Late last week the London Metal Exchange announced a rule change impacting any warehouse holding over 900,000 tons of inventory. The new rule would require those warehouses, beginning in April of next year, to load out a minimum of 3000 tons per day rather than the current 1500 tons per day. The rules primarily impact the Detroit Metro warehouse, owned by Goldman Sachs, said to hold about 25% of the world’s aluminum supply. Early indications suggest some large metal buying organizations do not believe the rules go far enough to address what they see as a market distortion perpetuated by warehouse owners (e.g. Goldman Sachs in the case of Metro, the warehouse with 7-10 month delays, but also JPMorgan, Trafigura and Glencore).
Most of the press accounts of the story paint the Wall Street bankers/warehouse owners as “more accountable for the market distortion than industrial metal buying organizations, though we did recently interview Jorge Vazquez of Harbor Aluminum who articulated several points worth repeating. We summarize the key points here:
- The market distortion (and subsequent delays) affect those buyers who are “short the metal and those who hold LME warrants in the Detroit warehouses.
- Any new rules should apply “to the margins only meaning load out changes should only impact new metal coming in, not metal already sitting in warehouse
- Consumers suffering the most from today ´s high prices and premiums and long lead times were probably the ones that first decided not to approach their vendors/producers to lock in metal but to stay short or play it via the LME.
The LME arguably made only modest tweaks to the rules. According to the Financial Times, on Friday, Martin Abbott, chief executive of the LME cited a Midwest critical truck shortage as an issue impacting the decision on the minimum load out rate. We talked to Sean Devine, Co-Owner and Founder of Partage LLC a partial truckload brokerage firm here in Chicago. Sean reiterated Abbott’s comment regarding a truck shortage, ” the flatbed trucking market is much tighter now than it was at the beginning of 2011. National spot prices are up at least 15% before fuel surcharge, and price increases have been even more dramatic in the mid-west, he continued, while a sudden surge in demand could be disruptive, we believe that problems could be avoided through a phased ramp up in the minimum loading out rate. Carriers would respond fairly quickly.
The LME announcement did not discuss a gradual ramp-up in load out rates.
Regardless of CauseÂ¦
Industrial metal buying organizations have a number of spend management solutions available to them to avoid the aluminum warehouse bottlenecks. We see some of those solutions as obvious (“hedge more) to less obvious (form a consortium/buying group with non-competing firms to book capacity and volumes at a negotiated rate with producers to avoid having to purchase metal on the spot market [e.g. LME].) Taking a leaf from Goldman-Sachs industrial buyers can pay a premium to direct supply to its own warehouses when needed as opposed to buying on the LME.
Though we haven’t read an independent study conducted on behalf of the LME, undoubtedly the LME wanted to address criticism proactively lest businesses start to move aluminum purchases “off exchange. And yet, wearing our sourcing caps, that solution moving off exchanges represents an interesting, viable scenario. By calculating the TCO (total cost of ownership) of paying the “Metro bottleneck tax aka the “Goldman price premium, buying organizations may wish to aggressively look to manage that risk and seek alternative sources and/or hedge their purchases.
We certainly can’t blame the Wall Street firms for seeing an opportunity and seizing upon it but that doesn’t mean industrial buying organizations need to play by the[ir] rules.