Vale

The ongoing spat between Brazil’s iron ore miner Vale and China has all the hallmarks of a sibling quarrel.

Not that there aren’t fortunes at stake here, but the various parties are so interdependent at a company and a national level that you have to think a solution will be found soon.

The issue at the heart of the quarrel — Vale’s decision to build a total of 35 mega ore carriers each in the region of 400,000 metric tons of capacity — has a great deal of logic to it. Brazil is at a geographic disadvantage to Australia in shipping iron ore to Asia, but by simple economies of scale, it can reduce the per-ton cost by shipping in bulk.

By building its fleet of vessels or operating them under long-term leases, Vale can fix costs and avoid the peaks which inevitably come back to haunt the industry in times of high demand. Shipping in larger vessels reduces fuel costs per ton of ore moved and, Vale says, the carbon footprint by 35 percent or so, adding a little greenery to an otherwise very un-green industry.

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As the above graph shows, total percentage returns for the huge industrial metal and raw material producers, who’d attended last week’s Reuters Metals and Mining Summit, have not really been all that hot — indeed, rather cool to cold — over the past year. Sovereign debt concerns, cooler global industrial demand, strikes, natural disasters and declining ore grades all play a role in the current metals climate.

The summit serves as a platform for these companies to come together and prognosticate, and for reporters to relate what these guys say — whether there’s much to back it up or not. If anything, though, benchmarking market activity against companies’ words and predictions could have value.

In case you missed the day-to-day reporting, let’s touch on some important announcements and news nuggets, all originally reported by Reuters, that might affect industrial metals markets and metals prices in the next year (or two, or five…)

  • Rio Tinto (-20.6% return over last 12 months) said things look pretty optimistic as far as finding buyers for parts of its aluminum business go. The aluminum market (with prices plummeting about a fifth since May 2011) has caused Rio to lose money since it dropped big bucks on Alcan, and they want to improve their aluminum margins by focusing on their Canadian operations. Rio also has its sights on Mongolia’s Oyu Tolgoi, now that it controls the mine’s owner, Ivanhoe.
  • Speaking of aluminum, Rusal (posting the worst return over the last year at -55.7%) is having trouble getting rid of its 25 percent stake in Norilsk Nickel (-26.1%). (Norilsk, by the way, sees average nickel prices around $20,000 per ton in 2012.) Rusal still has a big debt burden, but the company “reduced cash costs to $1,950 per tonne by the end of last year…and with prices hovering near $2,200, it is accumulating cash,” said Rusal’s Head of Equity and Corporate Development Oleg Mukhamedshin. Glencore owns a minority stake in Rusal, and will continue to sell Rusal’s aluminum exports. As Mukhamedshin characterized it, “we are good partners for the long term.”
  • Glencore, for its part, obviously made the biggest M&A news splash in commodity markets with its renewed takeover bid of Xstrata. That means other mining companies could surely follow in their M&A footsteps. “The market is reasonably conducive to M&A, other large strategic deals could provoke people to think about their own destiny,” said David Hammond, global head of metals and mining at Morgan Stanley. Another banker, Tom Massey (Citigroup’s head of metals and mining for Europe, Middle East and Africa), said, “Delaying corporate activity is not an option for some, as the best assets are getting more expensive because a lot of them have already been consumed.”
  • And speaking of consuming, China of course figures into the whole picture as well. Vale (-7.7% total return) hopes to unload its new, huge Valemax vessels in China very soon, to ship greater quantities of iron ore to China faster. Tito Martins, Vale’s chief financial officer, predicted that in the next decade, China’s economy will expand by $4 trillion, even if growth slows by more than a third. He also told Reuters “iron ore prices are likely to remain above $120 a tonne in the next several years…because demand remains strong and at prices below that, Chinese producers of low-quality ore begin to lose money.”

 Image Source: Reuters

MetalMiner welcomes guest contributor Carlos Tromben, executive editor at America Economia in Santiago, Chile. Carlos has an MA in communications from the ESCP-Europe in Paris, France.

The world’s mining industry looks increasingly like the opening sequence of “Game of Thrones,” the popular HBO saga. It’s like a map where bellicose and greedy Houses wage wars and forge tactical alliances between one another. No one is to be trusted; everyone is needed in the quest for total dominance.

Take Ivan Glasenberg, the secretive South African “Hand” who may well become the next King if he succeeds merging Xstrata and Glencore. Will he then go after embattled Anglo American? There you have sword-wielding Cynthia Carol, fighting off the beast of nationalization in South Africa and refusing Codelco as Chilean consort. Take Murilio Ferreira, Vale’s new Hand, courting the Middle Kingdom with large ships to form the biggest alliance of them all.

In this “Game of Thrones,” Codelco seems the lesser of the big Houses. Neighboring Vale was sold like a beautiful virgin to private suitors and is now a global powerhouse. Codelco stayed in the hands of Motherland Chile. Mind you, Codelco is still powerful, but looks rather withered. The Motherland’s strict moral code has kept it single, shielded from the lust of investment bankers, but also unable to reinvest its profits in expanding capacity of its vast yet dwindling deposits.

How To Explain This?

Well, in the first place, Codelco is young. It was born out of the kingdom’s wounds. Salvador (the Savior) Allende, the so-called comrade-king, nationalized the foreign-owned mines in the name of his people and the military later overthrew him. Since then the Motherland has forced Codelco to give 10 percent of its revenue to the kingdom’s righteous warriors. A significant royalty, when all the other Houses were allowed to exploit Chile’s copper almost for free.

The Motherland may have kept Codelco away from the banker’s greed and the stockbroker’s wickedness, but it opened the doors to the local politician, the power broker, and of course, the military-industrial complex (or Chile’s version of it). Now all of them want to keep things just as they are.

They’ve been able to do so because of the particularities of Chile’s psyche. Even after decades of neo-liberal and Chicago-inspired economics, Chileans are deeply identified with the State. That explains why any serious politicians, any consensus-builders have never attempted to explain to them how much would they benefit from a Codelco IPO. How their personal and national wealth would dramatically increase if pension funds could invest in the nation’s copper company.

There is also an identity issue here. Codelco and Chile’s mining policy are dictated by civil engineers, by logistics magicians and productivity geeks. No room for the bold global strategist, the financial maverick and the bold political leader to shake the status quo.

New “Hand” Sergio Hernandez was the man to do so. He knew Codelco could no longer afford to keep silent and humble, and he designed a battle plan. His first quest was a leveraged bid for Los Bronces, Anglo American’s half share of La Mina sin Nombre. The mine without a name is one for the fairest jewels of the Realm. It would have increased Codelco’s output by 10 percent. But mean Cynthia Carol said no. She brought in the lawyers and sold half Anglo American’s stake at the mine without a name to Mitshubishi, one of the big Houses of the Rising Sun.

Codelco could now be the most coveted middle-aged knight in the Realm, a $30 billion beau. But it needs a severe yoga, workout and soul-searching plan to be eligible and fashionable again. Or it will remain a respected middle-aged gentleman — cultured, but rather dull.

–Carlos Tromben

Here are some industrial metals industry-related stories we’re keeping an eye on this week:

China’s State-Owned and State-Controlled Enterprises

Source: BBC

On the heels of Chinese Vice-President Xi Jinping’s visit to the United States, the SOE issue takes center stage. From TradeReform.org:

  • Congressman Pete Visclosky testified before the U.S.-China Economic and Security Review Commission during their hearing on China’s State-Owned and State-Controlled Enterprises.
  • Also, the competitive challenges posed by Chinese SOEs were the focus of a hearing at the U.S.–China Economic and Security Review Commission in Washington D.C. on Feb. 17. Elizabeth J. Drake, a partner at the Law Offices of Stewart and Stewart, presented testimony to the Commission reviewing the policy options available for addressing these challenges. In a new trade flow, Ms. Drake reviewed three ways the U.S. can help level the playing field between American industries and Chinese SOEs by: 1) confronting Chinese government subsidies to SOEs; 2) challenging discriminatory and distortionary contracting practices by Chinese SOEs; and 3) correcting anti-competitive and unfair trade practices by SOEs, according to TradeReform.org.

Of course, Chinese SOE policies — and progressive steps to mitigate them — have been and continue to be vital for US steel producers.

Vale’s Move to Spot Iron Ore Pricing

Source: phongpo.com

From Reuters: “Vale, the world’s largest iron ore producer, said [last week] it is selling 80 percent of its ore using spot prices, nearly completing a historic shift to market-based pricing for the principal raw material used in steel. The new system was prompted by Chinese steelmakers, Vale’s largest client group, who wanted to benefit more quickly from falling iron ore prices. Iron ore averaged $141.80 a tonne in the fourth quarter, 11 percent less than a year earlier and 20 percent less than the previous quarter.”

What will this mean for steel-buying organizations? Check in tomorrow for MetalMiner Editor Lisa Reisman’s take on the watershed move.

2011 was a year plagued by bad weather — particularly in Asia and Australia — that impacted metals prices, and 2012 is starting off on the same foot.

A series of Reuters reports details problems first in Australia, where tropical cyclone Heidi lashed the west Australian coast last Thursday with winds up to 75 mph, closing the world’s biggest iron ore export terminals; and secondly in Brazil, where Vale said on Wednesday it halted some iron ore shipments due to heavy seasonal rainfall that has killed dozens of people and made mining hazardous.

Vale said it will lose an estimated 2 million metric tons of ore shipments, the equivalent of nearly 1 percent of its annual output, due to the rains that have affected its operations in the southeastern region of the country.

The storms in Australia center around Port Hedland, the region’s largest iron ore terminal, exporting around 240 million tons of ore a year; but the storm estimated as only a Category 2 was expected to weaken as it passed over land. At this stage no estimates of damage have been given, but the port is unlikely to be closed for long.

Australia’s second- and third-biggest iron ore miners, BHP Billiton and Fortescue Metals Group, both export through Port Hedland, which handled a record 60.9 million tons of iron ore in the last quarter, the bulk of which was shipped to China.

Iron ore prices are near a seven-week high at around $142/ton, although that is still nearly 20 percent down on 2011 highs as demand has slackened and supply has generally improved since early 2011.

So traders are not expecting a sharp boost from the supply disruption, given ample port stocks in top buyer China and slow demand from Chinese mills ahead of the Lunar New Year, Reuters said. The length of time it takes Brazilian shipments to reach China, some 30-40 days, also means any impact from the reduced supply may only be felt in February after the Lunar New Year.

Apparently, traders report there are large stocks sitting in bonded store at Chinese ports, including some 350,000 tons of ore from Vale’s first Valemax 388,000-ton ore carrier, which finally unloaded at the end of December after many delays.

Vale is said to be intending to sell the cargo at spot, but is waiting for better prices after the Lunar New Year holidays; the miner may also have one eye on the supply disruptions in Australia and Brazil, so expect these disruptions to lend price support, if not an outright price rise come next month.

It has to be said that in the face of softening demand, recent strength in the iron ore price is hard to understand. Producers are naturally positive, but steel production in the world’s largest steel market and largest buyer of seaborne iron ore, China, are looking less bullish this year than last.

–Stuart Burns

Continued from Part One.

So how does Beijing expect to achieve this consolidation, on which so much of the wider strategy depends?

One tactic is apparently to guide provinces to close the following: blast furnaces of less than 400 cubic meters, converters and electric arc furnaces of less than 30 tons, HR strip mills of less than 1,450-mm (57) width, HDG coil mills of less than 300,000 tons per year and color-coated sheet mills of less than 200,000 tons per year.

The Chinese way will be for smaller players in this category to scrap the old mills and build bigger new ones, so restricting access to investment credit will also have to be part of the coercion. Not that any reduction in the overall level of steel demand is envisaged; the new plan expects the steel sector to continue to grow by 5-6 percent per year, but the growth will come overwhelmingly from the larger producers.

Although not a specific government target, it is also hoped producers will become more profitable. Margins for China’s 77 largest steel companies have apparently declined from 8 percent, seen in the 2001 to 2005 period, to below 3 percent last year. Apart from the competition of over-capacity, many believe the biggest culprit to be the industry’s inability to control input costs.

China imports over 60 percent of iron ore consumed, mostly from the big three of Rio, BHP and Vale. China would like to reduce this to 45 percent by 2015 via the rigorous development of domestic sources, but this may prove challenging as ore grades are of poorer quality and imported material generally proves a lower cost per ton of steel produced.

Despite being the world’s largest buyer, China has been very frustrated by its inability to control the cost of imported ore, a situation CISA perceives as not helped by the small and medium-size steel producers breaking ranks and doing their own thing. Consolidation is therefore seen as a way of regaining buy-side control and countering the major iron ore suppliers’ dominant position.

The new plan contains much to commend it. A much greater emphasis on the industry’s environmental impact will be a good development for both current and future generations. The intent to bring structure to a chaotic industry is to be welcomed, not least if it reduces over-investment in new capacity. As we would expect, the plan is positive and confident about the future of Chinese demand, but it also paints a picture of a behemoth; as consolidation gathers pace, the top ten producers will probably outstrip just about every other producer in the world except for ArcelorMittal — China has four of the top five producers already, and nine of the top 20.

By the middle of this decade, Chinese steel producers will out-gun just about every other Asian or Western mill when competing for raw materials and potentially in export markets. Let’s hope Chinese demand holds up; we would hate to see a significant share of that capacity turn up on the global stage.

–Stuart Burns

China’s 12th Five-Year Plan, covering the period from 2011 to 2015, emphasizes a number of environmental issues to a degree not seen in previous plans. A KPMG report highlights three of the goals that will have a specific impact on the metals industry:

  • 16% reduction of energy use per unit of GDP
  • 17% reduction of CO2 emissions per unit of GDP
  • 30% reduction of water use per unit of industrial value

As with all statistics, the moment they are announced, those responsible for meeting the goals start devising ways of presenting the data in a way that shows they have met the targets, so don’t assume eventual claims of success will be the full story. However, the fact remains the metals industry (and its largest sector in particular, the steel industry) will be under considerable pressure to change in the coming years. China’s position as the world’s largest steel producer and consumer mean these changes will have far-reaching consequences for the global steel industry, including supply, competition and prices in Western markets.

The steel industry in China is facing a number of problems, largely brought about by rapid expansion. These have led to over-capacity, widespread pollution and a fragmented industry structure. As the report points out, the Chinese steel industry has grown at an average rate of 17 percent a year over the last ten years, reaching some 600 million tons of steel output last year, but with a capacity of between 720 and 750 million tons. So, high on the list of objectives is consolidation. Beijing will step up efforts to force mergers and acquisitions, particularly by state champions, to reduce the fragmented nature of the industry and achieve a level of control.

Data source: KPMG

Much of the pollution and over-capacity is coming from the smaller to medium-size, lower-value steel producers, a product area in which Beijing recognizes China will be increasingly less competitive, as the currency gradually appreciates and wages rise. So the steel industry is expressly charged with upgrading technology to produce higher-value steel products. An SBB newsletter lists engineering steels, auto sheet and high tensile rebar as products categories that will receive favorable support, while the KPMG report lists specific steels in more detail:

  • Steel designed for high-speed railways
  • High-grade non-orientated silicon steels used in applications such as electric motors
  • Highly magnetic induction grain-orientated silicon steels used in transformers
  • High-strength mechanical steels

Specific industries expected to drive demand for these steels are nuclear power, wind farms, energy savings for autos and hydroelectric power production facilities, but also ongoing developments of ports, shipbuilding, high-speed rail (in spite of the current problems), metro systems, coal mining, medical, construction equipment and of course the 36 million units of affordable housing Beijing is committed to building by 2015.

Property and infrastructure continue to be the largest drivers of steel demand in China as this pie chart shows.

Data source: KPMG

By bringing more steel production under the control of the top ten producers, Beijing expects to be able to direct investment not just in materials produced, but even in where steel plants will be constructed. Coastal regions have been identified for major new developments ostensibly to facilitate the continued import of iron ore and coking coal making the industry more competitive, reducing the environmental burden on traditional steel producing areas and providing access to water. But a benefit not mentioned in the plan is proximity to deepwater ports for exports. As China moves upstream technologically, Chinese mills will become a growing threat to Western and Japanese mills’ dominance of these higher-value steel product areas.

Continued tomorrow in Part Two.

–Stuart Burns

Are we seeing the beginnings of a bounceback in iron ore prices? After falling 36 percent since early September, the Platts 62% Fe iron ore price rose this week from $116.25/ton to $118.75/ton, according to an FT article.

Source: Financial Times

As the graph above shows, the iron ore price has plummeted this summer as Chinese steel mills have slowed buying. Steel production has eased in China as Beijing’s credit tightening has taken hold. This graph of steel production below illustrates how declining production added to supply chain de-stocking will have worked through to significantly lower iron ore demand.

Source: Reuters

The latest figures from the China Iron and Steel Association reported in a Reuters article showed national production falling from an annualized 705 million tons at the end of September to 657 million tons in the middle of October. Supply, though, has not responded accordingly. Iron ore imports increased every month between July and September — those from Brazil and Australia were up by 14 percent and 9 percent, respectively, in the first nine months of 2011, although that was in part compensation for the 24-percent slide in imports from India, China’s third-largest supplier. Brazilian and Australian producers have continued to offer large capesize cargoes of up to 150,000 tons per vessel into the spot market.

Meanwhile, Chinese steel mills have cut back, using up high-priced stocks and deferring purchases with the result that cargoes have chased ever-falling spot prices. The existing quarterly pricing mechanism is priced on the average spot price of the quarter before prices, so June-to-August 2011 is used to set Q4 contract price levels. That will be around $175/ton, yet spot prices are currently around $118/ton. It is the widening gap between that contract price and the spot price over the past few weeks that has caused many Chinese steel mills to hold off buying any iron ore at all as they seek to renegotiate terms in favor of the lower spot price.

Further complicating the picture, spot prices have now fallen well below much of China’s domestic miners’ cost of production. Some Chinese producers have costs as high as $150-160/ton, and costs for a quarter of all Chinese supply are above $135/ton, Reuters quotes Macquarie Bank as saying. Meanwhile, Vale estimates that around 120 million tons of China’s own production is now underwater at current prices, prompting both miners and investors to believe significant cutbacks will feed through to higher import demand, eventually.

Interest has been expressed not just in a higher spot price, but also a rising forward price. This stems from the belief that as domestic iron ore producers are forced to cease production due to low prices and are deprived of Indian supply due to the imposition of export taxes and quotas, Australian and Brazilian producers will be able to achieve higher prices again next year. To what extent this bears fruit will in part depend on the iron ore producers’ willingness to show production restraint. Up to now, many of the smaller miners (and BHP among the major three) have aggressively offered spot cargoes into a falling market, fueling further falls. Arguably, market share becomes less of an issue in an increasingly spot-oriented market inasmuch as a sale lost today can be recovered tomorrow, it is not a long-term contract.

Spot-market pricing could actually work to the iron ore producers’ advantage, but having invested literally billions in new and enhanced production facilities in recent years, it will be intriguing to see whether miners give in to Keynes’ “Animal Spirits this year and next. Will they fight for every sale or will they seek to cooperate in limiting production? How genuinely competitive and open an iron ore market do we have? Watching the plummeting spot price you have to say “very,” but the answer may depend on who you ask.

–Stuart Burns

Brazil has fared better than most over the last year or two. True, the country does have a problem with inflation, which has proved stubbornly hard to contain, and a strong currency has caused severe problems for Brazil’s exporters. Yet the country has low unemployment (part of the reason they have strong wage inflation), robust growth, and a trade surplus of $20.3 billion in 2010.

All is not quite as solid as it seems though, according to an FT article. Except for the export revenues of one company, that surplus would have been a deficit. Not that Vale’s exports are likely to disappear, but such reliance on one firm’s fortunes and one single commodity underlines that for as far as Brazil has come, it’s still very much a commodity economy.

Much is currently happening in Brazil. Growth is slowing as the country’s main export markets continue to struggle. Although Brazil’s largest trading partner is now China, much of that depends on the export of commodities like iron ore that are slowing. Back to Vale, an FT article last week reported a plunge in net profits for the third quarter, largely due to a currency loss, but analysts noticed sales were also weak. China has been cutting back on purchases as iron ore spot prices have plummeted, and while Vale is bullish about future demand, others are suggesting the tightening process in China may have been overdone and anticipate a period of consolidation before Beijing decides to take the foot off the brake and allow the economy more credit next year. The move to greater spot sales of iron ore will also hurt Vale’s revenues from the 4th quarter onwards as spot prices continue to slide. With steel production depressed in Europe and the US, the 40 percent of the company’s exports to those markets are not likely to pick up anytime soon.

The government of Ms. Dilma Rousseff has not been standing idly by as the rest of the world has been focused on debt woes. The central bank has already cut central bank rates 0.5 percent to 12.0 percent, a move that is expected to be repeated later this year and next year down to a (still eye-wateringly high) 10.5 percent by mid-next year, according to the EIU Viewswire report. This in spite of consumer inflation running at 7.3 percent year-on-year in September, well above the target of 4.5 percent and with a 14-percent increase in the minimum wage in the pipeline for January.

The central bank is hoping, as are central banks in the UK and elsewhere, that falling commodity prices will feed through to reduce inflationary pressures next year. Whether they are correct remains to be seen, but what does seem certain is that Brazil will experience lower growth next year just as spending will need to ramp up to meet the cost of the 2014 Soccer World Cup and the 2016 Summer Olympics, not to mention the inevitable vote-buying spending spree that will accompany local elections next year.

Brazil can weather the current downturn better than most. Iron ore sales may slow and prices may drop, reducing revenues, but they will still make a substantial contribution to export earnings. The fall in the currency will benefit manufacturers looking to export, although it will heap further inflationary pressure on imports for domestic consumption.

Deep-water oil discoveries and the infrastructure investments needed for the above events will make significant contributions to Brazil’s economy in the years to come, further reducing the country’s reliance on low-value commodity exports towards a consumer-driven mature economy. The challenge will remain to control inflation and the incipient erosion of global competitiveness that high inflation brings.

–Stuart Burns

MetalMiner welcomes guest contributor Rahul Jalan, a Chennai-based senior research analyst in metals for Beroe, Inc. who tracks the global steel and rare earths supply chain and analyzes global procurement developments to help develop procurement solutions for the company. Beroe specializes in providing procurement intelligence for a broad swath of industries, enabling buyers’ decision-making.

Previous posts in this series: Part 1, Part 2, Part 3, Part 4, Part 5

To overcome the current situation, steel plants depending on Bellary ore mines are now considering getting ores from other states such as Orissa. However, the landing prices in Orissa are more than INR 9,000 per ton, two times more than that in Karnataka. This will in turn lead to production cost increases of more than 25 percent, roughly INR 2,000 per ton.

So, the Bellary mines ban will either force steel plants to temporarily shut down or run at reduced utilization rates, as they can’t use the low-grade ore from Goa. Bringing in the required quantities from Jharkhand and Chhattisgarh will lead to increases in cost structures, as the high transport costs make that commercially unfeasible in the current climate of weak steel demand.

If the ban continues longer, mining activities may come to halt for the moment. This may force miners to form alliances with steel mills for setting up processing plants for converting low-grade iron ore into lumps.

The mining giants Rio Tinto, BHP Billiton and Vale are looking to utilize this opportunity to strengthen the iron ore export industry, which is expected to boom for the next five to ten years.

The steelmaking cost for Karnataka’s steel mills such as JSW Steel, on the other hand, has increased by more than US $30 per ton during the last quarter (July-September 2011) and the cost is expected to rise in the coming months if the ban continues.

The Indian government has to establish a technically competent and independent regulator for drawing up the necessary regulations and enforcing them strictly, which will de-politicize the sector and minimize violations of environment laws and rights of the tribal people.

The government also has to ensure that its policy framework attracts large, organized, technologically well-equipped and socially and environmentally conscious mining companies. If the government fails in bringing up a new, attractive and viable policy immediately, the country may lose its position as the world’s No. 3 iron ore exporter.

–Rahul Jalan