For those on the fringes of the aluminum market or with only a passing interest the machinations of the London Metal Exchange, its latest rule changes have long since lost their fascination. For buyers, traders or, indeed, anyone involved in the supply chain for this most highly consumed of all non-ferrous metals, however, the LME’s warehouse system and the rule changes aimed at solving it remain of significant importance.
A ThomsonReuters article this week aims to lay out the latest measures the LME has unveiled to resolve the load-out queues and, it is hoped, the associated issues such as the physical delivery premium. Although we must add the LME’s warehouse rules have been shown this year to have had so minimal an impact on persistently high physical delivery premiums, that it has become clear that the premiums are due, in no small part, to the stock and finance trade, both the delivery premium and the warehouse queues have their origins in this massive financial game, but we have to be careful not to mistake cause and effect.
As the article points out, the LME’s primary policy response to queues is a requirement that log-jammed operators load out more metal than they take in. This rule change will come into effect in February, 10 months later than planned because of UC Rusal‘s court action intended to delay any change that, in their opinion, may materially impact prices or premiums.
But as the article points out, the two principally log-jammed warehouse operators, Metro in Detroit and Pacorini in Vlissingen, Netherlands, have preemptively changed their operating behavior back in the summer to comply with the rule, so the rule change will not have any material impact on the market.
It may seem like closing the barn door after the horse has bolted but clearly these load-out rules had a gaping flaw that is only now being fixed to prevent a recurrence. Al the metals have been evaluated separately, particularly in relation to the size of the market and concentration of metal in locations. As such, the LME is looking at a separate 500-ton per day load-out requirement for aluminum alloy, which, particularly in the United States, has experienced even greater price distortion than that in the primary aluminum sector, Reuters says. Nickel and tin will each be given a separate load-out requirement rather than being combined at a 60-ton per day rate. In reality, the LME is moving towards a metal-specific delivery regime given that there are already separate load-out requirements for steel, cobalt and molybdenum.
For aluminum, the much discussed physical delivery premium contracts will launch in the second quarter of 2015, involving a split between LME premium and standard aluminum warrants and require a commitment from warehouse operators to load out within two days. How well this will work and how popular it will be remains to be seen. The market has clamored for a hedging instrument for the delivery premium, but how liquid it will be for the next 12-18 months remains to be seen, and liquidity is what will, in part, attract users.
In addition, the LME is introducing a number of less headline-grabbing changes, mostly around approval for warehouses, such as not approving warehouse operators if they exert potentially anti-competitive control over infrastructure in any good delivery point or if the geographical location is not one of net consumption, possibly a reference to the concentration of zinc in New Orleans. Others look like a response to some of the bad ways of the not-so-distant past the article says, such as requiring a bill of lading for load-out and requiring that the BL doesn’t name as recipient the same or a related warehousing company – aimed at avoiding the alleged merry go round of metal being “loaded out” only to be loaded back in again at the same location.
Another issue the LME is seeking to ensure is not repeated is one of inducements being offered for the storage of metal in specific locations. Reuters reports LME warehouse operators, will have to supply information, initially quarterly, on all charges and inducements “to ensure that they are not distortive and do not constrain the liquidity and elasticity of stocks under warrant.”
“Inducements” would be defined to include “without limitation, any fee, commission, discount, rebate, provision of transport services, or any other monetary or non-monetary benefit given to attract the load-in of metal or deter the load-out of metal.”
The bottom line is to ensure that warehouse operators “must not prevent the orderly functioning of the LME market” and to bring the operators into line with market abuse rules set by the UK’s Financial Conduct Authority.
Welcome as these changes are, and vital make no mistake, with the benefit of hindsight they are 5 to 10 years too late. The aluminum market, at least the storage market for aluminum and with it a key dynamic driving the market, has moved off-warrant. More metal is sitting in private sheds than is available on the LME, with more leaving the latter for the former every day. The LME has a long haul to reinstate the exchange as the true arbiter of a fair market price for aluminum, the new delivery premium contracts and warehouse rule changes will help, but the size and opacity of the off-warrant inventory will continue to exert an influence on the market that will add uncertainty to the fundamentals.
by Stuart Burns