Vale Retarded in China

Vale’s plan of building a “virtual mine” in China is hurdled, forcing it to delay the implementation of new pricing strategy.

When the iron ore price negotiation went heated at the end of March, one of the largest mining companies – Vale from Brazil – introduced the new strategy of spot pricing.

“That means the possible union of Vale with the other two main mining companies – Rio Tinto and BHP Billiton,” said an analyst in steel industry. However, Vale’s plan of building an ore distribution center in China has difficulty to meet, which will force the company to delay implementing the new pricing strategy.

Dilemma in China

“We are studying into the plan of building distribution centers in China or other Asian countries,” said an insider from Vale. These centers will become the “virtual mines”.

The distribution center, if done, can bring significant benefits for Vale. On the one hand, it can negate the influence brought by the long distance between China and Brazil. On the other hand, it can help the production meet different kinds of ores products.

In August 2008, Vale particularly ordered 12 ships, each of which can transport 400 thousand tons of iron ores to China.

“These ships are specially designed for China, so they are called the Chinese-style ships,” said Yuan Xin, former head of PR department, Vale China.

In order to accommodate these huge ships, Vale needed a port which can store 400 thousand tons of iron ores in China. According to the schedule of Vale, the “Chinese-style” ships will be put into use at the beginning of 2011.

In September 2009, it was reported that the construction of a port with the storage capacity of 400 thousand tons would be started in Dongjiakou, Qingdao and it would be put into use in 2010. This port, according to the “General Planning for the Use of Dongjiakou Port” issued by the Qingdao municipal government, the port is mainly used for storing iron ores, crude oil, coal and groceries.

The demand of Vale and the construction of port with enough capacity were in steps with each other and many people believed that Vale’s plan would be realized.

However, due to the boycott of the Chinese domestic steel enterprises, the National Development and Reform Commission (NDRC) and the Ministry of Industry and Information Technology (MIIT) conducted a survey on the possible negative influence over the interests of Chinese steel enterprises.

By the end of April, the construction has not been started yet. It was reported that the project is still waiting for the approval from the government and the fixed schedule of construction is not available.

“It will cost at least 2 years to build a port with the capacity of 400 thousand tons,” said Li Junying, a government official of Qingdao. According to him, the construction might be started in 2011.

Then the progress of port fell behind Vale’s “Chinese-style” ships. Therefore, these ships, which will be available in 2011, have to be idled away for at least 2 years.

End of Distribution Center?

As said before, Vale also plans to set up an iron ore distribution center, also known as “virtual mine”, in Qingdao.

“In order to increase our market share, we will make use of the facilities of the distribution center to produce different iron ore products that meet the demand of customers,” said an insider of Vale China. Apart from the “Chinese-style” ships, the “virtual mine” possesses multiple functions of iron ore storage, production and transportation by rail. “The total investment will be between 6 and 10 billion US dollars,” said the insider.

The source said that Qingdao Port and Vale always have good cooperation and the two parties have been talking about the port construction for long.

On March 12, 2010, an insider from Qingdao Port said that they commit themselves to the construction of “joint venture port between China and foreign countries”. Meanwhile, Vale is longing for the cooperation with the Chinese side on the project.

Qingdao Port doesn’t say no to Vale’s “virtual mine” plan. Previously a special port was made in Qingdao Port for the iron ores from South Africa. Vale compared the function of “virtual mine” with duplicating the mines in Brazil in China. Once the distribution center is finished, it will import millions of iron ores every year, which will exert great influence upon the iron ore price. Therefore, numerous discussions about “virtual mine” were raised in China.

“We don’t think that the cooperation is likely to happen based on our experiences,” said an insider from the China Iron & Steel Association (CISA). Right now, the Chinese government focuses on reorganizing the trade pattern in China. The distribution center, or the “virtual mine”, will add more difficulties to the examination conducted by the government towards the imported iron ores. This means that the government will not easily show green light for this project.

In fact, Vale once planned to build a storage place for its iron ores in Shanghai and Rizhao, Shandong at the beginning of 2007 in order to reduce the shipping cost. However, the plans were chucked out by the CISA, who worried about the influence over the iron ore price.

“It is out of question that a strong base will be built for the spot goods market if the iron ore suppliers are allowed to set up distribution centers in China. This will bring about negative influence over the long-term iron ore price negotiation,” said Li Xin, dean of China Metallurgical Industry Planning and Research Institute. But he thought that the “virtual mine” is not a worthless thing. At least it enables the small steel enterprises which can not enjoy the long-term iron ore price to buy cheaper iron ores without the agencies.

But the large-sized steelmakers, who dominate the Chinese steel market, are strongly opposed to the distribution center.

“We have already submitted our proposal of rejecting the iron ore distribution center to the MIIT and NDRC,” said a senior manager of Hebei Steel Group. “Many large steel enterprises in China stand alongside us. We must restrict the increase of iron ore price by every means.”

What about the responses from the government? An official in the NDRC said: “We are still studying it. Previously there was no precedent.”

“This is related with the iron ore price negotiation, so the government knows which side to stand on,” said the expert. With the use of the “virtual mine”, Vale may conduct the long-term negotiation based on the CIF price of the iron ores. It may even abandon the long-term negotiation and directly sell the spot goods in China. This goes against the intension of China to fix a uniform price of iron ores in China.

New Strategy

The worries of Hebei Steel Group don’t come out of nothing. Though the “virtual mine” project has not be approved, Vale is ready to conduct the spot goods sale in China.

Previously, Vale planned to force the Japanese steelmaker to accept the 90% increase of the iron ore price. Then it was reported that Vale has decided to spread the spot prices all over the world, forming an ally with Rio Tinto and BHP Billiton.

“Compared with the two Australian companies, Vale has no advantages in shipping. Therefore, it could not compete with Rio Tinto and BHP Billiton in spot goods sale,” said the analyst. The long distance results in the large shipping fees, which deprive Vale of the price advantages in China. Therefore, Vale kept sticking to the long-term negotiation price.

Fabio Barbosa, CFO of Vale said that the company is seeking ways to lower the shipping cost. “Building a fleet of transportation ships of our own is the best choice. That’s how the ‘Chinese-style’ ships come out.”

In addition to the 12 “Chinese-style” ships, Vale also bought 15 secondhand ships as well as 10 new ships whose capacity reached 150 to 300 million tons. These ships could give Vale 40 million tons of new transportation capacity every year.

“If Vale can reduce the shipping cost, its advantage in the quality of iron ores can be used to its best advantage,” said the aforementioned analyst. To build a distribution center in China is the best way.

“After eliminating the disadvantage in cost, Vale finally has the courage to spread the spot goods sale in China,” said the expert.

The new strategy may give Vale a new development opportunity in China, but it will make the iron ore price negotiation more complicated in the future.