Once again, in its quarterly production results published yesterday, Vale failed to achieve what they previously promised, which obviously is not a surprise by any means anymore, but it reinforces the view of randomness and the lack of accountability for the largest miner in the world. After all, as we have mentioned many times, the choice is simple: Either totally ignore guidance by Vale’s management and thus have limited information to work with or incorporate any forecasts the management provides but always keep in mind the historical failure of the company to achieve their own goals.
We choose the second path, like most of the investment community, but maintain a highly skeptical approach on Vale’s ability to achieve their own targets. After all, it was only late October that Vale pointed to sequential growth in production and inventory stabilization only to post a 5% drop and an implied drawdown in inventories.
Source: Vale
For shipping, if Vale manages to surprisingly deliver on its annual guidance over the next few years, that would be good news as it would mean increasing demand for iron ore transportation. On the other hand, we would always include a significant risk factor on any investment decision based solely on Vale’s forecasts.
The fourth quarter results is great example of the above. Vale actually produced less iron ore during the fourth quarter versus the previous quarter, despite record high iron ore prices and the further normalization of operations following the January 2019 dam rapture. Indeed, Vale shipped more iron ore sequentially by drawing down on inventories, but now there will be some replenishment of those inventories, so there is no free lunch there. Vale managed to barely match the low end of their annual guidance, which might sound as an achievement, but that was still some 10% below what management forecasted earlier in 2020, let alone a few months back. As a note, in 2020 Vale shipped the least amount of iron ore since 2009, a year when iron ore prices averaged more than $120/mt.
For the average investor on Vale’s stock, that does not really matter. When the fourth quarter financial results come in, we expect earnings to be double last year’s and exceed those of last quarter’s levels despite the lower sales volumes. Iron ore prices were up some 50% versus 2019, so the small variance in volumes won’t even matter when it comes to the profitability of the company (also a much weaker BRL).
Oddly enough, it is as if lower iron ore prices are actually better for shipping as the Brazilian miner is more reliant on volume rather than price and thus is incentivized to produce and ship more product. After all, if a ~5% drop in volumes can send prices skyrocketing, the incentives are there to “squeeze” the market. Vale has effectively become the swing producer in an iron ore world, where four companies account for some 85% of all production. As a comparison, OPEC has some 40% market share in the oil world and it is constantly in the headlines under the broader characterization of a “cartel”.
Iron Ore Prices, USD/mt
Yet, China, the most important consumer of iron ore, is taking notice of all the above and slowly but steadily is reacting. Significant strategic investments in mining by China in regions around the world are taking place behind the scenes, and although none of those are likely to affect the market in the next few years, we can envision a scenario several years out where major iron ore miners will struggle to sell their product.
For the relatively short-sighted leadership of mining companies such a development is irrelevant. After all, stock prices, the main measurement of management effectiveness and success, mainly react to real time information (i.e. iron ore prices) and the long term outlook becomes blurry in front of the momentum of such a ripping iron ore rally. Yet, eventually iron ore consumption in China will plateau and start to decline, as has been the case in all other maturing, service-oriented economies (see North Korea, Japan, US). When that time comes, the major iron ore miners will not only be faced with declining demand for their product but also increased competition from the China-funded iron ore projects globally.
Of course, all the above is irrelevant for most investors in both mining and shipping alike. It is also irrelevant for the decision-makers at the helm of those firms that would probably be long gone from their roles after achieving share price outperformance. The countries that rely on taxes and levies from iron ore exports will see a more permanent lower income which actually might be the most relevant issue for Australia and Brazil that heavily depend on the mining industry. The few long term inventors will also suffer, but in today’s markets we struggle to identify such.
Vale said yesterday that its capacity will reach 350 million tonnes by the end of 2021 and 400 million tonnes by the end of 2022. That represents the potential for some 100 million additional tonnes in the water during the next 24-36 months, or the equivalent demand of some 120 Capesize vessels out of a fleet of roughly 1,800. That is no small change if you also add the incremental demand from other regions that are increasing iron ore exports, though to a much lesser extend.
Source: Vale
Will that actually happen? The odds are stacked against such a scenario based on recent experience and at this point, the consensus is that such a ramp up in iron ore export is unlikely. Don’t believe us? Then just take a look at the very flat and low freight futures prices for Capesizes all the way to 2026.
If the consensus is wrong, dry bulk rates will see some good times, especially in 2022 when most of the additional volumes out of Vale’s network are scheduled to come, against a historically low dry bulk orderbook.
Our advice: Don’t hold your breath...