Vale Reaps Rewards of New Iron Ore System

NEW YORK (TheStreet) - Vale(VALE), the huge Brazilian mining conglomerate, offered investors the first insight into how this year's sea-change in the global iron ore trade has impacted the financial results of the world's biggest miners.

Vale, which released second-quarter results on Thursday evening, basically met analysts' expectations for both profit and revenue, but the results were close to record levels, the company said, despite the fact that production volumes remained below the all-time gangbuster highs that Vale experienced in the third quarter of 2008, just before the full impact of the financial crisis took hold of the industrial sectors.

Before we get to the numbers, though, a little history is in order.

In April, Vale spearheaded a successful effort to jettison the ancient pricing system that had governed the iron ore trade for the last forty years. Under that so-called benchmark pricing regime, the world's biggest three iron ore extractors -- Vale(VALE), BHP Billiton(BHP) and Rio Tinto(RTP), in that order -- would settle an annual supply contract with the world's biggest steelmakers, locking in a price each year.

But in recent years, as China's steel industry exploded in size and global importance, a spot market had developed for iron ore trade. With Chinese demand for industrial raw materials expanding rapidly along with its economy, spot market iron ore prices shot higher daily, while Vale and its Aussie peers were forced to suck it up and sell their metal at the lower benchmark prices. Each year, negotiations between steelmakers and their iron-ore suppliers grew more contentious - culminating in espionage indictments and international incidents worthy of le Carre. Eventually, though, they pressured their steelmaker customers this year into accepting a quarterly pricing system.

Under the new regime, each quarter's new price is based on the average spot price of iron ore over the course of the previous quarter. In the initial contract under the new system, the ore suppliers were able to force home a 90% increase compared with the year-ago period, all but erasing the drop in price suffered in recession-bound 2009.

If Vale's second quarter results show anything, it's that going to shorter-term pricing metrics was, as expected, a super lucrative move - for the time being, at least. Vale's average realized selling price for iron ore in the second quarter came to $91.93 per metric tonne. That's 15% higher than the $80.19 a tonne that the company fetched on average back in the third period of 2008, when Vale notched all-time records in nearly every financial category, and far better than what the company was able to get in the year-earlier quarter ($55.86 per tonne) or even during the first three months of this year ($64.67).