The Competition Between Vale and BHP and Rio Tinto for Asian Iron Ore Markets | Iron Ore | Mining

FUNDAÇÃO GETULIO VARGAS

Iron Ore: The Competition Between Brazil and Australia for Asian Markets
Atin Choenni, Julian Lehmann, Maciej Sewerski, Raffael Huber, Randolph Kirk
Fundação Getulio Vargas 30/03/2011

China and India are currently experiencing what can be termed a ´Second Industrial Revolution,´ which necessitates large scale mining and importation of iron ore from reserves in Brazil and Australia. Brazil´s Vale is theorized to have advantages in this competition with Australia´s Rio Tinto and BHP for Asian Iron Ore markets through Vale´s initiatives to reduce shipping costs, Vale´s strategic advantages in expansion, and Brazil´s iron ore reserve base advantages. Risks exists to Vale due to a possible a short term oversupply in Chinese steel use for residential and office construction; however, this risk is assessed as relatively low, as the Chinese government remains committed to stimulus spending to promote economic growth in the intermediate term.

Table of Contents
1. 2. 3. Introduction: ................................ ................................ ................................ .................... 2 The Competition between Brazil and Australia for Asian Iron Ore Markets: ...................... 3 Iron Ore supply - World resources ................................ ................................ .................... 5 Figure 3: 2010 Real Iron Ore Content Production, by Country:................................ .............. 6 Figure 4: World Iron Ore Reserves: ................................ ................................ ....................... 6 Figure 5: Exports of Iron Ore, by Country:................................ ................................ ............. 7 Resources in Brazil................................ ................................ ................................ ................ 8 Resources in Australia ................................ ................................ ................................ .......... 8 Resources in West Africa (the Simandou Project in West Africa)................................ ........... 8 4. Iron Ore supply - Companies................................ ................................ ............................. 9 Company profile BHP Billiton ................................ ................................ ................................ 9 Figure 6: BHP Iron Ore Production: ................................ ................................ ....................... 9 Company profile Rio Tinto Limited................................ ................................ ...................... 10 Figure 7: Rio Tinto Iron Ore Production: ................................ ................................ ............. 11 Company profile Vale S.A. ................................ ................................ ................................ .. 11 Figure 8: Vale Iron Ore Production:................................ ................................ ..................... 11 Figure 9: Comparison of Iron Ore Production, Vale, BHP and Rio Tinto: .............................. 12 5. Iron Ore demand - Major markets ................................ ................................ .................. 12 Figure 10: Global steel demand by region................................ ................................ ........... 13 Figure 11: US Consumption of Steel by Sector, 2009................................ ........................... 14 Figure 12: Demand forecast of the global steel industry from 2006 to 2015 ....................... 15 Figure 13: China s share of global steel demand ................................ ................................ . 16 6. Scrap Steel as a Substitute for Iron Ore:................................ ................................ .......... 16 Figure 14: Scrap Steel Usage by for BRICs and China, 2008 and 2009:..... Error! Bookmark not defined. 7. Vale´s Planned Shipping Fleet: Reduction of Australia´s Locational Advantages: ............. 18 Figure 15: Iron Ore Transport Cost (2007-2010)................................ ................................ .. 18 Model of Shipping Costs at Vale: ................................ ................................ ........................ 18 Figure 16, Shipping Cost Model, Vale:................................ ................................ ................. 19 Discussion: Vale´s Expected Shipping Costs: ................................ ................................ ....... 19 8. Strategic Advantage of Vale Compared to BHP and Australia in International Expansion: 21

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Figure 17: Game for Development of the Simandou Project, Brazil vs. Australia ................. 22 9. Chinese Steel Consumption Analysis:................................ ................................ .............. 23 Figure 18: Vale´s 2010 Investor Presentation of Future Steel Demand from Infrastructure Projects In China: ................................ ................................ ................................ ............... 24 Figure 19: Calculated Steel Consumption by End Market, China 2009:................................ 25 Analysis of Chinese Steel Demand: ................................ ................................ ..................... 28 Figure 20: Steel Consumption by Application, Calculated, China:................................ ........ 29 10. Conclusion:................................ ................................ ................................ ................. 31

Bibliography ................................ ................................ ................................ ........................... 32

1. Introduction:
The modern economy can be described as functioning within the Iron Age. Iron Ore is used to construct steel: the primary material of the structures, tools and machines of industrialized society. After the invention of the Bessemer process steel in the 19th century -- in an area relatively close to high grade iron ore deposits of northern Sweden steel could be efficiently used to make steam engines, skyscrapers, railroads (steel rails can support 7 times more weight than iron rails) (Kumar, 2007), bridges, tools, automobiles (the modern automobile is between 55-70% steel by weight) (Buckingham, 2005), electrical grids and power plants. All these sectors of the modern industrialized economy are unimaginable without iron ore. The first industrial revolution occurred in Western Europe, the United States and Japan in the 19th to middle 20th Century, which required massive iron ore mining from reserves in northern Europe and the Great Lakes region of the United States. A ´second industrial revolution´ is now occurring in China and India, which requires iron ore inputs from even more massive reserves in Australia, Brazil and West Africa. Steel is comprised of 5 inputs - labor, iron ore, coal, limestone and natural gas. Iron in this formula has no known substitutes, and therefore steel production cannot occur without iron ore or recycled steel. Steel production tends to be located in areas with an advantage in at

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least one of the 5 inputs. Currently, by far the world's largest producer of steel is China -which produced approximately 48% of the world's total of steel in 2009 which has input -factor advantages of labor and coal. However, China does not have advantages of supply of iron ore. India has factor advantages in coal, labor and currently, iron ore however Indian iron ore reserves are forecasted to be insufficient for the future development of India to fully industrialized status. Thus China must import a substantial percentage of its iron

ore,importing more than 300 million tons of iron ore per year, and India is expected to become a major market for iron ore within a decade. The competition of supplying iron ore to Chinese and, in the future, Indian steel markets from Brazil and Australia and the ´game´ for iron ore reserves in West Africa -- is the subject of this research paper.

2. The Competition between Brazil and Australia for Asian Iron Ore Markets:
Meeting China's need for imported iron ore is currentlythe domain of the world's two largest exporters of iron ore - Brazil and Australia. The mining firms Vale produces approximately 86% of Brazil's iron ore, while BHP and Rio Tinto produce approximately 80% of Australia's iron ore. Brazil and Australia can be viewed as competitors towards supplying the main iron ore market, China. Both Australia and Brazil have competitive advantages and disadvantages in the competition between the countries to serve China, and, in the future, India. This paper will focus on 4 main theses with regards to the trade of iron ore between Brazil and Australia.
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First,Vale can effectively offset the locational advantages of Australia to Chinese marketsthrough the large scale investment in a massive 80-100 vessel shipping fleet, consisting of some of the largest shipping vessels on Earth. This paper analyses Vale's proposed fleet in terms of potential shipping costs per ton, based on a model based on researched figures and statistics. This model shows that Vale can effectively reduce shipping costs to China to below $US10 per ton of iron ore on par with Australian , shipping rates.

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Second,Brazil has strategic advantages compared to Australia based on Vale´s aggressive expansion strategy into West Africa, from the perspective of game theory. The international iron ore market, in a game theory perspective, is a one-time game between Vale and Rio Tinto and BHP that to expand into Western Africa, one of the

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two major unexploited reserves of iron ore in the world (along with Russia). Vale´s significantly more aggressive strategy has allowed Vale to establish a dominant market position in this critical area.

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Third, Valehas long-term, geological reserve advantages. Vale has higher grade, lower cost ore, and has largely won the ´game´ for West Africa iron ore reserves. This will allow Vale to grab a larger market share of the long termdemand from China and India. Interestingly, it should be noted that iron ore reserves in both Australia and Brazil are not infinite: existing iron ore mines within both Australia and Brazil may be depleted in less than 30 years, based on geological data (note that historically the iron ore reserves of the Great Lakes area in the United States were initially thought to last for centuries, but were largely depleted by the 1940´s) Therefore West African sources of iron ore are important for long term market share.

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Fourth,risks exist over in the intermediate term with regards to Chinese iron ore demand. These risks, if they materialize, will likely be disproportionally borne by Vale compared to Rio Tinto and BHP, due to the fact that Vale is investing a higher amount in expansion than its main competitors. This paper will shed light on risks Chinese steel and iron ore demand, by calculating steel end usage in China by end market office, residential, white goods, oil and gas pipeline, expressway, bridges, power plant, container, electrical grid, railway, shipping, airport, refining, defense, factory and machinery and other. The major drivers of steel demand in China are likely office and residential construction, which could result in a bubble in office and residential construction in China.

The balance of the four theses proposed in this paper paint a relatively strong competitive position for Vale and the iron ore industry of Brazil. However, risks exist associated with the execution of Vale´s strategies, namely the relatively high cost of Vale´s expansion compared to BHP and Rio Tinto and the associated risk of a decline in Chinese iron ore demand.

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3. Iron Ore supply - World resources
According to the U.S. Geological Survey, China, Australia and Brazil have the highest reservesof iron ore -- not adjusted for iron metal content -- as shown in Figure 1 below and Figure 2 below. (Jorgenson, 2011)Note that West Africa is not on the list due to the relatively large new discovery of this resource by Vale (more information will be provided on West Africa in subsequent sections). Figure 1: 2009 Production in Million metric Country China Australia Brazil India Russia Ukraine South Africa Iran Canada United States Kazakhstan Sweden Venezuela Other Total World tons 880 394 300 245 92 66 55 33 32 27 22 18 15 53 2232 39% 18% 13% 11% 4% 3% 2% 1% 1% 1% 1% 1% 1% 2%

Country China Australia Brazil India Russia Ukraine South Africa Iran Canada United States

Figure2: 2010 Production in Million metric tons 900 37% 420 17% 370 15% 260 11% 100 4% 72 3% 55 2% 33 1% 35 1% 49 2% 5

Kazakhstan Sweden Venezuela Other Total World

22 25 16 61 2418

1% 1% 1% 3%

Source of above charts: USGS

The mine production estimate for China is based on crude ore, rather than usable ore, which is reported for the other countries. This makes China look like the biggest ore producer, but the usable ore is far lower, around 30%. Following is a breakdown of iron metal production.

Figure 3: 2010 Real Iron Ore Content Production, by Country:

Source: USGS, 2011 This still shows China as the biggest producer, but not by such a big amount as the previous production figures showed. China´s production is highly fragmented and requires large scale conversion to usable iron (a process called beneficiation) which is damaging to the environment and highly energy intensive. China could potentially increase production of iron metal, but at a high cost. The world iron ore reserves are as follows:

Figure 4: World Iron Ore Reserves:
Reserves Crude ore Million Metric Tons United States 6,900 Australia 24,000 Iron content 2,100 15,000 6

Brazil Canada China India Iran Kazakhstan Mauritania Mexico Russia South Africa Sweden Ukraine Venezuela Other countries World total USGS, 2011

29,000 6,300 23,000 7,000 2,500 8,300 1,100 700 25,000 1,000 3,500 30,000 4,000 11,000 180,000

16,000 2,300 7,200 4,500 1,400 3,300 700 400 14,000 650 2,200 9,000 2,400 6,200 87,000

Iron ore is mined in about 50 countries. The seven largest of these producing countries account for about three-quarters of total world production. Iron ore exports are dominated by Australia and Brazil, with demand dominated by Chinese imports. Global production fell just 4% in 2009 with growth of 13% in China countering a 23% fall across the rest of the world. Moreover 2009 saw Chinese imports of iron ore increase 41% on 2008 to 628 million tons, as the contribution from domestic mines fell. Despite the other major iron ore importers recording reduced imports this surge in Chinese import demand was sufficient to see 2009 total export levels reach record levels, up 9% on 2008. 2010 saw iron ore exports reach new heights with combined shipments by the top 15 exporting nations exceeding 280 million tons in Quarter 4 alone and with annual shipments exceeding 1 billion tons for the first time. The 2010 total represents a 12% increase on 2009 levels and was reached despite a 1% fall in China's imports.

Figure 5: Exports of Iron Ore, by Country:
Exports of iron ore 2009 Australia 381 Brazil 266 India 114 South Africa 45 Ukraine 28 Canada 30 Sweden 16 2010 427 311 104 48 33 31 21 % Change 12 17 -9 8 19 2 28 7

Russia Iran Kazakhstan Other USGS 2011

18 7 15 36

20 15 13 48

11 113 -10 32

The demand will be further delved into in the demand section.

Resources in Brazil
Iron ore production in Brazil reached 370 Mt in 2010 from 300 Mt in 2009. razil has the B highest amount of iron ore reserves, with 16,000 Mt or iron content. Iron ore has traditionally been country's largest export product, accounting for 5% of the total value of mineral exports. Japan (13%), Germany (11%), China (22%) and South Korea were t e main importers of h Brazilian iron ore. Vale and CSN (Companhia Siderurgica Nacional) are Brazil's largest iron ore exporters. A rundown of the mines and their production can be found in the Company overviews.

Resources in Australia
Australia is one of the world s major iron ore producers and has the second place in iron ore deposits with 15,000 Mt. Iron ore is mined mainly from secondary enrichments of banded iron formations and channel iron deposits predominantly in Western Australia. There are 2 main companies producing iron ore in Australia, Rio Tinto and BHP Billiton.

Resources in West Africa (the Simandou Project in West Africa)
Vale has estimated that reserves of iron ore are 2Bn tonnes in its Blocks 1 and 2 at a cutoff grade of 65% iron ore, and 6Bn tonnes at a cutoff grade of 44% (Vale, 2010). Rio Tinto has estimated reserves of 2.25Bn tonnes at a 65% cut off grade in its mining areas (Rio Tinto, 2010). The overall Simandou project has not been fully analyzed from a geological

perspective, so final reserve numbers are likely to be significantly higher than the 8.25Bn tonnes combined assessed by Vale and Rio Tinto for their areas. The iron rich region of Simandou is approximately the same size as the state of Michigan in the United States, and therefore exploration has not been completed to date. Note that at 8.25Bn tonnes and a metal content of 4Bn tons (estimated), Simandou alone would rank 7th in terms of iron metal reserves by country.

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4. Iron Ore supply - Companies
There are 3 major iron ore producers: BHP Billiton, Rio Tinto and Vale. BHP and Rio Tinto are Australian based and Vale is Brazilian. This does not mean however that the Australian producers don t exploit the mines in Brazil, the Samarco and Corumbá mines are examples of that.

Company profile BHP Billiton
BHP Billiton Limited (BHP) is the world's largest diversified resources group with a global portfolio of quality assets. Core activities comprise of production and distribution of minerals, mineral products and petroleum. The company was incorporated in 1885, working the Broken Hill lead/zinc mine in NSW. Mineral interests were expanded to include coal and iron ore, in part to supply its steel-making business, which commenced in 1915. The Petroleum diversification was initiated in 1960, with first Bass Strait production in 1967. The traditional steel businesses were spun-off in 2000 and 2002. In 2001, a dual-listing merger with UK-listed Billiton was approved. BHP is a leader amongst global resource companies, with the key differentiating factor being its Petroleum division, which represents about 15% of net operating assets. All other diversified resource companies are focused on mining, whilst oil companies tend to divest mining assets. This gives BHP exposure to a commodity that provides a natural hedge against increasing energy prices that have a negative impact on mining company profits. (BHP Annual Report, 2009) Europe represents 35% of sales by destination, closely followed by the fastest growing region of China/Asia/Japan at 33%. North America is next at 11%, with Australia at 8%. BHP has shown an increase of 9.22% from 2009 in iron ore production, producing 124.962 Mt in 2010.

Figure 6: BHP Iron Ore Production:
BHP IRON ORE ( 000 tonnes) Newman (Australia) Golfdworthy Joint Venture (Australia) Area C Joint Venture (Australia) Yandi Joint Venture (Australia) Samarco (Brazil) BHP total 2010 32,097 1,688 38,687 41,396 11,094 124,962 2009 2010/2009 %Change 31,350 2.38% 1,416 19.21% 35,513 8.94% 37,818 9.46% 8,318 33.37% 114,415 9.22% 9

BHP Annual Report, 2009

Company profile Rio Tinto Limited
Rio Tinto Limited (RIO) is one of the world's largest international mining groups, involved in every stage of metal and mineral production, producing aluminum, copper, diamonds, coal, iron ore, uranium, gold and industrial minerals (borates, titanium dioxide, salt, talc, zircon). About 85% of assets are located mainly in Australia and North America, with other operations in more than 50 countries in multiple continents. Rio Tinto Zinc and CRA have a long history of close association, with CRA being a subsidiary of RIO until 1986. The companies unified through a dual listed companies structure in June 1997. The UK listed entity was renamed Rio Tinto plc. and the Australian listed entity Rio Tinto Limited. In 2000-2002, RIO spent US$4B acquiring North Limited, Ashton Diamonds and 100% of Comal. RIO successfully delivered a knock-out US$38.1bn bid for Canada's Alcan in 2007. On 8 November 2007, the rival mining company BHP Billiton announced it was seeking to purchase Rio Tinto Group in an all share deal. This offer was rejected by the board of Rio Tinto as significantly undervaluing the company. Another attempt by BHP Billiton for a hostile takeover, valuing Rio Tinto at $147 billion, was rejected on the same grounds. Meanwhile, the Chinese Government-owned resources group Chi Nalco and the US aluminum producer Alcoa purchased 12% of Rio Tinto's London-listed shares in a move that would block or severely complicate BHP Billiton's plans to buy the company.BHP Billiton's bid was withdrawn on 25 November 2008, with the BHP citing market instability from the global financial crisis of 2008 2009. Rio Tinto's management sets the company apart from other resource companies, with an impressive track record of profit growth. This is partly due to the high-quality assets, with most of the core operations being very low cost, reliable and likely to contribute for a long time yet. However, Rio Tinto's management has applied new technology, innovative industrial relations practices and astute acquisition strategies, which have served to enhance the operations and, therefore, shareholder value. (Rio Tinto Annual Report, 2010) Rio Tinto has a wide range of customers, such as Asian iron ore and coal contracts with steel manufacturers and power stations particularly noteworthy. Buy of metals source their ers supply from a diverse range of mining companies, and Rio Tinto has a more significant position in copper than that in other metals such as nickel, aluminum, lead and zinc.

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Figure 7: Rio Tinto Iron Ore Production:
Rio Tinto IRON ORE ( 000 tons) Columba (Brazil) Hamersley Iron 8 wholly owned mines (Australia) Hamersley Cañar (Australia) Hamersley Eastern Range (Australia) Hope Downs (Australia) Iron Ore Company of Canada (Canada) Robe River (Australia) (y) Rio Tinto total Rio Tinto Annual Report, 2010 112,706 11,016 9,206 31,72 14,71 59,641 184,629 1,509 2010 2009 2010/2009 %Change -

106,808 5.52% 11,041 9,318 20,634 13,844 54,417 -0.23% -1.20% 53.73% 6.26% 9.60%

171,547 7.63%

Company profile Vale S.A.
Vale S.A. is the second largest mining company in the world. Vale is also the world s largest producer of iron ore and iron ore pellets. It also produces manganese ore, ferroalloys, bauxite, alumina and kaolin. It also produce aluminum, copper, coal, potash, cobalt, platinum group metals (PGMs) and other products. Vale operates large logistics systems in Brazil, including railroads, maritime terminals and a port, which are integrated with its mining operations. Directly and through affiliates and joint ventures, it has investments in the energy and steel businesses. Its principal nickel mines and processing operations are conducted by its wholly owned subsidiary Vale Inco Limited (Vale Inco), which has mining operations in Canada, Indonesia and New Caledonia. The Company is engaged in bauxite mining, alumina refining, and aluminum metal smelting. In September 2009, Rio Tinto Limited completed the sale of its Columba iron ore mine in Brazil and the associated river logistics operations to Vale. (Vale 2009 Annual Report, 2009) Vale's market is primarily Asia, with 52% South America and Europe are both 20% with North America and the rest of the world both being 4% of Vale s market. Vale s iron ore production reached a new record in 2010, namely 307.8 Mt, with a year-overyear increase of 29.4%, thus surpassing the 2007 record of 303.2 Mt.

Figure 8: Vale Iron Ore Production:
Vale S.A. IRON ORE ( 000 tons) 2010 2009 2010/2009 %Change 11

Southeastern System Itabuna Mariana Minas Centrals Midwestern System Columba Furculum Southern System Minas Itabiritos Vargem Grande Paraopeba Northern System Carajás Samarco1 Vale total (Vale Annual Report, 2009)

116,913 38,704 36,635 41,574 4,208 2,829 1,379 74,703 30,05 22,065 22,587 101,171 101,171 10,800 307,795

88,503 31,136 28,922 28,444 956 423 533 55,242 18,124 20,578 16,539 84,638 84,638 8,614 237,953

32.1% 24.3% 26.7% 46.2% 340.2% 568.7% 158.8% 35.2% 65.8% 7.2% 36.6% 19.5% 19.5% 25.4% 29.4%

Following is a comparison of the total iron ore production per company:

Figure 9: Comparison of Iron Ore Production, Vale, BHP and Rio Tinto:
Total Iron Ore Production IRON ORE ( 000 tons) BHP total Rio Tinto total Vale total 2010 113,868 184,629 307,795 2009 106,097 171,547 237,953 2010/2009 %Change 7.32% 7.63% 29.40%

This shows that Vale is as big an iron ore producer as BHP and Rio Tinto combined. Comparing the 307 Mt with the total Brazilian iron ore production of 370 Mt gives a good indication of the strong position Vale occupies in Brazil.

5. Iron Ore demand - Major markets
Iron ore demand directly translates into steel demand since almost all (98%+) of iron ore is used for steel production. On the other hand, steel can be produced in two ways: using iron ore or using scrap metal which we will examine in chapter 9. Scrap supply growth is limited by the life cycle of scrap production and hence, iron ore demand will to a certain degree depend on the future scenario of scrap metal use but will to a high degree be triggered by global steel requirements.

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China triggers global steel demand to a high extent, with 45% of global demand; but also India, South America and the Middle East play important roles.

Figure 10: Global steel demand by region
World Steel Organization, 2010

The most important steel using sectors are
y y y y y

Construction Mechanical engineering Automotive Consumer durables Metal goods

The American Steel Organization has published a chart of United States steel consumption for 2009, by end use, presented in Figure 11. As seen in Figure 11, construction is the largest end user of steel in the US for 2009 at 38% of total use, followed by Automotive at 21% of total use.

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Figure 11: US Consumption of Steel by Sector, 2009

Source: (AISI, 2010) Note that China and India have higher consumption of steel as a percentage of total in construction, however figures are unavailable from public sources for a detailed breakdown of Chinese and Indian steel usage by sector (note that a detailed breakdown is p rovided in this paper, in Chapter 9). Since the demand of these goods is very dependent on the macroeconomic situation, we can conclude that the development of the steel industry is deeply affected by changes in the global economy. Assuming a stable macroeconomic environment and following NA and EU patterns for China, we get the following forecast of global steel demand in 2015:

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Figure 12: Demand forecast of the global steel industry from 2006 to 2015
(World Steel Organization, 2008)

Global steel demand is expected to rise from around 1,260 million tons in 2010 to around 1,533 million tons in 2015e, corresponding to a cumulated annual growth rate (CAGR) of around 4%(World Steel Organization, 2008) Furthermore, BRICs play the most important role in demand increases with China forecasted to grow its demand by around 7,2% CAGR to around 820 million tons, significantly higher than global CAGR and much higher than OECD growth which is expected to be around 1% CAGR(Macquarie Research, 2010).This can partly be attributed to a large government stimulus and infrastructure plans. On the one side to build rails, roads and bridges in eastern China and on the other side for general construction and factory building in western China. Although India is expected to grow even faster than China, they start at a much lower level and will not yet play the same role during the next five years. India might play a future role after China has reached peak steel demand, which according to some sources s expected to be i between 2020 and 2025(Macquarie Research, 2010). The bottom line is that China, if it continues to grow its steel consumption as forecast by the World Steel Organization, will play an even more important contributory role to iron ore demand going forward with over 50% of global demand. This possibility will be analyzed in

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applie in the steel production process A significant boost in use of steel scrap could be rightly e plained with its ability to be successfully recycled as a secondary raw material without any significant quality loss The sector of steel scrap is also believed to be the world s biggest and oldest recycling sector, which provides the steelmakers with diverse benefits, e g. energy savings, more efficient use of space and conservation of raw materials.

As far as the definition of scrap steel is concerned, it is the steel that has been recycled after being used, discarded and recovered. Its source might be any type of equipment such as household and transport devices as well as scrap taken from demolished premises and -third of global steel (350 structures. Electric arc furnaces (EAFs , which produce about one million tons are able to produce one ton of steel out of one ton of scrap (1 to 1 ratio). Basic oxygen furnaces (B Fs), which are responsible for production of around 60

consume some scrap steel as well (apart from iron ore), but it accounts typically for only about 20 of the whole charge (Mackrell, 2006).

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The most important scrap exporting company is now the United States of America. In the United States there are around 8000 companies in the sector of scrap metal, although the revenue is not equally distributed, because the 50% of the whole of it is captured by the top 50 companies. Around a half of the revenues of the metal recycling companies in USA comes from processing steel and iron. On the other hand, the source of demand for scrap metal are mainly the automotive, steelmaking and construction industries. The whole industry has flourished in recent years, bringing approximately $80 billion dollars of revenue per year(Selzer, 2010).

As China is the world s biggest producer of steel, it is also a significant importer of scrap steel. Annual Chinese demand for scrap steel in reached 54 million tons in 2004, 63.3 million tons in 2005, 67.2 million tons in 2006, 68.5 million tons in 2007, and 75.71 million tons in 2008. In 2009 the overall supply volume of ferrous scrap was 89,890,000 tons in 2009 (The Tex Report, 2010). The domestic supply was responsible for 76,200,000 tons (7,9% up from the previous year). Therefore, China imported in 2009 13,690,000 tons (3.8% up from 2008) of ferrous scrap. The estimations for 2010 indicated the amount of 92.02 million ton of scrap steel consumption. Moreover, China has announced data informed about a gradual boost in ferrous scrap applied per ton of its crude steel output that stood at 140 kg in 2007, 144 kg in 2008, and 146 kg in 2009. (The Tex Report, 2010) Scrap steel therefore provides approximately 16% of source iron for Chinese domestic steel production (iron ore, the remaining 84%).

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7. Vale´s Planned Shipping Fleet:Reduction of Australia´s Locational Advantages:
Vale has historically faced higher shipping costs than it Australian competitors, asAustralia is significantly closer to China than Brazil. It takes on average, 60 days to ship iron ore from Brazil to Australia, compared to an average of 15 days to ship from Australia to China The . differential between Brazil and Australia in terms of shipping costs has ranged between $US10 and $US60, based on spot market dry bulk shipping rates, as is shown in Figure 15.

Figure 15: Iron Ore Transport Cost (2007-2010)

Source: (Chan, 2010)

According to the spot pricing mechanism of iron ore, the supplier of iron ore has to pay for shipping to the end market. Therefore the higher and wildly fluctuating shipping costs for

Brazil to China means that Vale faces significantly higher costs than Australia in serving Chinese markets. Throughout the 1990´s the price of iron ore ranged in the $40 range per ton note that with shipping costs above $40 Vale would face a loss on every ton of iron ore shipped. Note that Brazil has on average, 3% higher grade ore which should fetch approximately $9 higher prices per ton than Australian ore (on average, a one percent increase in iron ore content translated to a $3 premium in per ton pricing) (Thomas White, 2010) however, the higher shipping costs historically have negated this advantage completely for Brazil.

Model of Shipping Costs at Vale:
The main aim of this section is to estimate shipping costs per ton with the new, proposed fleet at Vale. Traditionally Vale has been secretive concerning its proposed shipping fleet, disclosing 18

a minimal amount of information in its latest Annual Report (2009), quarterly reports (Q1-3, 2010) and declining to answer direct questions regarding the shipping fleet in detail on quarterly and annual earnings conference calls. Perhaps this unwillingness to disclose

information on the part of Vale is to prevent valuable information concerning its shipping fleet from assisting its main competitors, BHP and Rio Tinto, in planning logistics costs. However, Vale has disclosed selected information concerning its fleet, including number of vessels and size of vessels which, combined with publicly available information, can be utilized to effectively calculate expected future shipping costs per ton after the fleet is in place. This calculation is presented in Figure 16, with sources of information and assumptions listed as notes to the chart.

Figure 16, Shipping Cost Model, Vale:
Ships 80 Cost per Ship (SUSM) (A) 125 Total Cost ($USM) 10000 Tonnage (Mtons) 350000 Trips per year (single ship) 3 Tons shipped per year (sing ship) (Mtons) 1050000 Total Tons shipped year (fleet) 84000000 Value total tons shipped year (at $130)($M) 10,920.0 Depreciation Period (ship)(years) (B) 40 Amortization Cost year (fleet)($USM) 250 Operating Costs (per ship)($M)(year) (C) 3,285 Total Operating Costs Fleet ($M)(year) 262,8 Total Op Costs Fleet/Tons Shipped per year (D) 6,10 A. Costs per ship are presented by Vale press release (Kessai, 2010). Vale´s iron ore shipping vessels are produced mainly at Chinese shipyards, which have disclose pricing information concerning per vessel cost. B. Depreciation period is assumed to be 40 years, which is in line with the depreciation period utilized at Dry Ships (world´s largest publicly traded dry bulk shipping co)(DryShips 2009 Annual Report) C. Operating costs include fuel, crew and maintained costs, assumed to be 30% higher than at Dry Ships per vessel due to the fact that Vale´s proposed fleet will be approximately 30% large by volume per ship. (DryShips 2009 Annual Report) D. Total operating costs include depreciation and direct operating costs.

Discussion: Vale´s Expected Shipping Costs:
As shown in figure 16, Vale can effectively reduce shipping costs to approximately $US6-7 per ton with the completion of its shipping fleet. This level is actually historically lower than shipping costs from Australia to China, which are ranged from $US8 to $US40 since 1997. The

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dramatic reduction in shipping cost verses the spot market pricingfor Vale can be seen as a function of two main factors:
y

Economies of Scale: Vale´s ships are much larger than existing ships: Dry Ship s fleet (Dry Ships is the largest publicly listed dry bulk transport company) averages approximately 250,000 tons in capacity while Vale´s fleet will be between 350,000 to 400,000 tons in capacity per vessel. (Kassai, 2010) Shipping operates on economies of scale: the larger the fleet, the more ore can be transported per trip, without proportionally higher fuel and crew costs.

y

Ability to Expand Overall Shipping Capacity relative to Demand based on Access to Financing: The spot market for dry bulk shipping is currently dominated by privately owned shipping companies, which do not have as strong access to capital as Vale. Almost no private shipping company can afford to expand overall dry bulk shipping capacity by $US10Bn. Vale´s massive entry into dry shipping will dramatically expand capacity relative to demand, reducing spot prices.

Note that there is no news currently from BHP or Rio Tinto whether they are planning to invest in their own shipping fleet; however, if BHP or Rio Tinto reduces their shipping costs to $2-3 from $10, with their own shipping fleet, it is not likely to change the competitive picture between them and Vale. Vale is likely to ensure a significantly higher margin on iron ore shipped to China once the fleet is up and running.

Payback Period Calculation of Vale´s Shipping Fleet: The payback period on Vale´s
proposed $US10 investment can be calculated as follows. I. Historically shipping costs per ton have averaged approximately $23.13 between Brazil and China before the significantly higher shipping costs from 20072008(Freed, 2006). II. With a $US6.10 shipping cost per ton, the annual savings will be ($23.13-6.10) = $17.03 per ton of ore shipped. III. Vale shipped approximately 126M tons of Iron Ore to China in 2010 (Interfax China, 2011), which results in an annual cost savings of (126M*$US17.03) $US2,146M per annum. IV. The payback period for the new shipping fleet is ($10Bn/2.146Bn) = 4.66 years.

The payback period of 4.66 years is generally a strong result in the mining industry and the oil and gas industry, firms target a payback period of less than 5 years. The overall result is 20

that Vale proposed fleet makes economic sense both in terms of reducing the competitive advantage of Australian iron ore and in terms of reducing Vale´s internal shipping costs.

8. Strategic Advantage of Vale Compared to BHP and Australia in International Expansion:
Vale has been more aggressive concerning expansion into international markets compared to its main competitors, BHP and Rio Tinto. According to the Vale, (Vale, 2010) there are two major untapped, high grade deposits of iron ore worldwide: West Africa and Russia. However, essentially these options can be narrowed down to one option: West Africa. This is due to the fact that Russia is essentially closed to outside investment in mining and oil and gas projects of value over $US1Bn, according to the Russian Federal Antimonopoly Service(Helmer, 2010). Further, the West African market is mainly the Simandou project in Guinea, which according to Vale can be compared to Carajas in terms of quality and reserve base. (Vale, Investor´s Day Vale 2010, 2010). According to Vale, other, lower grade deposits exist around the world, but long term (over several decades), large scale production (over 50M tons of iron ore per annum) in a single location with a single infrastructure is likely to only be possible at Simandou in the foreseeable future. This is to say, the mining firm with development rights to this project will have supply advantages over its competition for decades. Vale has won significant development rights to the Simandou project through what is termed in this paper a ´´game-theory winning strategy.´´ Rio Tinto originally had the majority of the rights to this project to 2008 when the government of Guinea, after repeated warnings that Rio Tinto was moving too slowly, awarded two of Rio Tinto´s blocks to BSG Resources. (Adhikari, 2010) Vale stepped in and aggressively bid on this project and won development rights, and is now moving ahead with the project with approximately 50% of the project, with Rio Tinto on threat of being kicked out of the project entirely (note that Rio Tinto´s involvement with Simandou is constantly being updated, although according to Rio Tinto their half of the project appears to be going ahead at 3/2011 according to (Rio Tinto, 2011) The development of the Simandou project can be viewed in terms a onetime game with payoff states in game theory. Game theory is defined by Roger B. Myerson of Harvard University as ´´ providing mathematical techniques for analyzing situations in which two or more individuals make decisions that affect one another´s welfare.´´ (Myerson, 1991)In other words, the result 21

of a game is the interaction of the choice of one player, combined with the strategic choice of the other player, in a matrix of end-states in terms of payoff. The strategic interaction of Vale

assumed that the total market before the strategic interaction is 100 , divided between Brazil and Australia. Depending on the strategy employed by the players, the reward will vary as shown in Figure 17.

Notes to Figure 17 The payoff is listed as Brazil in the first column and Australia in the second column. Australian firms are assumed in this game to act as one unit (in reality they would compete, e although B nearly acquired 100 of Rio Tinto in 2009 b fore the EU blocked the merger). The game above is a onetime game based on the geological reality ofWest Africa the game is not repeatable and therefore there is no dominant strategy or ´´Nash Equilibrium´´

In figure 17 above, Vale is represented as winning the majority of the gains in west Africa due to the interplay of its aggressive development strategy combined with the chosen strategy of the Australian firms to be risk adverse. It follows, why have the Australian firms been risk adverse with regards to the Simandou development project? The answer to this question is not known with certainty, but it appears that the Australia firm may have been unimpressed

business since the discovery of the iron ore deposits in Pilbara in the 1940 (the name B P actually stands for the place ´Broken Hill Properties which was a major iron ore deposit in the 22

p

qp

by the relatively recent high prices of iron ore B

and Rio Tinto having been in the iron ore

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can be viewed by the following payoff matrix in Figure 17 below. It is

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Pilbara, which was the first major mine of the company, developed in the 1940´s). BHP and Rio Tinto may have used historical prices to calculate the value of the Simandou project, which would mean prices in the range of $US40 per ton. Vale, a relatively younger company, with a more entrepreneurial mindset, may have used a price of iron ore at a higher range. It is also possible that Vale is more future oriented culturally, in so far that Vale will look to the future to a higher degree than BHP and Vale in its major markets. BHP and Rio Tinto mainly discuss record existing profits in their investment presentations, while Vale mainly discusses future projects, with discussion of existing record profits mentioned mainly as a financing means to achieve a higher market position in future years.

9. Chinese Steel Consumption Analysis:
Steel consumption in China is the major driver of iron ore exports worldwide and therefore it is of value to provide additional analysis concerning this critically important end market The . majority of analysis by the major iron ore exporters (Vale, BHP and Rio Tinto)(Annual Reports, Vale, BHP and Rio Tinto) as well as the major steel producers worldwide (Baosteel of China, Arcelor Mittal)(Annual Reports, Baosteel and Arcelor Mittal), the major steel trade organizations (the World Steel Association) and consultancies (the McKinsey Global Institute) (McKinsey, 2009)have provided cursory analysis of Chinese steel demand to a public audience, preferring to present overall consumption numbers per capita of steel, urbanization rate statistics and average consumption of steel intensive goods, such as automobiles, per capita. The leading sources of information concerning steel statistics within China Steel home (a joint venture set up in 2004 between the Chinese government and Shanghai based entrepreneurs to provide data on Chinese steel usage) (SteelHome, 2011) and the National

Bureau of Statistics of China (NBSC, 2011)do not provide detailed steel consumption figures per application within China, only overall numbers of total consumption and across regions. In so far that China can be seen as two or more countries a relatively wealthy coastal region and a relatively rural central and eastern region an analysis of steel usage per capita would not accurately capture several aspects of Chinese steel consumption, as it is unlikely that China will fully urbanize to western rates within a decade. Equivalent numbers of steel consumption per capita in China verses western countries (note that China surpassed the US in 2011 based on steel consumption per capita) will likely mean much higher steel consumption per capita in urban areas in China however per capita statistics will not shed light on which application of steel (construction, energy, auto, expressway, etc.) is used in the higher steel intensive areas. 23

Note that it is likely that internally, the major iron ore and steel producers have much more comprehensive analysis of steel consumption in China, however, for the purposes of impressing investors, only a brief analysis is presented. For example, Vale, it is 2010 Investor Day´s presentation, presents the following chart to support the continued growth of steel consumption in China, which can hardly be called comprehensive in scope.

Figure 18: Vale´s 2010 Investor Presentation of Future Steel Demand from Infrastructure Projects In China:

Source: Vale 2010 Investor´s Day Presentation (Vale, 2010) Perhaps the most comprehensive publicly available analysis is a 2010 report by the Reserve Bank of Australia as Australia is heavily dependent on mineral exports to China, the RBA

presents significant analysis of internal Chinese industrial dynamics (Holloway, 2010). Note however, that the RBA analysis only segregates Chinese market demand into flat products (for consumption of steel) and structural products (for construction), and does not go into detail concerning individual end use markets. The analysis presented in this section will go beyond these normal analyses by calculating, based on publicly available sources, the end use demand of steel in China. The categories of end use for steel are known, from charts in at the AISI in other words, all major categories of steel can be labeled, moving from construction to energy to white goods to railway to container, etc. -- and then it is a matter of finding estimates of steel usage for that application and estimates of production of that category. In this way, additional insight can be presented into end market consumption of steel in China, detailing which sectors are the biggest consumers of steel, and whether this consumption appears sustainable or not. Note that for certain end markets in China, such as automotive and oil and gas pipeline steel usage, the consumption numbers can be calculated with reasonable certainty. This is due to the fact that total production numbers in these sectors can be found from relatively reliable sources (government agencies, respected research institutions) and the steel per unit is also

24

known with reasonable certainty, also from reliable sources. For other end use markets, such as large scale buildings (skyscrapers) and apartment construction, the total Chinese construction numbers are known with low certainty. Note that the certainty of the numbers for steel consumption is indicated in Figure 19 below by sector. However, it should be realized that not having complete certainty in all end use markets is actually potentially useful to an analyst, because discrepancies in the total calculated steel usage in Figure 19 and the total, actual steel usage in 2009 for China can be re-assigned to the areas in which the steel consumption is not known with certainty. This is to say, if almost all areas of steel demand can be based on reliable sources (official government figures, respected bank figures) but some other areas are not known but estimated, the excess of actual steel production over the calculated steel consumption can be implied to occur in the areas with less certainty (this last point sounds complicated, but will be discussed in further detail below).

Figure 19: Calculated Steel Consumption by End Market, China 2009:
Guide: = estimate of annual production figures based on uncertain forecasts, revision possible = estimate of annual production based on reliable sources, estimate of future production based on uncertain forecasts, but analysis estimate believed to be conservative (if any error, in the direction of too much annual steel usage in this chart) Items in bold font are total steel usage calculations for each category of steel usage, based on the steel usage estimates in normal font. Project Name Tons Steel Used Notes Source of Information Concerning Steel Usage and Construction/Manufacturing Estimates: http://skyscraperpage.com/cities/?b uildingID=5 http://www.infoplease.com/spot/wt c1.html http://jutiagroup.com/20080625the-asian-skyscraper-boom/

Willis Tower

World Trade Center Empire State Building Average Skyscrapers

76000 total steel used, tallest building in the US 100000 per tower, 200,000 tons used total 60000 78,667

1000 massive 78666667 Based on 30 years skyscrapers per year to av US eqiv skyscraper to pop ratio (A) 30 Story Apartment 10000 per building Building 1000 large 10000000 10M sq meters Apartment added per year Buildings per year eqiv

http://jutiagroup.com/20080625the-asian-skyscraper-boom/

http://chinahousing.mit.edu/englis h/china/housing/

25

Oil and Gas Pipelines 12000 km pipelines per year Golden Gate Bridge Akashi Kaiky Bridge

300 per km 3600000 Based on CNPC estimates 83000 total bridge 181000

http://www.oilandgaseurasia.com/a rticles/p/111/article/1093/ http://www.interfax.cn/news/1675 8 http://www.goldengatebridge.org/r esearch/factsGGBDesign.php http://www.technologystudent.com /culture1/akashi1.htm

Average Bridges 132000 5 la rge scale Bridges per660000 Estimate based on year Bridge Projects, China (B) Oil Refinery 12000 per 100,000 bpd refinery 1Mbpd new Refining Capacity Annually Automotive 10M annual car sales Railway 120000 Based on Sinopec estimates 0,6 per car on average, 9.6M cars sold annually in China 6000000 1290000 For all rail

http://www.supermetal.com/metalstructure/projects/scotford-shellrefinery-upgrader.aspx http://www.chinadaily.com.cn/bizc hina/201005/25/content_9890521.htm http://www.usatoday.com/money/a utos/2009-02-10-china-autosales_N.htm

2250KM annual new rail Highway

10000km annual Added expressways Electrical Grid

Power Plant

4515000 According to the Chinese Min of Transport 100 per km expressway, assum 25% higher than US (C) 1000000 According to China´s Ministry of Transport 20000000 Total steel used in transmission, est. William Blair, 2010 17000 per coal power plant, 1000MW

http://www.steelorbis.com/steelnews/latest-news/steelconsumption-for-high_speedrailways-to-increase-in-china430371.htm http://gz.focus.cn/news/2011-0205/1185627.html pubs.usgs.gov/fs/2006/3127/20063127.pdf

http://www.newgeography.com/c ontent/002003-china-expresswaysystem-exceed-us-interstates http://www.williamblair.com/docu ments/ElectricitySectorInChina.pdf http://www.rdmag.com/News/Feed s/2010/07/materials-thyssenkruppto-supply-17000-tons-of-steel-forsou/ http://www.worldnuclear.org/info/inf63.html http://www.modernsteel.com/Uplo ads/Issues/February_2000/0002_02 26

100 1GW power plants added annually Airport

1700000 According to power forecasts to 2015 for China (D) 60000 2x Steel used in SF airport

8 Airports Constructed Year VLCC (Ships) 42M DWT VLCC year White Goods

construction 480000 According to Vale 2010 Investor´s Day 108000 Per 310,000 Tons 14632258 Chinese ship production in 2010 18900000 7 times US production of white goods, assumed (D) 25200000 7 times US production of contains, assumed (D) 5400000 Same as US production (D) 37800000 7 times US production cat: other, assumed (D) 75600000 7 times US production mach & factories, assumed (D) 30321042 5

_hassetferch.pdf

http://www.aukevisser.nl/supertank ers/part-1/id713.htm http://www.china.org.cn/business/ 2010-01/25/content_19304098.htm http://www.steel.org/en/About%2 0AISI/Statistics.aspx

Container

http://www.steel.org/en/About%2 0AISI/Statistics.aspx

Defense Related Other

http://www.steel.org/en/About%2 0AISI/Statistics.aspx http://www.steel.org/en/About%2 0AISI/Statistics.aspx http://www.steel.org/en/About%2 0AISI/Statistics.aspx

Machinery + Factories

Total:

Steel Consumption China 2009 Actual 50% Construction

56780000 According to the 0 World Steel Organization 28390000 According to the 0 Reserve Bank of Australia, for China

http://www.worldsteel.org/pictures /newsfiles/2009%20graphs%20and %20figures.pdf

Notes: (A) The estimate for skyscrapers is based on an assumed 30 year period for China to attain the ratio of skyscrapers to people as realized in the United States. Each skyscraper is assumed to utilize as much steel as on average as the average of three of the largest skyscrapers in existence today (Willis Tower, tallest building in the US, World Trade Center (NY) and the Empire State Building). (B) The amount of steel utilized in bridge construction is believed to be conservative because the total amount of steel even in building an average of 5 bridges the average size of the longest bridge in the world (Akashi Kaiky Bridge in Japan) and the 9th largest bridge in the world (Golden Gate) is only 132,000 tons of steel per bridge, totaling less than 1 million tons per year of steel usage.

27

(C) Steel is used in expressways to reinforce concrete. China is assumed to use 25% more steel per KM than the US in its interstate system. Estimates are based on the Chinese Ministry of Transportation Estimates. (D) For categorieslabeled ´´D´´ in the Chart above, these categories were difficult to find reliable estimates of production for China. The steel usage for these categories (white goods, Machinery and Factory construction, military, container and other) are arrived at through the taking of known US 2009 steel production in these categories and conservatively multiplying this number by 7 (7 is chosen because it is a relatively high number). Note that the military steel usage is assumed to be the same as US steel usage as the US has the most military expenditures in the world.

Analysis of Chinese Steel Demand:
The analysis in figure 19 shows several items. First, certain end markets consume much more steel than others. For example, the construction and completion of an equivalent of 5 Golden Gate bridges (the Golden Gate Bridge is the 9th longest bridge in the world) per year will consume significantly less than 1 million tons of steel per year, (Goldengatebridge.org, 2011) and the construction of an incredible 100 1,000 MW coal power plants will only consume an estimated 1.7M tons of steel per year. (R&D, 2010) Note that China´s 2009 steel consumption was approximately 568M tons of steel, so Chinese power plant construction and bridge construction can only (under any reasonable scenario) consume only a fraction of the total steel consumption in China. The calculated steel usage per application is presented in Figure 20.

28

Fi ur 20 S

l

u pi

b Applic i

,

lcul

St

l Consu ption C l ul t d b End t Chin 2009
Skyscrapers/Buildings

0%

Oil Gas Pipelines Oil Refinery 1% 2%
0% 0% 5% 0%

Railway

17%

6%

Highway/Expressway

11%
2%

8%

Electrical Grid Shipbuilding
Airp rt

Container

Source Data from Figure 19 above.

Large scale building of residential and large scale (skyscraper) buildings for office use consumer a higher amount of steel per building than other markets, -- for example the steel used in the construction of the World Trade Centers (both buildings) was 200,000 tons, compared to the steel consumption usage of the construction of 650 km of high speed rail in China of 129,000 tons of steel. As the construction of new high speed rail according to the Chinese Ministry of Transportation will be approximately 2250 km over the next 10 years, the total consumption of steel in high speed rail will be approximately 4,500,000 tons per annum (SteelOrbis, 2008). Therefore the construction of several skyscrapers will consume more steel than the high speed rail network of China. The total calculated consumption of residential and skyscraper based on an incredible

construction of steel is estimated in Figure 19 is almost 90M tons

1000 large scale (nearly the size of the World Trade Center) skyscrapers and 10M square meters of residential apartment space constructed per year. Note that the 10M square meters of residential apartment space is forecasted by MassachusettsInstitute of Technology for China, so should be fairly reliable (MIT, 2010). Perhaps the most striking takeaway from Figure 19 is that the calculated steel consumption is far less than the actual steel consumption in China for 2009. This is to say, the actual steel 29

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consumption in China is nearly 90% higher than the calculated steel consumption: a calculated 303.2M tons of steel in Figure 19 verses an actual consumption of steel of 567.8M tons a difference of 264.6M tons. As the areas in the chart above labeled with a ´green check´ are known with reasonable certainty, and the areas of consumption labeled with a yellow check are estimated conservatively (this is to say, that the actual steel consumption is likely not above the estimated steel consumption, due to high estimates for Chinese consumption in Figure 19), the remaining steel consumption is likely in the categories labeled with a ´red question mark´ -- skyscraper construction and residential construction. It is proposed that it is likely that China is building more than 1000 equivalent skyscrapers (which use the average steel content of the three largest skyscrapers in the US) more in the area of 3000 to 4000

equivalent per year. This is an incredible number, in so far that if China has 95 cities with more than 1 million people, China is likely constructing an average of well over 10 to 40 World Trade Centers in each of these cities every year.

Implications:The takeaway from the analysis in this section is that steel consumption in China
appears to be driven by large scale office and residential construction areas of construction which are likely driven by Chinese governmental stimulus spending, and areas which probably mean that supply can with reasonable probability exceed demand in the near future (if not currently, particularly in office). Therefore, as China is the major export market for iron ore based on office and residential construction demand, Vale is recommended to exercise caution in this intermediate period when Chinese consumption is paramount in importance and

before India can take up the slack as a major consumer of steel. These actions of the part of Vale would be hedging future iron ore prices at near record levels currently, where possible, and locking in long term financing at lower rates, perhaps considering utilizing Vale´s currently record high stock price to solidify its industry position over the long term by doing acquisitions of other iron ore and base metal mining companies through all stock deals.

China Can Afford to Continue to Spend on Infrastructure Stimulus : It should be noted
that China is very capable of continuing stimulus spending to support construction to drive steel consumption growth, at least over the next decade, if not longer. Chinese governmental debt to GDP is estimated at only 21.9% in 2010, increasing only 370 basis points from 17.6% in 2009, according to the IMF, even afterChinese governmental stimulus package estimated at close to 9% of GDP in 2009. (IMF, 2009) China´s debt to GDP numbers are very favorable compared to other industrialized nations as shown in Figure 21.If China adds an additional 400 bps to debt per year by stimulus spending, China will reach the average of industrializednations debt to gdp of 81.6% in 15 years. Further, it should be noted that 30

according to the chief economist at Nomura, Richard Koo, China remains committed to stimulus spending to drive economic growth. (Koo, 2010)

Figure 21: Debt to GDP Levels, Industrialized Nations:

Source: IMF, 2009 The balance of the analysis of Chinese steel consumption is that China likely is close to an oversupply of office and residential space over the near term, but is committed and has the financial capability to continue to spend on infrastructure going forward, for a substantial time frame 15 years at least at the current rate of stimulus spending. The risk for Vale for

significantly lower steel production in China over the next decade is therefore assessed, based on the balance of these factors, as moderate to moderately low. This should allow China to be a significant market for Vale on the balance of probabilities until India can become a future large scale importer of iron ore, perhaps with some stress and ´nail-biting´ at for top management at Vale in the intervening period, however.

10.

Conclusion:

This paper has analyzed the overall iron ore market in terms of a competition between Australia and Brazil for Asian markets. Brazil´s Vale is assessed to have effective strategies improving its competitive position vis-a-vis its Australian competitors: an effective strategy for 31

reducing shipping costs by investing in a massive shipping fleet, a significantly more aggressive expansion strategy and reserve base advantages. The main risk to Vale is a slowdown in Chinese demand for steel, driven by oversupply of particularly office and residential construction. This risk is assessed to be moderately low, due to the fact that China remains committed and financially capable of governmental stimulus spending. Currently the game for Asian iron ore markets remains essentially a two country contest between Australia and Brazil, driven by the high iron ore reserves of these countries and their involvement in West African reserves. It is possible that one additional player could enter the iron ore market in future years Russia. Russia has large reserves of iron ore ranking third

according to the USGS in terms of iron metal reserves. However, similar to Russian coal industry, Russia has not shown the initiative to produce its iron ore reserves, producing only 4% of total global iron ore in 2010, with no signs of attempting to increase production in future years. If Russia enters the iron ore game, it will likely be in distant future decades, according to current trends. Overall, Brazil´s Vale is very well positioning in the long term competition to supply Asian markets with iron ore, due to competitive advantage factors, for the modernization and industrialization of China and India. Due in a large part to Vale´s supply of iron ore, approximately 40% of the world´s population can expect to improve living standards immensely over the next decades.

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