Brazil Takes China's Road

08/13/2009 2:08 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The Brazilian government has told Vale (NYSE: VALE), the country's largest iron-ore producer (and either number one or number two in the world), that it has to do more to build up the Brazilian domestic steel industry, rather than just selling iron ore to Chinese steel makers.

Sounds like a page right out of China's book of industrial policy:  Designate strategic economic sectors and then develop domestic “champions” in those sectors.

Vale is now exporting record amounts of iron ore to China, the world’s biggest steel producer. At the same time, Brazil's budget minister, Paulo Bernardo, said that in the first six months of 2009, Brazilian imports of flat-rolled steel climbed 26% from the first half of 2008. (For more on China, Vale, and the iron ore industry see my August 10th post.)

In the second quarter of 2009, 68% of Vale's iron-ore shipments went to China.

"We cannot be one of the biggest ore producers and ship it all abroad and end up importing steel," Bernardo said.

Did Vale push back? Did the company say, if we're really good at producing iron ore—and the company is the world's low-cost producer—then that's what we should do? Did Vale tell the Brazilian minister to re-read Adam Smith?

No way. Vale instead pointed out that it has already invested about $1.35 billion with Germany's ThyssenKrupp (Frankfurt: TKA.F) in the Cia. Siderurgica do Atlántico steel mill being built in Rio de Janeiro state.

That response might have something to do with this:  Previ, the pension fund of Banco do Brasil, a state-owned bank, is the majority shareholder in Valepar, Vale's controlling shareholder. 

The mill will be the first integrated steel mill to be built in Brazil in 20 years.

Vale also has investments in three other steel mill projects in Brazil, the company noted. When the four are completed, they will add 18.5 million metric tons to the country's steel-making capacity. That's about a 50% increase.

Which certainly should give steel company executives and investors pause. Vale, the world's low-cost iron ore producer, is investing to enlarge the captive domestic steel sector. The decision seems driven by politics, rather than by some analysis of potential return on capital from adding more steel-making capacity to a world awash in such capacity.

That can't be good for profits in the steel industry as a whole—or in the already hard-pressed Chinese steel industry.

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