A very large deal

The Valemax war looks to be over as Cosco and Vale finally make peace

Tugs move the damaged the Vale Beijing at Ponta da Madeira Port near the northern Brazilian city of Sao Luis

Valemax: stood upright, it’s taller than the Eiffel Tower

Fabius Maximus is known – at least among military strategists – as the general who undertook the first ‘war of attrition’. The strategy was devised to defeat the superior army of Carthage’s Hannibal. The crux of this tactical innovation was to curtail enemy access to food and deny Hannibal his preference for a pitched battle (an outcome via which he hoped to annihilate the Roman army). Victory instead would come from weakening Hannibal’s formidable troops without directly challenging them. As such, the forces of Carthage would be defeated by time, rather than the usual pincer movement preferred by generations of generals.

Time eventually saw Rome prevail over its rival, with Carthage destroyed in 146 BC – albeit a half century after Fabius had died. His role in its defeat was recognised and he was bestowed with the honorific title ‘the Shield of Rome’. Almost two millennia later, George Washington emulated the very same tactics in the Revolutionary War against Britian, a deed that earned him the monicker: the American Fabius.

A war of attrition has also been waged in China’s ports over the past couple of years too. The battle on this occasion has seen the Chinese state-owned shipping firm Cosco look to wear down Vale, the Brazilian mining behemoth.

WiC first reported on the conflict in 2011 (see WiC125). The casus belli in this case was Vale’s decision to enter the shipping industry. In a bold move, it announced it would build 35 ships – known by the name the Valemax – each capable of transporting 400,000 deadweight tonnes. This new fleet – to be completed by 2013 – would carry Vale’s iron ore to China, lowering its freight costs by a quarter and helping it to compete with rival exporters of iron ore from Australia.

The scale of these vessels dwarfed anything in China. Cosco was concerned: its largest ship could carry roughly half as much ore. To make matters worse, many of its own capesize vessels were performing unprofitably due to some ill-timed leases signed in 2008 at the height of the shipping bubble. The last thing it needed was yet more competition – the effect of which would be to drive freight rates even lower and cause it and other Chinese shippers to go further into the red.

And the Valemax promised formidable competition.

In 2011 Caijing magazine calculated that the full Valemax fleet making four round trips a year would account for about a 40% share of existing freight volume between Brazil and China. The threat to Cosco was palpable.

Thus the Valemax’s greatest advantage was turned against it: the vessel’s sheer scale (one of WiC’s favourite stats about the ship is that if stood upright it would be taller than the Eiffel Tower).

Vale’s Chinese rivals lobbied the government to deny the vessels access to the nation’s ports on “safety grounds”. Sure enough, the first Valemax to head for China was denied permission to dock in Dalian in June 2011 and in February the following year the Chinese authorities clarified that no ship would be allowed to unload in China if it exceeded 300,000 deadweight tonnes. The ship being targeted by this measure was fairly clear.

The 21CN Business Herald reports that by 2012 Vale had already committed $4 billion to the building of its fleet – owning 19 of the ships itself and leasing back the rest. However, the Brazilian firm hadn’t factored in the nightmare scenario that Beijing would bar the boats from Chinese ports. Overnight, the Valemax fleet looked like becoming some of the most expensive white elephants the world had ever seen (Hannibal’s elephants were real, of course). A Fabian war of attrition had begun, with Vale losing money almost by the hour on a fleet that it couldn’t deploy as intended. Instead it has had to unload the Valemax vessels in neighbouring countries and switch their cargoes onto smaller boats. Then in a tit-for-tat reprisal, it also refused to buy freight space on Cosco’s fleet.

Both Vale and Cosco had an interest in seeking some sort of truce to end the war. And last week it emerged that the pair had signed a ‘cooperative framework agreement’ that might bring an end to hostilities. Vale later disclosed that this 25-year deal will see Cosco transporting large quantities of its iron ore to China once more. As part of the pact, Cosco has purchased four of Vale’s Valemax vessels and is building 10 equivalent-sized ships of its own.

So who won this war and why has the deal been done now?

Political pressure played a part in the timing, with both countries mindful that this year is the 40th anniversary of the establishment of diplomatic relations between Brazil and China. In fact, in May the Chinese ambassador to Brazil had made public that China intended to establish some form of partnership with Vale.

For Vale there were financial pressures that made plain the logic of an armistice. As 21CN reports, falls in iron ore prices – largely due to a slowing Chinese economy – have seen Vale’s net profit fall from a bumper $22.85 billion in 2011 to $4.86 billion in 2012 and only $584 million last year.

But Cosco too had reason to seek some form of compromise. As regular readers know, the shipper narrowly missed being delisted in Shanghai (see WiC233) this year after consecutive years of losses. It avoided the delisting with sleight of hand, selling assets to its parent in 2013. But 21CN reckons it’s almost a foregone conclusion it will be drowning in red ink again this year. A deal with Vale is one route back to profitability.

By 2018 Vale predicts it will be shipping 300 million tonnes of ore every year to China. A big chunk of that could fill the Cosco fleet, 21CN estimates.

So far there have been no formal announcements from the authorities about a relaxation of its port restrictions on larger vessels. But in an interview with CBN, Liu Bin, a professor at Dalian Maritime University, said that he expected Valemax ships will soon be allowed to dock at ports with the capacity to handle them (such as Dalian).

The outcome of the war: Vale’s strategy to control more of its China supply line has been jettisoned. The Chinese side has got what it probably wanted: a partnership. But for Vale, getting the Valemax fleet into full operation is an imperative. That will again have hit home this week with the Financial Times reporting that prices of iron ore fell below $80 per tonne (versus the peak price of $190 per tonne in 2011). Such declines in ore rates mean that the Valemax strategy and its economies of scale now look more vital for the Brazilian miner than ever.

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