World Crisis Online

Brazilian football mega-star Ronaldo, whose face is long familiar to Chinese football fans, appears nightly on CCTV-2, one of China’s state-run TV channels, with a simple three-pronged message: Vale has bought $1.6 billion worth of cargo ships from China; Vale’s joint venture is feeding tens of thousands of Chinese; Vale is serving as an economic bridge between China and Brazil.

One can see Ronaldo’s smile plastered all over, and not just on TV: in the Chinese Communist Party’s mouthpiece, the People’s Daily, and on web engines Sina and Sohu, with the caption “Vale, investing in China and repaying China.”

A Vale spokesperson explained, “Vale began its advertising in China in May this year to celebrate the 35th anniversary of diplomatic relations between China and Brazil, and hopes to reinforce a cooperative relation with China by investing, sourcing, creating job opportunities, and with product sales. The TV and website advertisement are the second stage of the company’s advertising plan.”

Many Chinese are skeptical.

The world’s three largest iron ore suppliers, Vale along with Rio Tinto and BHP Billiton, are facing a crisis of trust in China. By its widespread media advertising, Vale may (must?) be trying to take advantage by currying favor in China while Rio Tinto is embroiled in an industrial espionage scandal here.

Vale, together with BHP and Rio, control the pricing in the world’s iron ore market. The three miners account for over 70% of the world’s total iron ore supply by sea freight.

The quality of Australian iron ore cannot match that of the Brazilian product, but Australia being so much closer to China so that sea freight is cheaper gives BHP and Rio quite a jump in the trade.

In February of 2008, Baosteel negotiated with Vale a 65% price increase over the 2007 contract. Usually, the other two miners would go along with this price, but this time, the two Australians claimed that, given Australia’s proximity to China, they required a higher price hike. At the end of June, Baosteel was forced to grant an 85% price rise to BHP and Rio.

This put Vale into a snit, and it required a renegotiation of its already signed contract for a 20% further increase. Vale also stopped shipping ore to China. Things might have gotten interesting, but the story collapsed with the global financial crisis and the steep recession in the steel industry.

Since the second half of last year, the global trade recession has narrowed the sea freight difference, though since April and May this year Rio and BHP are have been pushing up sea freight rates by chartering lots of ships to transport iron ore to China, making more apparent their sea freight advantage against Vale. “This is a traditional trick by Rio and BHP during iron ore negotiations,” said a steel industry insider.

Vale is reaching into its hat to offset this weakness. It has begun to set up its own fleet (see above) and has since last year been lobbying Chinese steel makers to set up a joint venture shipping company. Last August it signed a contract on the manufacturing of 12 iron ore transport ships, each with the capacity of 0.4 million tons, with Rongsheng Heavy Industry, a Chinese ship maker. The order marked the biggest single trade volume and highest total capacity in the world.

Meanwhile, Vale is also trying to persuade Chinese steel companies to settle iron ore with a CIF price, in which sea freight is fixed. Usually steel companies sign FOB price contracts with iron ore suppliers. Big steel companies usually charter ships themselves and sign long-term sea freight contracts with shipping companies. However, when amounts are smaller, small and medium-sized steel companies cannot enjoy the price of a long-term sea freight contract, and therefore can’t control the risk of freight price volatility. By chartering ships or building its own fleet, Vale can help them to control freight costs, quite attractive to small and medium steel makers.

Rio Tinto’s espionage case is also providing Vale opportunities. Since the beginning of July, shipping orders for spot iron ore from Brazil have risen to a record high, with orders for iron ore from main Australian ports decreasing.

The situation for the annual iron ore negotiation is also changing because of Rio’s legal problems. At the beginning of this year, Vale suspended negotiations, planning to decide whether to accept the price reached by China and two Australian giants for the new contract.

However, after the Rio story broke, the China Iron and Steel Association (CISA) appealed to Vale to break the deadlock. In fact, several weeks before the espionage case, CISA had already tried to curb Rio and BHP using Vale as a threat.

Industry insiders believe that because of Rio’s China troubles and BHP’s stated preference for a pricing mechanism based on the spot price, China is more likely to first reach agreement with Vale, though Vale cannot be described as a negotiating pushover.

Vale’s China advertising costs do not amount to a large investment, compared to what they stand to gain in China’s huge market. In this year’s first quarter, China imported on average 12 million tons of iron ore from Vale every month, 4 million tons over the average monthly import last year. In the first quarter, 45% of Vale’s total iron ore sales went to China, while in the fourth quarter of 2008 that figure was only 13%.