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Vale shifts to spot pricing for vast majority of iron ore contracts

The main means for Vale to cut transportation costs - the construction of a fleet of giant 'Valemax' ships - ran into trouble after China refused permission for the 400,000-deadweight-tonne vessels, some of the largest afloat, to dock in local ports.


Vale SA, the world's largest iron ore producer, said on Thursday it is selling 80 per cent of its ore using spot prices, nearly completing a historic shift to market-based pricing for the principal ingredient to the world's steel.

The remaining 20 per cent of the contracts, largely with Japanese and South Korean steel companies, charge customers using an average price from previous quarters, Vale executives said on a conference call with investors.

The contract change came as Chinese steel makers, Vale's largest client group, sought to get in quickly on falling iron ore prices. Iron ore averaged $141.80 (U.S.) a tonne in the fourth quarter, 11 per cent less than a year earlier and 20 per cent less than the previous quarter.

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"Our expectation is for stability in the first half of the year with prices showing recovery in the second half," Jose Carlos Martins, the company's iron ore and strategy chief, told analysts in a conference call.

While construction, a major source of demand for steel, has slowed because of Chinese efforts to cool the real estate market and because of seasonal construction slowdowns during the Chinese winter, Vale expects demand for steel and ore to pick up in the second half.

Demand will be driven by China's plan to build 10 million new units of affordable housing for middle and lower income families, Mr. Martins said.

Vale, which accounts for more than a quarter of the approximately one-billion-tonne seaborne iron ore trade, moved away in 2010 from a decades-old system of setting prices annually through negotiations between the largest steel makers and the largest suppliers, including Vale, Australia's BHP Billiton Ltd. and Rio Tinto PLC.

Vale and its main rivals shifted to a system with contracts that set prices according to the average spot price of ore over the past few months. That system has now been largely replaced by prices linked directly to current spot market prices.

According to the Platts resources pricing service, iron ore is trading at $138 a tonne.

The negotiated price system made planning easier for the miners to plan investments in the giant mine, rail and port projects needed to supply European and Chinese steel makers.

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On Thursday, Rio de Janeiro-based company said profit in the three months to Dec. 31 dropped sharply to $4.67-billion, compared with $5.92-billion a year earlier.

The result was in line with the average estimate of 11 analysts surveyed by Reuters for a $4.68-billion profit.

Iron ore production jumped 3.5 per cent to 80.3 million metric tonnes in the quarter and reached a record 311.8 million tonnes for the year. Vale ships most of its output overseas, with around 40 per cent bound for China.

The new pricing system has put pressure on Vale to increase efficiency. Rivals BHP and Rio Tinto, whose Australian mines are closer to China, have a transport cost advantage over Brazilian producers, Mr. Martins said.

The main means for Vale to cut transportation costs, the construction of a fleet of giant "Valemax" ships, ran into trouble after China refused permission for the 400,000 deadweight tonne vessels, some of the largest afloat, to dock in local ports.

Vale is working with Chinese authorities to end the ban, he said. Even if the ban is maintained, the completion of a 30-billion-tonne-a-year iron ore distribution centre in Malaysia to work with another distribution centre at Subic Bay in the Philippines, will resolve the problem by 2014.

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The centres will allow Vale to move ore from Brazil cheaply to Asia in Valemax ships and then transfer ore to smaller vessels for the shorter voyage to Chinese ports, he said.

"This is a game-changer story for the iron ore market and we think it is good for Chinese steel makers who can get cheaper iron ore," Mr. Martins told analysts. "We are prepared for alternative solutions and, as you know, China needs ore and as time goes on all this will be solved."

Chinese ship owners, the main group opposed to the entry of the giant ships, have called for a halt to the Valemax fleet program.

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