The world’s largest iron ore producer wants to extend its logistics dominance beyond mines and ports to the oceans with a $10bn investment, which includes orders for 33 of the biggest bulk carriers ever built. But do the numbers stack up?
AN APRIL Fool’s Day email did the rounds this year, purporting to be from
The Brazilian mining giant was negotiating with Asian shipbuilders and its contract of affreightment partners to cancel some of the 33 very large ore carriers it had on order, the email said. They were too inflexible for future customers.
But who will really have the last laugh? Sceptics say the world’s biggest fleet-building programme under way by Vale, the second-largest metal and mining company, is economically flawed. The ships are so big that terminals must be built to take them and the cash breakeven rate is too high. Others observe that China’s dry bulk dominance gives Vale no choice but to ship ore on its own vessels.
But whether the joke will be on Vale, Chinese steel mills, or the European shipowners set to miss out on Vale’s lucrative iron transportation ore business, remains to be seen.
“It’s a big risk,” says a senior maritime researcher familiar with Vale’s plans. “These ships were ordered in a relative boom. If we come back to a slump in the next 15 years, the accountants in Vale are going to come and say ‘who ordered these ships? Why are we shipping at $25 per tonne when we can do so for $13 on the spot market?’”
So what are the costs? Lloyd’s List estimates that the cash breakeven cost for Vale to ship iron ore on the specially commissioned VLOCs on a dedicated maritime shuttle service from Brazil to China is at least $19 per tonne. Others familiar with plans suggest the cash breakeven might be as high as $23-$25 .
Not only have Vale executives declined to be interviewed by Lloyd’s List but they have avoided questions from their shipping customers.
“I can’t even get past reception,” one senior shipping executive told Lloyd’s List. “They are intensely secretive and don’t want anybody knowing their business.”
A key team of executives has done the rounds of owners and shipbrokers over the last 18 months, selling the Big is Beautiful concept. Some have bought in. Oman Shipping, STX Pan Ocean, Anangel Maritime and BW Group are among those to have agreed to build VLOCs against long-term charters of up to 25 years.
The logic underscoring Vale’s return to an industrial shipping model, last embraced by oil companies, miners and steel mills in the 1970s, is obvious.
Vale’s market share declined last year, but it still controls around a quarter of global seaborne iron ore volumes — set to hit 1bn tonnes in 2010. The company wants to drive freight rates from Brazil to Asia, the destination for 75% of its iron ore and pellets, as low as possible.
That would help cut the crippling price disadvantage that Brazil iron ore has compared with Australian competitors, nearer to Chinese steel mills. In the last three years, China has emerged as Vale’s largest customer and consumes two-thirds of all seaborne trade.
So Vale has rolled the dice. Its strategists have bet that over the next 25 years it will be cheaper and more efficient to ship iron ore on its own giant ships than at the prevailing spot voyage price for smaller bulk carriers, less than half their size.
“This must be the largest hedge in shipping history,” said one analyst, who like many interviewed for this feature, insisted on anonymity.
At the moment the current capesize spot rate is $17.50 per tonne, lower than the estimated cash breakeven rate for Vale’s largest VLOCs. Furthermore, derivatives trading shows that traders anticipate rates to average $21 per tonne in 2011.
Sceptics believe that spot rates around this level lend weight to their argument that the Vale concept is unworkable. Between Vale commencing studies into VLOCs in 2005, and signing first contracts for orders in mid-2008, freight rates had climbed steadily and peaked at all-time highs. In May 2008, voyage costs from Brazil to China were as high as $105 per tonne, while Australian costs were $55 cheaper, at $50 per tonne.
Rates over $40 per tonne “practically eliminate our profitability”, one executive conceded to investors in August, 2009.
But the cooling global economy ended the dry bulk supercycle, tempering unsustainably high rates. The bulk carrier fleet has also grown rapidly in the last two years, removing the heat from these iron ore freight differentials. Australian iron ore voyage costs to China are now $6 per tonne, or $11 cheaper than Brazil.
“Their strategy is good,” said one senior European figure in dry bulk shipping. “Those who think it is a bad idea are mostly shipowners, because it’s taking business from their capesize orderbook. But Vale ordered at the wrong time, and this [the VLOC fleet] is another kneejerk response. Vale has always reacted to the market, they are not very good at anticipating it.”
Another respected maritime figure believes Vale could even be kicking an ‘own goal’.
The large number of VLOCs entering the market — mostly deployed to ship Brazilian iron ore, and many on Vale’s account — has already helped bring overall dry freight rates down, largely killing the gaping Australian advantage.
Once all the Vale VLOCs start trading, the avalanche of new ships could keep the overall spot market depressed. Then the economics might start to unwind, critics argue, and it might be cheaper to use more flexible capesize or panamax bulk carriers.
“Whether it makes perfect sense depends on what your costs are,” said Nikos Nomikos, a director at the Cass Business School. “It totally depends on the timing of your purchase and the price you paid, and the amount of outstanding debt.”
Vale has never released this information. A brief public disclosure came in 2007, when the head of ferrous metals divisions Jose Carlos Martins said the cost of using VLOCs was $12 per tonne, or 30% cheaper than conventional capesizes.
But there is more to add to this headline figure. Financing costs have to be included and these total around $40,000 per day, as Vale has outlined to potential customers, according to those familiar with the deal structure.
The VLOCs consume 108 tonnes of bunkers daily, costing $47,500 assuming a price of$440 per tonne. Plus there are port expenses for the return journey — estimated at $220,000 — as well as commissions and other operating costs of about $8,000 per day.
The VLOCs would ship iron ore from Brazil to Asia but make the return journey in ballast. This would take around 80 days, allowing for 32 days sailing each way, loading and and discharging at terminals, and queuing.
With these daily costs calculated and then divided over the journey period, they come to a very rough cash breakeven figure of about $19 tonne.
That more or less matches with the average cost of about $19.50 per tonne calculated for STX Pan Ocean’s consecutive voyage contract, one of only a handful that have been publicly disclosed with Vale. Signed last September, STX Pan Ocean will ship 300m tonnes of Vale’s iron ore over 25 years for $5.8bn. STX is building eight VLOCs of 400,000 dwt to do so.
Cash breakeven figures could be even higher, at $20-$23 per tonne, others have told Lloyd’s List, based on a higher estimate of finance and operating costs of $60,000 per day. Even so, the spot rate has averaged $25 per tonne since May 1998, when the Baltic Exchange index on this route started. Vale always has the option of swallowing freight losses, and making up the difference with the iron ore price.
But savings advantages can quickly evaporate if there are delays or disputes that result in vessel under-utilisation.
“These ships have to work like a pendulum,” said one service-provider to Vale. “Once they are out of sync, Vale is knackered.”
Then there are Chinese steel mills which have a testy relationship with Vale at best over new iron ore pricing regimes, and are keen to thwart the miner’s growing dominance.
Vale’s strategy is premised on selling individually blended parcels to smaller mills at different prices and terms. This is contrary to the Chinese government’s policy to merge and consolidate the steel production sector to give the industry more pricing clout.
China is also buying Brazilian mining start-ups and financing the construction of terminals, while Baosteel, China’s largest mill, is even investing is own bulk carrier fleet that will compete with Vale’s.
But while the VLOCs are new, the concept is not. Steel mills had shipping vertically integrated into their portfolios nearly 30 years ago, but abandoned the concept and sold their fleets when it no longer added up.
“History is like fashion. Certain things come back after 2o years and people think they’re new but they’re not,” said an experienced researcher at a major shipbroker.
“There were reasons why this concept worked before and there were reasons why, at the end of the day, they [large ships] were white elephants. Either these ships will be white elephants and the accountants will be all over them, or the market for the conventional capesize will be limited. Take your pick.”
Brazilian giant plays down $10bn bulk investment
VALE might have embraced the ‘big is beautiful’ concept, but is keen to downsize the economic importance of its $10bn-plus investment in bulk shipping, writes Michelle Wiese Bockmann.
Recent presentations fleetingly suggest a “low-cost portfolio of maritime freight and distribution centres” from which Vale will blend ore and tranship to customers in Asia.
As well as the 33 very large ore carriers under construction at four different shipyards in South Korea and China, Vale will own or charter 13 converted very large crude carriers, as many as 20 secondhand capesize vessels, as well as ships covered under 20 contracts of affreightment.
By 2014, the fleet is set to exceed 55 vessels. That’s hardly small change, even for a company that made $5.3bn profit last year.
The first scheduled VLOC is scheduled to call at Brazil in May 2011. The VLOCs will call at specially built distribution centres planned for Qingdao, China; Sohar, Oman; Teluk Rubiah, Malaysia and possibly ports in Mozambique and Indonesia.
While work has started on a development at the port of Sohar, no definite site has been selected for Asia.
Read part 2 of our Big is Beautiful feature: Vale logistics plan hits Chinese wall