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Mega-Ships to stall maritime recovery

Singapore, December 2010

The rollout of the world's largest dry bulk carriers by Brazilian mining giant Vale in 2011 will slash the cost of shipping commodities and choke off a recovery in the freight market for years. China's ravenous appetite for iron ore and coal, the two main commodities shipped in the dry bulk market by volume, has transformed the maritime industry, with mining and shipping firms building bigger and bigger vessels to meet its demand.

Vale, the world's biggest iron ore producer, was scheduled to take delivery of the first of more than 30 400,000-tonne iron ore carriers in the first half of 2011. The ships, to be delivered through 2013, will surpass the largest bulk carrier now in operation, the 365,000-tonne MS Berge Stahl.

The arrival of these so-called Chinamax carriers will not only cut costs for Vale but will also lower freight rates for the entire industry, as the new vessels swell an already oversupplied market. "This will be the biggest factor affecting the market for at least a couple of years, with the big increase in supplies driving down the market," said Rahul Sharan, senior analyst at Drewry Shipping Consultants.

The Baltic Exchange's Dry Index, a composite of global trade routes for dry commodities, has fallen nearly 30 percent this year to 2,173 points due to ample tonnage and the expected flood of new vessels next year.

OVERSUPPLY PROBLEM

Vale's gigantic ships, which will be longer than the 324-metre-high Eiffel Tower, were expected to exacerbate the oversupply problem and could push the benchmark index below 2,000 points next year, analysts said. That translates into less money for shipowners, many of whom oppose Vale's new carriers.

"We don't need (Vale's) ships," said Torben Skaanild, chief executive of BIMCO, the world's largest shipowners' group. "We have quite a huge inflow of capesizes of 150,000 to 180,000 tonnes coming to the market. If you start building 400,000 tonne ships, it is going to take them out of the market."

A Vale spokeswoman declined to comment on industry criticism surrounding its Chinamax vessels. Credit Suisse estimated that Vale's ships could displace as many as 168 capesize vessels, representing around 15% of the existing fleet, forcing them into shorter routes from long haul voyages.

"Given the size of these vessels and lower cash breakeven costs than current spot rates, we believe the likely deployment of these ships on the Brazil-China route could leave the capesizes with no spot cargo demand," said the bank's shipping analysts in a monthly research report.

Average earnings for capesize vessels, typically used to ship iron ore and coal, could tumble between 20 and 35 percent next year to under $25,000 a day, analysts said. Earnings for smaller dry bulk ships, which carry everything from grain to cement, were also expected to decline.

The chairman of China COSCO , the world's largest dry bulk firm, told Reuters last month it strongly opposed Vale's mega vessels and predicted the industry's oversupply problem would prevent a recovery until 2013 at the earliest.

The global dry bulk fleet was expected to expand by 11 percent next year to 594 million deadweight tonnes, outpacing demand growth of 8 percent, according to Macquarie Securities. "It looks like supply and demand could be back in balance by 2012, but much of this will depend on whether the current low rate environment discourages new orders," said Janet Lewis, shipping analyst with Macquarie.

The freight industry was battered by the economic downturn two years ago and has struggled to recover, with the dry bulk market still down more than 80 percent from its peak in May 2008.

COMPETITIVE EDGE

The volatility in the spot market prompted Vale to build its own fleet of mega ships, which will allow the company to better compete with Australian rivals BHP Billiton and Rio Tinto .

Due to the longer distance from Brazil, Vale typically pays a $15 a tonne premium to ship iron ore to China, compared to its Australian counterparts. That premium could be cut by more than half to $7 a tonne with the arrival of the Chinamaxes, analysts said.

"In 2008, they were hit very hard because it was costing over $100 a tonne to ship a product they were selling for $80 a tonne," said Janet Lewis, shipping analyst with Macquarie Securities.

"They definitely suffered then and Brazil lost market share, so they don't want to be vulnerable like that again." Although freight rates to China will remain slightly higher for Brazilian iron ore shipments than for Australian grades, Vale has said the costs would be offset by the higher quality of its iron ore.

Vale estimated annual iron ore production to hit 311 million tonnes next year and hoped to further increase output to 522 million by the end of 2015.

With lower freight rates and higher output, Vale could grab some market share from its Australian rivals, analysts said. But Australia would remain by far China's No. 1 iron ore supplier. Brazil has accounted for 20 percent of China's iron ore imports so far this year, shipping 103 million tonnes in the first 10 months, according to Chinese customs figures.

That was second only to Australia, which exported 217 million tonnes to the world's second largest economy, representing 43 percent of China's iron ore imports.

Only two ports in the world, the Ponta da Madeira terminal in Brazil and the Port of Rotterdam in the Netherlands, can handle the largest bulk carriers. But Vale is building ore distribution points in Oman and Malaysia to handle the Chinamaxes, where cargoes will be split and transferred to capesize vessels for shipment to Chinese and Middle East customers.

Chinese ports in Dalian and Dongjiakou were also expanding operations to accept the Chinamaxes, analysts said, but Beijing has yet to approve Vale's request to store and trade iron ore in China.

Ends --


By Randy Fabi, Reuters - for Commodities Now.