The Ningbo Port Company, which operates the eastern Ningbo-Zoushan port, has said that it will need two to three years to build the berths necessary to receive Vale‘s (NYSE:VALE) giant Valemax ships. Ningbo-Zoushan is China’s second biggest port and was given permission in May by the Transport Ministry to build berths big enough for Vale’s ships. The Transport Ministry, however, does not have a final say in the matter and before the port starts building the berths, it needs approval of the local government and the National Development and Reform Commission. This poses further delays for Vale should Beijing lift the current prevailing ban on the vessels. ((China port needs years to prepare for Vale’s big ships, Business Recorder))
The Valemax Story So Far
Valemax vessels are the world’s largest iron ore vessels with a capacity of 400,000 deadweight tons. These were ordered to be built by Vale to reduce shipping costs to the Asia Pacific region, so it could compete better with Rio Tinto and BHP Billiton. The latter two enjoy a cost advantage over Vale due to the geographical proximity of Asia-Pacific countries to Australia from where they primarily ship iron ore. Thirty-five ships, each costing about $110 million, were ordered and all of them were expected to be in service by 2013. The company’s plan, however, went into a tailspin as China refused to allow these ships to dock at its ports.
The first and only Valemax allowed into China, the 380,000-tonne Berge Everest, docked at Dalian port in December last year. An accident at the Brazilian port of Ponta da Madeira, in which one of the Valemax ships was damaged while loading its maiden cargo, came as a huge setback to Vale as it gave China an excuse to ban Valemax vessels from its shores on safety grounds. China slapped a 350,000 deadweight ton limit on vessels docking at its ports, to protect its shipping industry and reduce its dependence on imported iron ore. This was partially in response to a complaint from the China Shipowners Association, which claimed that Vale’s massive ships would drive freight rates down throughout the industry. As a result, Vale has had to send its giant vessels to costlier trans-shipment hubs in the Philippines and Malaysia and then transfer it to smaller vessels. Since the ban came into force, however, Vale has received support for its protest against the ban from Chinese steelmakers who contend that the vessels will lower the costs significantly. ((Vale’s huge iron ore ship back in service after maiden accident, Reuters))
What If The Ban Is Lifted
The permission given to Ningbo-Zoushan to prepare for docking of Valemax vessels shows that the Chinese plan to eventually allow Vale to bring these vessels to its shores. Although dredging work has begun, we believe that real and rapid progress cannot happen unless the highest authorities give their approval. Even if the ban were to be lifted now to build a 400,000-tonne berth, there are some challenges to overcome, such as ensuring adequate water depth along the navigation route. This would take two to three years to accomplish. Since no other Chinese port has received even a preliminary permission, it is a safe bet that Valemax won’t be visiting China for some time. As a result, shipping costs will continue to remain higher for Vale relative to its peers and in the downbeat market conditions prevailing now, profit margins will suffer.
Earlier this year, the company idled two of its Valemax vessels for as much as a month after China’s reduced its growth target in March. Further, in April, the company delayed taking delivery of two new vessels. ((Vale’s Biggest Ore Carriers Idle as Exports to China Slump, Bloomberg, April 05 2012)). Not much has changed since then, but Vale claims that Chinese producers are cutting supply because of lower prices which will cause them to rise, going forward. ((Vale Sees Iron-Ore Rebound As China Producers Cut Supply, Bloomberg)). We believe that the upside, if any, would be tempered by the prevailing weak economic conditions.
Iron ore prices have been very weak this year, and this has had an impact on Vale’s bottom-line. Ferrous minerals (iron ore) constitute 62% of our price estimate for Vale; accordingly, any prolonged weakness in iron ore demand and prices could impact our price estimate for the company.