships are the largest bulk-carriers on the ocean today and have created new vessel categories: Chinamax (generically) or Valemax (those belonging to Vale).
Ningbo Port Company Limited is the company that runs the Ningbo-Zhoushan Port. President Wu Jinkun’s comments on updating the port were quoted by The Bulletin Panama last week.
Of course we hope that we can be the first port (to receive Valemax ships) …but the construction will require at least two or three years.
Berths need to be widened. Channels need to be dredged. But none of this can start, according to Jinkun, until the port receives finalized permission from The Chinese Ministry of Transportation, as well as approval from the local government and China’s National Development and Reform Commission.
The story might sound familiar: In the US, ports scrambling to update themselves in anticipation of the expanded Panama canal -- set to open in mid-2014 -- have announced similar time frames, and have struggled to secure financing from the federal and local governments. (Read more on the problems facing US ports in Double-Wide: Who's Set to Benefit From the Expanded Panama Canal?)
China claiming to be in the same boat, as it were, with US ports is a bit ironic since Vale commissioned the Chinese shipbuilder Jiangsu Rongsheng Heavy Industries to build the first twelve vessels in 2008. Given that China consumes roughly 60% of the global output of iron ore and is the world's largest maker of steel, it would seem self evident that they would eventually have Valemax ships docking at their ports.
So why would China have any incentive to deter Vale, the world’s second largest mining company, from feeding China’s voracious appetite for iron ore?
“Probably, like a lot of things in China, one has to dig a little bit deeper to really understand what’s going on,” says Robert Lax, a lawyer and business consultant focusing on Brazilian trade mining and private equity in emerging markets for the past 19 years, who spoke to Minyanville this week.
The first Valemax was launched from the Nantong shipyard in 2011 and there are currently 13 afloat. The Vale Minas Gerais, the fleet’s fourteenth vessel, will launch on its maiden voyage next month and another eight vessels are expected to be completed in 2013. Taking into account current orders with shipbuilders, including South Korea's Daewoo Shipbuilding & Marine Engineering (DSME), there are expected to be 35 of the vessels on the ocean the next few years.
Jose Carlos Martins, Vale’s head of Ferrous Minerals Operations and Marketing, underscored the potential for even more ships when speaking to the Financial Times in April: “A Valemax can make four trips per year, carrying about 1.5 million tonnes per year. Given that Vale exports about 200 million tons to Asia, the market would justify more than 100 ships.”
So far, Vale had sunk $4.2 billion into the venture, and it’s an investment that was set to pay off: In December 2011, The Berge Everest -- built by China's Bohai Shipbuilding Heavy Industry -- was the first Valemax ship to return to China from Brazil. It docked at China’s Dalian Port and delivered a load of nearly 390,000 tons of iron ore.
One month later, in January 2012, China officially banned Valemax ships, along with other super-sized freighters, from entering any of its ports.
“Now, the Chinese government said they couldn’t take the [Valemax] ships and that 300,000 tons is the maximum, but there is no objective evidence that there really is such a practical limitation,” Lax explains.
No One Believes China
China, commissioned by Brazil, constructed and launched close to a dozen Valemax vessels and successfully berthed one on its return. No one's buying the argument that the country can't accommodate the ships.
According to Mining Media’s Engineering and Mining Journal, three Chinese ports are fully capable of receiving Valemax ships: Dalian, Dongjiakou, and Majishan.
So, why such a swift (and perhaps dishonest) turn around?
Well, there is the official reason, and then there’s the speculative reason -- a reason widely accepted to be the case by many in the mining industry, according to Lax.
Officially, China has said it issued the restriction in the interest of its own local shipping industry, which, at the time, was suffering from a steep fall in global shipping rates. With shipowners worldwide seeing lower revenues at the time, there’s no reason to doubt China’s motive behind the protectionist move.
Additionally, the China Shipowners Association -- already very upset by Berge Everest’s arrival weeks earlier -- and major Chinese steel makers went on to express their fears that Vale could use these massive tankers to monopolize the global iron-ore industry.
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.
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.
Since at least one third of Vale’s new fleet has been constructed by Chinese shipbuilders, the country has already seen some profit from Vale’s investment. Vale has retaliated by refusing delivery of three Valemax vessels completed by Rongsheng in April.
A month later, it appeared Beijing had finally yielded, sort of. It said it would take two to three years of construction at the port of Ningbo-Zhoushan to accommodate the ships and the construction would only start after "permission" from the government was received.
It shouldn’t come as a surprise that China’s most recent revision to (what appears to be) the highly volatile status of its ports’ capacities has garnered a few doubts.
“I think there is great skepticism that [China’s] ports can’t handle Valemax ships today,” Lax says. “I certainly don’t think the Brazilians think that’s the case. And I think that there’s great skepticism in the mining industry and the commodity industry that that’s the case.”
Meanwhile, the price of iron ore has fallen over the past few months. In the Chinese spot market 62% iron (or Fe) content ore, an industry benchmark, hit its lowest levels in three years in September, at $86.70/ton due to a slowdown in steel manufacturing. A year earlier, it had been trading for $190/ton. It is currently slightly over $100/ton.
Australian iron ore is frequently under the standard, at 61% Fe content or lower while Brazilian iron ore is near 65% Fe content. In addition to its higher quality, Brazilian ore has fewer impurities. China's domestic iron ore ranges from less than 15% Fe to 40% Fe. It takes more energy and higher production costs to process the lower grades. In addition, lower grades cannot be used at all in metallurgical plants.
Lax believes business between China and Vale won’t stay frozen for long.
I suspect that they will reach a deal. China has a tremendous need for ore and steel to continue building out their infrastructure and they certainly wouldn’t be doing themselves a favor by making it impossible for one of their three biggest suppliers not to be able to participate in the market and then be left at the tender mercies of BHP and RIO Tinto.
Then, there is also the matter of Chinese demand.
Lax says, “There are all sorts of questions about what China’s steel stocks actually are today, and whether a lot of the steel that’s supposed to be in Chinese warehouses is actually there. To the extent that its not, they’re going to need that iron ore more critically.”