Vale China exposure may be liability in price talks

RIO DE JANEIRO, May 29 (Reuters) - Brazilian mining giant Vale's strong presence in China has been an asset for years and driven iron ore sales, but its heavy reliance on Chinese steelmakers is now becoming a liability as the company heads into tough price negotiations. The world's largest iron ore miner wants to avoid China's demands for a 40 percent cut in benchmark prices, but China generates 40 percent of Vale's revenues and is the only country where ore demand is growing amid a global recession. Vale's bargaining power may further erode with the rise of a spot market in which the company has refused to participate and the decay of a 40-year-old benchmarking system in which miners and steel mills each year set prices. "Vale took advantage of an opportunity (in China). It was something positive but it has turned into something negative because it has an excess of concentration in China," said Antonio Ruiz of brokerage BB Investimentos in Sao Paulo. "China is very confident in its strategy of seeking a (large) iron ore discount," he said, adding it is unlikely Vale will be able to limit this year's price cut to 25 percent, even though its current projections show prices in that range. Analysts say it is too early to know how Vale will fare in talks but agree its heavy reliance on China, which provided Vale with $2.9 billion in revenues during the first quarter, poses a dilemma. Vale has opposed a major price cut, arguing it sells better ore than competitors and that in 2008, amid a six-year run-up in commodities prices, it accepted a lower price hike than Australian rivals Rio Tinto and BHP Billiton. Vale this month said it sold iron ore at $62.79 per tonne in the first quarter compared with $73.92 in the fourth quarter. Iron ore prices are generally less transparent than other commodities such as oil because of the traditional benchmarking and because the spot market is relatively new. It also warns that failure to reach an agreement would force it to shelve investments in new projects that would supply the Chinese market in the medium and long term. Delays could help Vale if prices continue recovering because Chinese mills may warm to benchmarking as a hedge against ore price spikes. China is highly dependent on foreign ore because its own low quality ore cannot be economically developed in the current price environment. Rio Tinto in recent days agreed with several Japanese mills including Nippon Steel as well as with South Korea's POSCO to cut ore prices by 33 percent from the previous year's benchmark, but China quickly said it would press for a bigger cut. Vale has said it will wait for its competitors to close agreements with China before negotiating, an effort to avoid letting rivals follow with a better deal as they did in last year's benchmark price negotiations. Wall Street banks including Goldman Sachs have downgraded Vale's stock, while Brazilian bank Brascan lowered its price target by 13 percent on concerns of the slowdown in the global steel industry and the lower prices for Vale's production. TOUGH TALKS China is eager to demonstrate its clout in the global economy and importance as an iron importer by negotiating a bigger price cut than rival Japan and turning itself into the lead negotiator of future talks for benchmark ore sales. China became the world's biggest iron ore importer in 2002, when its steel mills were still signing individual supply contracts or buying on the spot market, and in 2005 replaced Japan as Asia's lead negotiator. "The Chinese are being firm because they are the only ones that increased demand, they have important strength because they are the world's biggest importer of (iron ore) and the biggest producer of steel," said Cristiane Viana, an analyst with Agora brokerage Rio. The financial crisis has slowed global demand for iron -- the principal ingredient in steel -- and given extra clout to China's steel mills to ask for a 40 to 50 percent cut. Such a reduction would leave prices near current spot market levels. Vale says it does not participate in the spot market but has begun discounting iron ore from last year's benchmark price, which was set shortly before the financial crisis hit. But it recognizes the benchmark system's era may be ending. Markets believe the discounts vary with market conditions and that Vale may even be paying for some shipping to further adjust the price downward -- reports Vale flatly denies but which analysts take as a sign the company may be easing toward the spot market. But Vale has less experience working in the spot market than rival BHP Billiton, and may be forced into selling spot to China if pushes so hard that benchmark talks fall apart. "If there is no agreement it will be frustrating for Vale because for a second year they didn't get a better price than the Australians," said Gilberto Cardoso of Banif Investment Banking in Sao Paulo. "And if there is no formal agreement, the Chinese will continue using the spot market."