China, Vale And The BDI

News was prepared under the information support of Online Daily Newspaper on Hellenic and international Shipping "Hellenic Shipping News".

30 Sep 2008

There's an interesting story playing out between China and Brazil. It's about iron and steel and ships, and it could have a bigger impact than you think. In early September, Companhia Vale do Rio Doce announced that it wasn't happy with the 65% price increase it negotiated back in spring with China for its iron ore contracts for the year that started in April. Vale negotiated separate price increases for its European and Chinese customers, and apparently, they're regretting that. One would think that once the negotiations are concluded and the contract signed, that would be that. At least, that's how things usually work for me. But as any lawyer would tell you, you can always try to renegotiate. That's what Vale is working on.
Here's the logic - at the time of the original deal, when the then-unheard-of increases in the price of iron ore were negotiated, steel makers knew a price increase was coming. Supply was low, demand was high and the iron ore companies were facing increasing costs as energy prices skyrocketed. The steelmakers weren't happy, but they understood the score. They went into the negotiations knowing they were facing a price hike - it was just a matter of keeping it to something they could afford.
The steelmakers themselves were also facing increasing energy costs and had to account for increasing transportation costs as shipping costs rose due to high fuel prices. Demand was high for dry bulk ships, and Chinese companies were stuck paying the high rates because they needed the iron ore (and coal, and the other commodities that travel on those slow boats to China). Apparently the Chinese steel makers were able to negotiate a slightly lower price for their iron ore by crying poor - they had to pay higher shipping prices to get the ore from Brazil to China.
Well, since then, the bottom has dropped out of the shipping market, and Vale wants a mulligan.
Vale is asking for a price hike of around 11% in order to bring the price of iron ore shipped to China in line with ore that's sold to Europe, on the idea that shipping costs have come down, which they have. When I wrote about the Baltic Dry Index a few weeks ago, it was down 50% from its early summer high. Make that 67% today.
Last week alone, the index dropped 25% due to global economic worries (shipbuilding takes credit) as well as this little tussle between Vale and China.
Perhaps the long-horizon shipping collapse analysts have been predicting (which we wrote about before) has arrived quicker than anticipated. Or maybe this is an opportunity to get in the Claymore/Delta Global Shipping Index ETF (SEA) near the bottom.
Since this all began, China has accused Vale of slowing down the loading of iron ore bound for China, tying up ships and reducing China's iron ore imports in an attempt to pressure China to accept the price increase. Vale has, of course, denied both the Chinese allegation and a report by Lloyd's List claiming the same thing. (Color me skeptical, but the classic Teamster-slowdown tactic has been around since Sumerian slaves weren't happy with the gruel.)
Roger Agnelli, CEO of Vale, spoke Friday at a sustainability forum hosted by the company. Here are few of the relevant sound bites (courtesy SmartMoney):
There has been no cut in shipments. We have zero tons of iron ore at our ports.
Despite the grammatical challenge presented here, isn't this a contradiction? Is Agnelli saying that they are shipping everything that is coming out of the ground in an attempt to prove that Vale has not cut shipments? Or is he stating that Vale has not cut shipments in the past, but that may not be true in the future because Vale has no inventory to ship? If it is the latter, we might want to cast a skeptical eye on Vale's forward earnings.
In defense of the price increase, Agnelli said:
In practice there will be no rise for the Chinese because the fall in freight prices will compensate them. Shippers are strongly arbitrating freight prices. China is shouting and crying but is losing nothing.
Then there is this beauty:
If Vale stopped selling ore to China, then the Chinese steel industry would stop.
Talk about biting the hand that feeds you! This is Chicago-level hardball. Vale's main iron customer is China, and we all know that China demand is driving steel growth.
But does China need the ore right this second? Perhaps not. Prior to the Olympics, China stockpiled all sorts of materials.

Source: iStock Analyst