Earlier this week the London Metal Exchangeannounced that its clearinghouse would now accept offshore Chinese renminbi as collateral, effective immediately. MetalMiner Editors and Co-Founders Lisa Reisman and Stuart Burns discuss the significance of this announcement but more important, its potential impact on industrial buying organizations.
For the first time, the LME will accept renminbi as collateral.
Lisa: Do you think this could mean that eventually metals are offered in a currency other than US dollars?
Stuart: I think that is still some way off for the main London market but the HKEx has run RMB-priced Asian mini metals markets for aluminum, zinc and copper since late last year in Hong Kong. This announcement by the LME now is about collateral placed by market participants for open positions. They are not suggesting London contracts will be priced in RMB.
Stuart: On one level there is the recognition of the RMB’s growing importance as an international (although we’d like to point out, not freely traded) currency and of China (and Chinese companies) importance as a major player in the global metals markets. On another level, it could also be seen as a political move. The LME is owned by the Hong Kong Exchanges and ClearingGroup (HKEx) and the key to unlocking fair value in their purchase of the LME was always their ability to open up China as a market for the LME’s services. Anything they can do to make the LME more accessible and more acceptable as a trading platform for Chinese companies is a beneficial step in that direction. Read more
Part of the reason is to be found in that phrase, particularly “warehouse system.” Independent operators run the warehouses; they are licensed or approved by the LME but they are not owned by the exchange. In addition the warehouses are located in different continents, in multiple legal jurisdictions and changes permissible at one may be considered illegal in another.
To add further complication, the legal challenges to rule changes in the past have come from primary producers such as UC Rusal and end users such as MillerCoors and Coca-Cola. So, the LME moves cautiously. This week’s announcement of an industry-wide consultation is to review two proposed changes that the exchange hopes will both increase the decay of existing queues and prevent the build up of new ones.
These aluminum ingots just want to leave Detroit an Vlissingen.
The first is to increase the minimum load-out rate warehouse operators are obliged to achieve, the minimum, as considered by some operators, is the maximum and they believe it is set far too low. For operators holding more than 900,000 metric tons of metal, they are currently loading out only 3,000 mt per day, yet the same warehouse will take IN tens of thousands of tons.
The new minimum daily load-outs proposed for warehouses storing between 150,000 mt and more than 900,000 mt range between 2,000 mt and 4,000 mt a day, scaled according to the amount of metal stored. It’s hardly a transformational change as the two remaining warehouses with extended queues are still potentially out to a year on a 3,000 mt/day minimum.
According to Reuters the LME’s warehouse report shows queues to load out at Vlissingen, Netherlands, were 365 days in May and at Detroit were 387 days. With rents at these warehouses on average about 0.50/mt per day, that remains a massive financial burden for metal owners waiting in the queue. The change will do little to reduce delays in the short term.
Of more significance is the move to cap rents for metal while it is in the queue. This is a suggestion we have long held as being the most practical to implement and the most effective to encourage early load out. If operators do not receive rent for metal in the queue, they will work to remove it as quickly as possible and replace it with metal they can earn rent on.
Specifically, the proposal reads warehouse companies that fail to deliver out-queued metal within 30 calendar days would be required to halve the maximum published rent charged to the affected metal owners. After 50 calendar days, no rent could be charged at all. It’s still a far cry from when I started in the trade and we could take physical delivery in 48 hours, but 30 days is better than 300.
So, some tough changes for the warehouse operators then? Well, no, not really. For one thing, 90% of LME warehouses do not exhibit any queues, so changes will not make any difference to them, and even for the two remaining problem locations — Detroit and Vlissingen — the changes are not going to be introduced before next May, by which time their queues will have decayed to no more than about 50 days based on current trends.
The changes will, however, inhibit the build up of new queues if the stock and finance trade roars back. For the time being, the physical delivery premiums have fallen back to “normal” levels and the market shows no signs of the shortages that could drive competition for metal, but the LME’s forward curve for aluminum does support the return of the stock and finance trade. The difference now compared to 2010-12 is the use of off-market rather than LME warehouses for the trade. Let’s hope the combination of rules and trade changes combine to avoid a repetition of queues in the future. The LME changes are a step in the right direction.
My colleague, Jeff Yoders, referred last week to action taken by Alcoa, Inc. to challenge the Commodity Futures Trading Commission (CFTC) over its involvement in the London Metal Exchange’s (LME) upcoming rule changes.
The LME is in the process of a long running review of it’s warehouse rules following industry criticism of the length of queues, particularly at it’s Detroit and Vlissingen (Netherlands) warehouses, a situation that was initially viewed as driving up physical delivery premiums. It has since been seen to be only part of a wider problem created by the stock and finance trade’s competition for physical metal.
Pile of aluminum ingots stuck in Detroit, even though its owners want to take delivery.
Queues have declined in nearly all locations but still remain at upward of a year in Detroit and Vlissingen, although Metro International and Pacorini, the warehouse operators at those locations, have taken steps to further limit intake while the LME’s deliberations are underway. Read more
Asia has led the fall due to weakening regional demand and a flood of Chinese semi-finished products hitting the market. In part, some of this Chinese material is said to be destined for re-melting and, as such, is replacing primary ingot sales in the region but our belief is this is limited, as much by economics as anything.
Exchange Prices Nearing Parity
The Shanghai Futures Exchange metal price is not at such a discount to that of the London Metal Exchange to make the re-melting/reselling trade even profitable.
The three-month aluminum price on the London Metal Exchange is back below $1,800/metric ton. In April, aluminum rallied with most industrial metals thanks to a weaker dollar. However, in May the dollar bounced back up, unwilling to give up more ground, hurting industrial metals.
LME 3-month aluminum price 1 year out
Aluminum prices are now hanging near previous troughs. If the dollar continues to rally, we would expect aluminum prices to hit record lows this year.
Same story with nickel. The metal rallied in April after hitting its lowest level in six years, but in May, nickel also fell and is now near that record low. As with aluminum, a stronger dollar would put nickel prices into a tailspin. Read more
The London Metal Exchange (LME) yesterday launched a month-long consultation on proposals designed to broaden access to its electronic trading platform, LMEselect. The changes put forward include opening up LMEselect access to category 3 and category 4 (non-clearing) members of the exchange as well as adding flexibility to the criteria required to apply for LME membership.
“Today’s proposals are crucial to our overarching aim to maximize liquidity and participation on the LME,” said Garry Jones, LME CEO. “Opening up access to trading on LMEselect is beneficial to everyone trading on any one of our venues as it will bring more liquidity and price transparency to all.”
Adding flexibility to the application criteria for LME membership means that prospective members may, in some cases, benefit from exemptions from the UK Financial Conduct Authority (FCA) authorization requirements, which represents a significant step in the LME’s Liquidity Roadmap. The changes would make the LME electronic market more attractive to non-UK based traders who want to take advantage of the Exchange’s enhanced liquidity initiatives but who are currently not eligible or are discouraged from applying by electronic access restrictions.
If the LME decides to proceed with the proposed changes after the consultation period ends, then full details of the category 4 membership requirements including fees and B share requirements will be published.
The London Metal Exchange wants to grow its electronic trading marketplace. Executives at the world’s biggest and oldest market for industrial metals believe they can grow it quite rapidly if the right conditions are put in place. Paul MacGregor, the exchange’s head of sales, said at an LME event in Chicago that the group is in a position where it has a good electronic trading platform and good participation in it, but needs more volume.
The Hong Kong Exchanges and Clearing, Ltd.-owned LME still uses open outcry trading. This system works great for actual metal users, but the professional traders and bank traders that the LME would like to have participating are used to a faster pace.
“The actual financial participants, the so-called algorithmic traders and the market movers, are 10% or less of the marketplace,” MacGregor said in Chicago. “So there is a great potential to get more market participation out of these players.”
“This (reform of the LME warehouse system) is really about recommitting to the quality of LME pricing, a goal that’s always going to receive our top attention because the smooth operation of that physical delivery network really underpins everything we do for both the financial and the physical players in the market.” – Matthew Chamberlain, Head of business development, London Metal Exchange
LME Aluminum for three-month delivery has fallen back below the $1,800-per metric ton level from over $2,100 in the third quarter of last year. The prospect of a disorderly unwinding of the stock and financing trade, which, until recently, had locked up large amounts of aluminum in deals, is causing a chilling effect in the entire aluminum market.
Physical delivery premiums are also falling worldwide. Reuters reports that South Korea’s state stockpiler bought 2,000 mt of aluminum at a premium of $330/mt over LME cash. That’s the lowest level in a year. Our own Stuart Burns reports that, in Europe, premiums for aluminum without duty have gone from $425 in November to $305 and that much of the fall can be attributed to the fact that “the stock and finance trade is not the game it was 12-18 months ago, so those hedge funds and banks previously engaged in that activity are not sucking up metal in the same way.”
How rapidly these declining physical delivery premiums will affect the aluminum market is unknown even by the major players, but companies such as Alcoa are diversifying themselves away from primary production of the light metal.
If the metal continues to exit the LME system, however, would the exchange’s goal of supply transparency actually be served? Much of this metal is moving to off-warrant warehouses and not going into immediate production. The new rent-capping and decay measures the LME is discussing implementing would take away an incentive for LME warehouse operators to keep metal in a queue and likely give players in the market yet another reason to pick up their aluminum and take it off-warrant. The decay factor affects the rate at which queues are reduced under LILO (for a warehouse continuing to load in metal).
The “decay factor” broadly means that LILO must be in operation for two business days to eliminate one calendar day of queues. The proposed increase in decay factor to 1.0x means that LILO must only be in operation for one business day to eliminate one calendar day of queues.
By accelerating “decay time” in a queue the LME wants to give another incentive to take metal out of warehouses with long queues. Source: London Metal Exchange.
Since the International Aluminum Institutestopped reporting monthly numbers, it’s nigh impossible to tell how much aluminum has moved to off-warrant storage.
Solving the 50+day queue problem at the warehouse operations at Metro International in Detroit and Pacorini Vlissingen in the Netherlands would certainly be a good thing for users of the LME system, but it may not deliver the overall market transparency that exchange’s executives desire.
That is what recent reports seem to be suggesting. We have written extensively on falling aluminum physical delivery premiums with the first chink in the producer’s armor showing in Europe this quarter and in negotiations for Q2 prices in Japan. As lower physical delivery premiums work their way through to product producers, the price of extrusions and rolled products should ease during Q2.
Converters will resist price falls, of course, as they will claim, with some justification, that high-priced billet and slab stock remain in the system, but the direction seems set even with a relatively static London Metal Exchange price, the additional delivery premium should continue to fall. According to Reuters, this week a major Japanese aluminum buyer has agreed to pay a producer premium of $380 per metric ton for metal to be shipped in the April-June period, an 11% fall from the previous quarter price of $425 per metric ton in January-March and is the first fall in six quarters, as inventories in the region outstrip demand.
In Europe, premiums for aluminum without duty have gone from $425 in November to $305, according to CRU. With LME warehouse rules set to change this year, load-out rates at remaining LME sheds with long queues could pick up further – most lost any queues months ago following the LME’s announcements of impending changes.
The challenge the 138-year-old exchange faces is primarily one of trying to balance competition law across the 37 international locations in which it operates – what is legally enforceable in Baltimore may not be in Bremen or Busan. The LME has to move cautiously, give all parties the opportunity to discuss, review and agree to changes and, above all, try to avoid getting dragged into London’s High Court as Rusalso cynically did last year in an attempt to stall changes which it saw potentially damaging to the aluminum price.
Still in the cards are new rules to cap or ban rents for metal held up in exit queues, a move that, most agree, would result in a rapid deterioration of the load out queue as any incentive to keep the queue in place would evaporate the moment the rule change went into force. There is also discussion about capping the level of daily rents, possibly in recognition that millions of tons have been lost to the LME system as metal has flowed into non-LME warehouses under the stock and finance trade.