Fortescue Solomon iron ore mine. Picture: REUTERS / DAVID GRAY
Fortescue Solomon iron ore mine. Picture: REUTERS / DAVID GRAY

RIO DE JANEIRO/MELBOURNE — The world’s number one and number four iron ore miners are in talks that could result in Brazil’s Vale taking a minority stake in Australia-based Fortescue Metals Group, and the blending of their iron ore to win market share in China.

The proposal will help the pair match the quality of iron ore produced by rival Rio Tinto, seen as the benchmark in China, and comes just as beaten-down iron ore prices stage a recovery to eight-month highs.

The two companies have been in talks for about a year, Fortescue said on Tuesday, for what would be the first deal involving the "big four" iron ore miners, following a collapse in the price of the steel-making commodity in recent years.

The nonbinding memorandum of understanding could result in Vale’s buying up to 15% of its Australian rival’s shares on market, which up to Monday had been sitting not far off seven-year lows.

It would also allow Vale to take stakes in Fortescue’s existing or future mines, while joint blending operations in China could begin within six months.

"The key to this agreement is about creating efficiency and supply chain consistency and reliability to our customers," Fortescue CEO Neville Power told reporters, adding the deal would make both companies more competitive.

Vale produces some of the world’s highest grade iron ore, but has long complained it does not fetch the premium its high-quality iron ore deserves in the international market.

Blending Vale’s ore with lower-quality material from Fortescue would bring down the grade to a more standard quality, and create a better sintering product for Chinese steel mills.

"What we’re trying to do is what some other traders and perhaps some of our customers have had to do internally," Mr Power said.

Citi analysts said in a research note the deal was aimed at "maximising the price realisations of Vale’s high-grade and Fortescue’s low-grade product". It also gave Vale the option of buying stakes in Fortescue’s mines, protecting itself from potential challenges in securing environmental approvals for new mines in Brazil’s south in the wake of the deadly Samarco dam disaster, Citi said.

Vale is in the process of phasing out higher cost, lower-quality production from its older mines in Minas Gerais state.

Fortescue did not expect to run into any trouble with competition regulators in China or elsewhere, although analysts said opposition in China could be a big hurdle.

"There is no reduction in competition from this. If anything, it improves the competitiveness of supply to the Chinese steel industry," Mr Power said, adding that the companies had already started talks with regulators.

Fortescue, which has been racing to cut costs and slash debt to help weather the collapse in iron ore prices over the past two years, said it did not consider issuing new shares to Vale despite $6.1bn net debt.

The company, controlled by founder and chairman Andrew "Twiggy" Forrest, has long been reluctant to water down Mr Forrest’s one-third stake and has done everything it could to raise funds without issuing new equity.

Fortescue’s shares rose nearly 7% after the announcement to a 16-month high, adding to a stunning 24% gain on Monday, when iron ore prices soared on expectations of a short-term jump in steel output in China.