What China’s Vale Investment Means for Aussie Iron Ore Giants

Iron ore mining
Reddit

The news just gets worse for Aussie iron ore exporters. The Chinese have announced a massive deal with Brazilian iron ore producer Vale [NYSE:VALE]. China’s $5 billion investment in Vale will put more pressure on already-low global iron ore prices.

The market share for Australian exporters in China will drop as a result of the deal. Not to mention iron ore prices. Overnight the price of iron ore delivered at Qingdao port dropped 2.4% (to US$57.12) on the back of the deal. That’ll hurt profit margins as the cheaper new supply from Brazil floods China.

This isn’t what the three major Australia producers wanted to see. Fortescue [ASX:FMG] will be the worst hit by this deal. They’ve made a recent effort to cut costs and improve their profit margins. But the Chinese-tie up is likely to push Fortescue’s margins further behind Vale’s. And it guarantees Fortescue will remain the fourth lowest cost exporter behind Vale.

Rio Tinto [ASX:RIO] and BHP Billiton [ASX:BHP] also face pressure from the deal. Vale’s total output in the next few years will outdo both BHP and Rio combined. The deal will lift Vale’s total production capacity by 120 million tonnes (to 450 million). That will cut into Aussie producers’ market share in China.

Fortescue denied that competing exporters would pick up the slack if Rio and BHP slowed production. They thought it was foolish to increase supply to China, where demand was slowing.

It’s not looking as irrational now that Vale is ramping up production. In fact, it only vindicates BHP’s and Rio’s continuing expansion into China. Both still have plans to increase exports to China in the coming years. But they both now face pressure from Vale’s future exports.

The deal will also price the cost of Vale’s iron ore exports roughly on par with Rio Tinto and BHP. Rio’s shipments are currently the lowest cost in the industry, followed by BHP. Vale is currently the third lowest cost producer in the world. That threatens to eliminate any competitive advantage Rio and BHP had in China.

The terms of the deal

The investment will see China loan Vale $5 billion to help fund an expansion project. The S11D operation, set to come online in 2016, will produce 90 million tonnes of high quality iron ore. But there’s more.

The Chinese will also invest in eight of Vale’s iron ore carrier ships. The new Valemax ships will reduce freight costs by 25%. And they’re already 40% bigger than any ships leaving Australian ports. That means that not only does Vale’s export capacity eclipse that of Australian exporters, but they’ll do so at competitive prices.

One of the benefit Australian producers had was their proximity to China. The Valemax ships will go a long way to making Brazilian iron ore just as cheap to export from South America.

So while the Australian iron ore industry is bickering among themselves over supply outputs, the Chinese are diversifying. And they’re doing it by cutting Australian exporters out. The long term prospects for iron ore prices were already looking poor. Now it looks even grimmer, especially for Fortescue. Unless they can improve their profit margin — and it’s hard to see how — they’ll remain the fourth lowest cost producer by some distance.

And iron ore prices aren’t likely to get better. The outlook for the next few years is grim. High supply and low prices will carve up profit margins even at the most profitable companies.

But as iron ore profit margins drop, other commodities are set to take up the slack. Investment guru Rick Rule says there are three commodities which are set to explode and lead the new cycle of growth.

Rick’s been in commodities for most of his life. He’s witnessed several commodity cycles in his 40 year career. He can spot companies that are destined for failure. But he’s also an expert at picking out companies that will flourish when the new commodity cycle booms.

That’s why he’s put together a free video for you. In it, Rick reveals his top three commodities you should be in right now. He’ll show you how to identify the right companies to boost your portfolio as the new cycle gains pace. To find out how to watch the special report, click here.

 

Mat Spasic,

Contributor, The Daily Reckoning

 

Join The Daily Reckoning on Google+

The Daily Reckoning
The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.
Reddit

Leave a Reply

1 Comment on "What China’s Vale Investment Means for Aussie Iron Ore Giants"

Notify of
avatar
Sort by:   newest | oldest | most voted
slewie the pi-rat
Guest

say!
what’s the difference between an Australian and a Brazilian?

[the bush!]

wpDiscuz
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au