Vale (NYSE:VALE) recently completed a trial run for its Valemax ships, the world’s biggest bulk carriers, by entering Nippon Steel & Sumitomo Metal Corporation’s Kashima steelworks port. This is the third of Nippon Steel’s Japanese plants to receive the Valemax vessel, after Oita and Kimitsu. These trials may be precursors to a contract between Nippon Steel and Vale on using Valemax ships for transporting iron ore produced by Vale to Nippon Steel’s plants. 
Vale, with its iron ore mines located in Brazil, suffers from a disadvantage when it comes to transportation costs, as compared to other iron ore majors such as Rio Tinto and BHP Billiton. These iron ore majors have their mining operations concentrated in Australia. Geographically, Australia is much closer to major iron ore consumers in Asia, as compared to Brazil. The Valemax ships are an integral part of Vale’s strategy to lower transportation costs from its iron ore mines in Brazil to major customers in Asia. In this article, we will take a closer look at Vale’s endeavor to lower its transportation costs through the Valemax ships.
- Vale Q1 2016 Earnings Review: Lower Costs Offset Impact Of Decline In Commodity Prices On Earnings
- Vale Q1 2016 Earnings Preview: Cost Reduction To Offset Impact Of Decline In Commodity Prices On Earnings
- How Will Vale’s Revenue Composition Change By 2020?
- How Has Vale’s Revenue Composition Changed Over The Last 5 Years?
- Vale: A Look Back At The Year 2015
- By What Percentage Can Vale’s Revenue & EBITDA Increase Over The Next 3 Years?
The Valemax System
The Valemax ships are Vale’s ultra-large vessels, which have a capacity of 400,000 dead weight tons (dwt). These vessels have 2.3 times the capacity of Vale’s Capesize ships, that ordinarily ply the route between Brazil and China.  In addition to these carriers, the other components of Vale’s transportation system to Asia are its floating transfer stations in Subic Bay, Philippines and the distribution center in Malaysia, which is still under development.  These floating transfer stations and the distribution center provide transshipment services. Transshipment refers to the transfer of cargo from Valemax ships to smaller vessels, which deliver it to its destination.  Transshipment provides ore transportation options for ports where Valemax ships are either not allowed to dock, or whose waters are not deep enough to receive Valemax ships or to receive them fully loaded. This system has allowed Vale to reduce its transportation costs, capitalizing on the economies of scale generated from the use of these ships.
Benefits and Challenges
The Valemax ships were built primarily to serve Vale’s markets in Asia, particularly China. Asia accounted for roughly 60% of Vale’s total sales in 2013, with China accounting for 39% of the company’s total sales. China accounts for more than 60% of the global seaborne iron ore trade, and around half of Vale’s iron ore and iron ore pellet shipments. 
The Valemax ships are currently not permitted to dock at Chinese ports, which are permitted to allow ships only as big as 250,000 dwt.  Chinese shipping companies have lobbied hard to ensure that Valemax ships are not allowed to dock at Chinese ports. They argue that allowing Valemax ships to dock at Chinese ports will exacerbate overcapacity in the shipping industry. Overcapacity in the global shipping industry has lowered freight rates and forced many Chinese companies into the red. 
As a result of the Valemax system, transportation costs from Brazil to China are currently about $22 per ton. If Valemax ships were able to take cargo directly to Chinese ports, it would save about $7 per ton over current costs. To put this into context, Australian iron ore producers currently have around a $10 per ton advantage in terms of freight costs as compared to their Brazilian counterparts.  Thus, if Valemax ships are allowed to dock at Chinese ports, it would significantly reduce Vale’s transportation cost disadvantage vis-a-vis its Australian rivals.
The Road Ahead
If Nippon Steel agrees to use Valemax ships for receiving iron ore deliveries, its shipping costs would decline by around $400,000 on each cargo.  The global steel industry is characterized by overcapacity and a subdued pricing environment, at least in the near term. Reducing costs is a major incentive for Vale’s customers, including Chinese steelmakers. With ports in Japan, Malaysia, Philippines and Korea accepting Valemax ships, it may be a matter of time before China also follows suit. Should this happen, it would definitely provide a boost to Vale’s business prospects.Notes:
- Nippon Steel may start talks to transport iron on Valemax ships, Reuters [↩] [↩]
- Shipping division, Vale website [↩]
- Valemax, Vale company presentation [↩]
- China wants shipping partnership with Brazil’s Vale, Yahoo Finance [↩] [↩]
- Vale’s 2013 20-F, SEC [↩]
- Brazil’s Vale adjusts iron ore shipping, Chinadaily USA [↩]
- China permits giant Valemax to dock, Financial Times [↩]