Vale Brasil Sends Shipping Returns Plummeting: Freight Markets

 

April 27, 2011, 7:32 PM EDT

 

 

By Alaric Nightingale

April 28 (Bloomberg) -- The biggest iron-ore carrier ever built arrives in Brazil next week, a sign of strengthening demand for commodities that means record profit for Vale SA and a slump in earnings for shipping companies.

 

The Vale Brasil, almost as big as the Bank of America Tower in New York, is scheduled to be at Rio de Janeiro on May 3, tracking data compiled by Bloomberg show. It is the first of a fleet of 19 such vessels that Vale, the world’s largest iron-ore producer, is building to supply China, which buys about 60 percent of all shipments of the raw material used to make steel.

 

For Rio de Janeiro-based Vale, the new ships ensure it can export more ore at a time when shortages drove prices 84 percent higher in a year. For ship owners, it worsens a glut that caused returns to drop 66 percent since January. A measure of the combined earnings of the 12-member Bloomberg Dry Ships index will fall 23 percent this year, with Genco Shipping & Trading Ltd. reporting a 75 percent decline in profit, according to analysts’ estimates compiled by Bloomberg.

 

“These sea monsters are going to prolong the slump,” said Erik Nikolai Stavseth, an analyst at Arctic Securities ASA in Oslo whose recommendations on shares of shipping companies returned 27 percent in six months. “It’s going to change the way iron ore flows to China, and it will take longer until the market rebalances,” he said, predicting some rates in the spot, or single-voyage, market may not be profitable until 2015.

 

Busiest Route

 

Vale’s Chinamaxes, named for the customer they are being built to serve, will displace ships competing for the industry’s single-biggest cargo on its busiest route. The ore is currently hauled mostly by capesizes, which use shipping lanes around South Africa’s Cape of Good Hope and Chile’s Cape Horn.

 

Returns for owners of capesizes, which have less than half the carrying capacity of a Chinamax, are at $6,755 a day, according to the Baltic Exchange in London, which publishes daily rates for more than 50 maritime routes. The assessment is for contracts in the spot market. Ship owners also lease their vessels on long-term contracts at fixed rates.

 

Owners of capesizes valued at $60 million need $25,000 a day to cover expenses such as crew and financing, according to HSBC Shipping Services Ltd. Variable financing costs mean companies have different break-even rates, and while the cost of a new capesize averaged $59 million over the last decade, it reached $97 million in 2007, according to Clarkson Research Services Ltd., a unit of the world’s largest shipbroker.

 

Forward-freight agreements, traded by brokers and used to bet on or hedge future transportation costs, anticipate rates no higher than $20,268 a day through 2016, Baltic Exchange data show. Rates are volatile, rising or falling 17 percent or more in each of the last 12 quarters.

 

Global Recession

 

Vale ordered its Chinamax fleet from Cayman Islands-based China Rongsheng Heavy Industries Group and Seoul-based Daewoo Shipbuilding & Marine Engineering Co., Clarkson data show.

 

The mining company wants to better manage its costs after capesize rates averaged $116,054 a day in 2007, up from $11,928 in 2002. Returns slumped from a peak of $233,988 in June 2008 as the worst global recession since World War II cut the number of cargoes and a growing glut of ships were produced at yards in China, Japan, South Korea and the Philippines.

 

There are 1,085 capesizes in service, with an order book equal to 40 percent of the capacity of the fleet, according to Redhill, England-based IHS Fairplay, which compiles data on ships and ports. The average capesize can carry about 170,000 tons of cargo, compared with 400,000 tons for a Chinamax.

 

Vale’s fleet will have a combined capacity of 11.4 million deadweight tons when complete, according to Clarkson data. That compares with 217.1 million deadweight tons for the capesize fleet. China imported about 10.9 million metric tons of iron ore a month from Brazil last year, customs data show.

 

‘Doesn’t Make Sense’

 

“They wanted to take freight into their own hands, but freight costs are incredibly low right now,” said Jeffrey Landsberg, president of Commodore Research in New York. “They made the decision when capes were earning over $100,000 a day or $200,000 a day, but when you have capes at $6,000 a day, it doesn’t make sense for a miner to be an owner too.”

 

Vale’s strategy may save money over the two decades or more the vessels will operate. Costs on the route to Qingdao in China from Tubarao in Brazil have risen or fallen at least 29 percent every year in the last decade, Baltic Exchange data show.

 

Global trade in iron ore will advance 7 percent to 1.06 billion tons this year, from 450 million tons in 2001, London- based Clarkson estimates. About 90 percent of global trade moves by sea, according to the Round Table of International Shipping Associations.

 

Steelmaking Nation

 

While China, the world’s biggest steelmaking nation, sought to curb inflation through four interest-rate increases since October, its economy will still expand 9.5 percent this year, according to the median of eight economists’ estimates compiled by Bloomberg. The U.S. will grow 2.9 percent and the euro region 1.7 percent, the estimates show.

 

Iron-ore prices will average a record $164 a ton this year, up from $115 in 2007, Sydney-based Macquarie Group Ltd. said in a report in January. Global steel demand will expand to 1.44 billion tons in 2012, from 1.28 billion tons in 2010, with 38 percent of the increase coming from China, the Brussels-based World Steel Association estimates.

 

China accounted for 43 percent of Vale’s iron-ore exports by volume last year, and the company has said it will spend $720 million on shipping this year to serve Asian clients. Vale will report adjusted net income of $25.1 billion this year, compared with $17.1 billion in 2010, according to the mean of nine analysts’ estimates compiled by Bloomberg.

 

Estimated Earnings

 

While shares of the company fell 4.6 percent in Brazilian trading this year, every single one of the 19 analysts tracking Vale rate it a “buy.” It is trading at about 7.8 times estimated earnings, compared with a peak of 22 times in November 2009, data compiled by Bloomberg show.

 

That contrasts with this year’s 10 percent drop in the Bloomberg Dry Ships Index, now trading at 11 times forecast earnings. A measure of combined earnings per share across the index will drop 23 percent this year, according to data compiled by Bloomberg using analysts’ forecasts.

 

Nine of the 12 members of the index will report lower profit or losses this year, the data show. Genco, based in New York, will earn 81.2 cents a share this year, down from $4.07 last year, the mean of 11 analysts’ estimates shows. The shares fell 41 percent since the start of January. Capesizes account for about 40 percent of its fleet capacity, company data show.

 

Index-Linked Rates

 

Genco operates mostly in the time-charter rather than spot market and has a combination of fixed and index-linked rates in those agreements, Chief Financial Officer John C. Wobensmith told a conference in New York on March 22. Six of its nine capesize time charters expire this year, and the remainder in 2012, company data published that day show.

 

Delays in the delivery of new vessels and accelerated scrapping means the fleet may not expand as quickly as expected, Wobensmith told the conference.

 

Even the rebound to $20,000 a day in returns anticipated by forward-freight agreements would still mean a return on capital of no more than 4 percent for a capesize costing $55 million, according to Andreas Vergottis, the Hong Kong-based research director at Tufton Oceanic Ltd., which manages the world’s biggest shipping hedge fund.

 

“The first of these ships loading in Brazil is a seminal moment,” said Nigel Prentis, head of research at HSBC Shipping Services in London. “We’ve seen a reduction in the amount of spot cargoes coming out of Brazil. The market should be fairly nervous about the introduction of these ships.”

 

--With assistance from Juan Pablo Spinetto in Rio de Janeiro. Editors: Stuart Wallace, Steve Stroth

 

To contact the reporter on this story: Alaric Nightingale in London at anightingal1@bloomberg.net

 

To contact the editor responsible for this story: Stuart Wallace at swallace6@bloomberg.net