China will help to bankroll a major expansion by
Brazilian iron ore giant Vale and invest in huge Vale ships that will transport
high-quality ore to North Asia – a deal that will reshape the global industry
and put more pressure on Fortescue Metals Group.
On a state visit to Brazil with Premier Li Keqiang, Chinese officials agreed to
invest in up to eight of Vale's huge iron ore carriers, known as Valemax ships.
More importantly, China will loan the company up to $US4 billion ($5 billion) to
help fund a $US16.5 billion expansion called S11D. The project, which should be
finished next year, will produce 90 million tonnes of high-quality iron ore that
will be shipped to China at a cost almost as low as that achieved by industry
leader Rio Tinto.
While Fortescue's Andrew Forrest has repeatedly attacked BHP Billiton and Rio
for continuing to expand into a weak iron ore market, Brazil's plans are
accelerating.
Vale plans to increase capacity to 450 million tonnes as early as 2018 from 330
million tonnes this year. Its expansion easily eclipses the combined tonnes BHP
and Rio will put into the market over the next three to four years.
While the timing of the deal is unexpected, it validates
BHP chief
executive Andrew Mackenzie's warning that conducting a parliamentary inquiry
into Australia's iron ore sector would be "a gift to Brazil".
Mr Forrest has slammed as a "fallacy" Rio and BHP's rationale that if they don't
expand, other producers will.
The deal with China will pave the way for Vale, the world's third-lowest-cost
exporter of iron ore, to narrow – and possibly close – the gap on all-in costs
with leader Rio and second-placed BHP.
It is also set to put daylight between the margins of Vale and Fortescue – the
highest-cost producer of the four iron ore majors – once the expansion is
complete.
Fortescue's cost-cutting drive since the iron ore price plunged last September
has lowered its break-even price – the point where it is not making or losing
cash – to near, and at some points below, Vale's.
Credit Suisse mining analyst Paul McTaggart said China executed the Vale deal
"to ensure S11D gets up".
"It is the Chinese helping them out – as a major consumer of iron ore, China
wants to ensure diversity of supply," he said.
"S11D is very low-cost and, importantly, it will produce the high-quality tonnes
that China needs for blending at a time when the quality of their domestic
product is falling away, as is Australia's, and it is important to their steel
industry."
China's move is uncannily similar to Japan's investment in Vale in the 1980s,
also at a time when the Brazilian giant was under cash flow pressure. The
Japanese – then the world's biggest importer of iron ore – ensured Vale's
Carajas expansion got away, securing the miner's dominance. Carajas is the
crown jewel in Vale's portfolio to this day – set to be eclipsed only be S11D.
Mr McTaggart said it was fair to draw a parallel between China and Japan's
investment in Vale – albeit three decades apart. About half of Vale's production
went to China last year.
EIGHT VESSELS SOLD
China's deal with Vale on Tuesday night has seen the Asian nation invest in
eight of its super-sized Valemax iron ore vessels. China had – until now – made
life difficult for Vale over the vessels, first banning them and then imposing
restrictions on them docking at Chinese ports.
Now, Vale can get rid of up to eight of the ships, which have been weighing on
its balance sheet – it netted $US445 million through the sale of four in Tuesday
night's deal, and has agreed to sell another four.
It is 25 per cent cheaper to ship ore on the mega vessels than using Vale's
next-best fleet.
Brazilian producers saw their market share in China decline slightly to 18 per
cent last year. By contrast, Australian producers increased their share from 51
per cent to 59 per cent of imports.
Vale's S11D project contains 4.2 billion tonnes of ore at 66.7 per cent grade –
well above the 62 per cent benchmark grade and the 61.5 per cent grade coming
from Australia's flagship "Pilbara Blend".
Credit Suisse analyst Matthew Hope said Vale intends to remain the largest iron
ore producer, but it needs to be competitive with the lowest-cost Australian
miners, "and that is why it is intent on completing S11D in any iron ore price
scenario".
UBS mining analyst Glyn Lawcock said Vale was lagging Rio and BHP on margins
because its freight costs were about $US4 a tonne higher than the Australians'.
Shipping ore direct to China using the Valemax fleet will narrow the gap, he
said.
Vale's Carajas operations produce some of the lowest-cost iron ore in the world
and it is only freight that makes it higher-cost than BHP and Rio's product. But
Vale also has a southern system of ore which is lower-quality and higher-cost.
Bringing S11D into production from the second half of next year will help to
lower the company's broader cost base and replace some of its higher-cost
production.
Vale is near the peak of spending on the expansion, which is putting financial
pressure on the company. The company's loss of market share in the past year has
been mainly Australia's gain.
Source: www.afr.com
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