Is Vale Ready to Squeeze the Chinese?

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In the all-important annual negotiations of iron ore price agreements, Vale (NYSE: VALE) was determined not to repeat its experience last year. Waiting a while had good results in Japan and Korea, but will it also work in its talks with the Chinese?

The game is on
Rio Tinto (NYSE: RTP) set the trend last month by reaching an agreement with Japan's Nippon Steel calling for a 33% discount in this year's price of iron ore, the primary ingredient in steelmaking and an important indicator of global economic strength.

Vale has followed suit with an agreement with Nippon, Korea's POSCO (NYSE: PKX), and other Asian steelmakers. In a victory for the miner, Vale managed to limit its price reduction to 28%. That confirms that iron ore prices will fall for the first time in seven years.

But how did Vale manage to get what looks like such a better deal than Rio Tinto's? First, when Vale took its typical place as the leader in annual negotiations with the steelmakers last year, it didn't negotiate as large a price increase as Rio Tinto and BHP Billiton (NYSE: BHP), when commodity prices were going through the roof.

So in essence, Vale's lower discount this year just makes up for the smaller increase it received in 2008. But there's still good news: Although Vale typically gets lower prices than its Australian competitors because of higher transportation costs from Brazil, the contract narrowed the gap from $14 a ton last year to just $8 a ton this year. 

The lower prices reflect the new world economic environment, in which steel demand has plummeted, affecting U.S. companies such as U.S. Steel (NYSE: X), Nucor (NYSE: NUE), and Steel Dynamics. Now, all the big three miners need to do is to conclude their negotiations with the Chinese.

The final play
Easy task, you say. Just get the Chinese to fall in behind their Asian brethren and accept the discounts that have already been established.

Unfortunately, the Chinese manufacturers are still holding out for discounts of 40% to 45% this year. But now that other steelmakers have settled for lower discounts, giving in to Chinese demands would risk ill will between the iron ore producers and their other Asian customers.

In the meantime, Chinese manufacturers have reportedly been tapping the spot market to obtain their iron ore. But that market itself has responded strongly, with spot prices having jumped 11% last week alone. It's now anyone's guess how long the largest buyers will continue to deal with the price uncertainty of the spot market, rather than reaching agreements with the threesome that controls the lion's share of the world's high-quality iron ore.

After sinking to their lowest levels in years late last fall, Vale's shares have risen more than 50% in the past three months. So while you're looking at investing in Brazil and its amazingly popular Petrobras (NYSE: PBR), be sure to take a quick gander at Vale as well.

For related Foolishness:

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• Rio Tinto Cuts a Cheap Deal