(Bloomberg) -- For years, Brazil’s Vale SA fought with rival iron-ore producers in Australia to supply the fast-expanding steel industry in China by building more mines and boosting output. But slowing demand and prospects of a multiyear glut are changing the battle lines. Now, it’s all about protecting ever-narrowing profit margins.
The challenge for Vale is that its mines are more than 8,000 miles (13,000 kilometers) farther from China than Australian competitors Rio Tinto Plc and BHP Billiton Ltd. That means shipments are more expensive at a time when ore prices are half what they were two years ago. After a record $13.5 billion loss last year, the Brazilian company is investing in higher-quality reserves and automation to erase that cost gap.
It won’t be easy. Vale is producing record amounts of iron-ore, which accounts for more than half its revenue. While operations are returning to profit in 2016, earnings will drop next year, according to analysts surveyed by Bloomberg. After taking on massive debt when commodity prices were booming, Chief Executive Officer Murilo Ferreira is selling assets and betting he can streamline operations enough to cut production costs by 2018 to $10 a metric ton, or about half what they were in 2014.
“This is what’s fundamental -- the fight for even one minute of efficiency,” Humberto Freitas, Vale’s executive director of logistics and mineral exploration, said in an interview in Rio de Janeiro. “Because it’s not just that one minute. It’s one minute spread over, for example, six thousand train cars. When you talk about one minute, you are talking about a lot of money.”
Five years ago, costs were far less of an issue. Commodity prices were surging, with iron-ore approaching $200 a ton as producers struggled to keep pace with demand from China. But as new mines were developed, supplies outpaced what steel mills needed. Ore has since tumbled, fetching $59 this week. With a global surplus, prices probably will be stuck around $50 through 2018, according to the average estimate among analysts tracked by Bloomberg.
Mine owners are getting some help lately from lower freight rates and weaker domestic currencies, which help reduce costs because iron-ore is sold in dollars. As a result, the break-even price for large producers has been cut in half since 2013, Citigroup Inc. analysts calculated in April. That same month, UBS Group AG estimated Vale’s total break-even cost for producing and delivering ore to China at $33 a ton, compared with $28 for BHP and $27 for Rio. Vale is targeting less than $25 by 2018, including the $10 cost of production, CEO Ferreira said in December.
BHP advanced 0.8 percent to A$23.04 in Sydney trading Friday, while Rio was little changed at A$50.95.
Rio de Janeiro-based Vale, which will report financial results on Oct. 27, is expecting a cost-cutting boost early next year when it begins shipping ore from the $14 billion S11D project in northern Brazil. More than half the investment was on a mine-to-ship logistics corridor featuring truck-less operations that will help save on fuel, a three kilometer-long (1.9 mile) train that can haul the equivalent carried by 1,000 trucks, and a port terminal capable of loading five vessels simultaneously.
The port terminal, scheduled for completion in November, will allow Vale to load more than 70,000 tons an hour. Three decades ago, it would have taken days to load that amount. The company hopes production costs at the new mine will drop to $7 a ton when it reaches full capacity in a few years, Freitas said. That compares with an average of more than $12 from the company’s southern systems in Brazil’s traditional mining heartland during the first three quarters of last year.
Once the ore is out of the ground, it has to be delivered to Brazil’s export terminals and then to mills in China. Vale estimates it spends about three times more on freight than BHP and Rio.
“The negative competitive advantage we face in relation to our Australian competitors is distance,” Freitas said. “But we can make gains from the quality of our ore which is the best. Our costs putting ore into ships is also less than theirs.”
Vale’s rivals also are cutting costs.
BHP has cooled its supply additions as it carries out 24 months of railroad maintenance to improve reliability and boost capacity. The Melbourne-based company’s cash cost in Western Australia fell 19 percent in the year to June 30 to $15.06 a ton, the producer said in an August filing.
Rio Tinto’s shipments fell in the three months ended in September, as it carried out work on a port and sought to complete a $518 million program to install autonomous trains along its 1,700-kilometers of track in Western Australia. London-based Rio cut its equivalent costs to $14.30 in the first six months of 2016. The measure excludes freight and royalty charges. Vale’s cash cost was about $12.75 in the first half, based on an average of reported quarterly results.
While Vale expanded production in the third quarter, the company has lowered its output forecast for 2017. Rio Tinto on Thursday cut its shipments guidance for 2016 and forecasts annual sales may remain flat in 2017.
Producers in Australia’s Pilbara will seek to defend their transport cost advantage over Vale, said Nev Power, chief executive officer of Fortescue Metals Group Ltd., the world’s fourth-largest supplier. The exporter’s break-even price is currently $28 to $30 a ton, with cash costs of about $13.55 a wet ton, Power said.
“Because their sea journey is more than three times longer than ours, they are much more exposed to increases in shipping rates and in oil prices,” Power said. “We intend to make sure that we maintain that advantage.”