Vale: Banking on Big in Brazil
A full range of risk awaits Vale’s new transport strategy. Are they on the right course?
Vale do Rio Doce, the second largest mining company in the world, is facing various challenges in 2012. These include low iron ore prices in the international market, logistics and casualties involving its iron ore transport trains and ships. If that wasn’t enough, the company now finds itself going through a judicial battle with the Brazilian Internal Revenue office (Receita Federal), primarily revolving around taxes imposed on profits that Vale earned through international transactions. Most observers agree that Vale is in no position to pay those additional taxes.
The new president of Vale, Murilo Ferreira, took over the company just one year ago. His first main hurdle was to calm investors who feared that Vale would be eventually come to be controlled by the Brazilian Government. The company’s finances are said to be significantly influenced by federal pension funds and the federal investment bank (BNDES); both of which are major Vale shareholders. Ferreira’s efforts in this regard have yielded some early successes, but this aspect of his leadership represents just one of his many headaches.
Vale by the Numbers
Record income and profits were presented by Vale in 2011, but performance declined during the fourth quarter, due mainly to lingering effects from the global economic crisis. According to numbers released in mid February 2012, operational revenues last year reached R$105.5 billion (around USD $50 billion), a 23 percent increase over 2010. Vale’s profit reached R$38 billion in 2011, also a 25 percent increase over 2010 numbers. Declining iron ore prices had a major impact on the company, as iron ore is its main product.
“The results of the last quarter of 2011 were strong, but inferior in dollars to the last quarter of 2010 due to lower (iron-ore) prices caused by the European recession and the negative expectations caused by the Euro zone debt crisis”, said Vale in a media release.
Many market analysts had (correctly, as it turned out) forecast a profit decrease of between 20% and 22% in 2011. Unfortunately, Vale’s fourth quarter numbers could be the harbinger of even weaker results in 2012, especially if the European economy continues its downward trend. A similar situation in China is also weighing on the company’s future prospects. Significantly, Vale reported record iron ore and pellet sales last year, reaching a total volume of 299 million tons; slightly more than its output in 2010.
Murilo Ferreira puts an optimistic spin on Vale’s performance, “Our financial performance was excellent, the best of all time. We broke various records, even with a challenging economic environment.” He attributes this to what he characterized as a disciplined execution of strategy, benefiting from strong global minerals and metals demand.
According to Vale, the capital return for shareholders hit the record high of $12 billion, made up of the distribution of dividends reaching $9 billion, equivalent to $1,735 per ordinary share and by the $3 billion program to re-acquire shares, which was completely executed. For 2012, Vale has announced minimum dividends of $6 billion. In 2011 Vale’s investments reached $18 billion, excluding acquisition costs. Of this total, $13.4 billion was spent through project operations and research/development initiatives.
Vale continues to face serious challenges in transporting iron ore and minerals; both on land and at sea. In the first three months of 2012 alone, Vale experienced two train accidents. The second casualty occurred in the north of the country, which left the Carajas railway shut down for five days, incurring steep losses for the company.
At sea, the news was not much better. One of their new Valemax ships ran aground while loading in Brazil and another experienced a ballast tank leak. It is here where Vale’s bid to build a fleet of Valemax ships – the biggest bulk carriers by volume in the world – has also been met with skepticism; in Brazil and abroad. Some shipowners – particularly Chinese-based operators – complain that, with these ships, Vale may have a stranglehold on iron ore and minerals exports from Brazil, which negatively affects the already struggling offshore minerals and iron ore transport market. At home, more than one naval architect – all of whom declined to be named – expressed concerns as to the long-term viability of the behemoths.
In recent years, Vale acquired 22 Capesize ships, but the huge Valemax ships – capable of carrying 400,000 metric tons of cargo and at 362 meters LOA – are what Vale is banking on. According to Vale, these massive ships have improved the efficiency of ore transport from Brazil to Asia and also cut carbon emissions per metric ton transported by as much as 35 percent.
Skeptics of the Valemax ship design maintain that these ships are unsafe to carry such large volumes and the recent ballast tank rupture that occurred while loading the ship in a Brazilian port have only increased the outcry.
Banking on Big: economy of scale
Vale has ordered 35 large Valemax ships, each with 400,000 DWT, each priced at a little under $110 million. Beyond this, they have also ordered another 4 Capesize ships (about 180,000 DWT tons each), plus two barge convoys composed of two pushboats and 32 barges for inland waterways.
Not surprisingly, Vale has met with strong opposition in its bid to berth the Valemax ships in major Chinese ports. That said, the Brazilian government has intervened on behalf of the company and it is now expected (although not guaranteed) that permission to dock in Chinese ports will be released within a few months. To be fair, some Chinese ports had to do some dredging in order to allow the ships to dock and changes also have had to be made in loading infrastructure and procedures in order to accommodate the massive ships.
Already, Vale has received eight of its planned 35 Valemax bulkers. Notwithstanding the previously mentioned ballast tank problem, Chinese shipowners are also claiming that the carriers will worsen the already oversaturated bulk markets and depress freight rates even further. Moreover, the steelmakers are also lining up against the Valemax strategy, claiming that the new vessels, if delivered in full, will give Vale even more control of pricing and delivery.
What if? Depreciation Looms Large, too …
Bloomberg has reported that the latest Valemax received by the company is already valued at 36 percent less than what it originally cost. Hence, if their long-term strategy of building large and in great quantities does not pan out, a decision to sell some of these assets in the near term would inevitably create sizable loss to Vale’s bottom line. Today, about 80 percent of the world’s iron ore is being transported by Capesize ships. These can only carry about one third of the cargo capacity of a Valemax and these Capesize ships are also being devaluated.
It is important to note that Vale, BHP Billiton (BHPLF) and Rio Tinto (RTNTF) thoroughly dominate the annual billion ton seaborne iron-ore trade. Vale itself actually controls a quarter of the world’s supply of iron-ore.
In a nutshell, if the Chinese do not permit these gigantic bulkers to unload in their ports, Vale will face some serious problems. As MarPro went to press, Valemax ships are being forced to unload in other Asian ports, where the cargo is then transshipped to China by smaller ships. Although the system is working on an operational level, the practice clearly defeats the purpose of the “Valemax strategy.” None of the five Valemax ships have reached Chinese ports since they began operating in May, although the Berge Everest, another large vessel used by Vale (388,000 metric DWT) called at the Chinese port of Dalian in December. In the meantime, Vale has set-up plans to bypass the exclusion by establishing a transshipment vessel in the Philippines.
Bottom Line: Big Risk, Bigger Possible Headache(s)
Vale claims it needs these ships in order to compete with BHP Billiton and Rio Tinto, which are both located much closer to China (10 days from Australia versus 45 from Brazil), and who pay about half the transport fees to move their product to the world's largest ore market as Brazilian producers do. But, according to Vale itself, Vale’s strategy of reducing freight cost volatility won’t change even if the company sells its giant ships, because it will lease them back under long-term contracts. According to Vale, the VLOC (very large ore carriers) or Valemax class carriers are here to stay and the problems faced in Chinese ports are only a temporary setback.
At the heart of Vale’s new transport strategy is, of course, China itself. China's economy expanded by $2 trillion in the last decade as growth averaged about 10 percent annually. And, even if growth slows by more than one- third, the slower pace of growth – on top of previous gains – still translate into huge demand. When it comes to China, then, Murilo Ferreira, president of Vale do Rio Doce, insists, “We are looking at the long term.” That much is clear.
Long term, though, Vale’s ability to solve its transport pricing issues will depend on just how badly China needs Brazil’s iron ore output, and what it will give up to get it. Clearly, Vale is banking on big – big ships and big volumes – moving ever larger volumes with economy of scale and in what they claim is a decidedly greener fashion. It all sounds good, on paper.
The world's largest iron-ore producer supplies more than a quarter of the world's annual seaborne iron-ore exports. Gambling on a transport strategy that is at odds with many other shipowners in an already depressed bulk freight environment, while at the same time trying to supply the proverbial 600-pound gorilla known as China, leaves Vale at a critical moment in its corporate history. This big producer has big plans based on big ships. What happens next will make all the difference.
+ (taken from Maritime Professional magazine's 2Q print edition) +
Claudio Paschoa is a reporter and photographer from Rio de Janeiro specializing in shipping and oil & gas related subjects.