CME Challenging LME for Aluminum Contract

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Every problem throws up an opportunity, they say, and the London Metal Exchange’s self-inflicted problems over warehouse queues is prompting the Chicago Mercantile Exchange (CME) to consider revisiting a North American aluminum contract in direct competition with the LME, according to Reuters.

We have written extensively on the problems getting aluminum out of LME warehouses has placed on physical traders. Delays of up to six months have been experienced at some locations, during which time the owner of the metal is forced to continue to pay warehouse rent and insurance. and finance the metal until they can take delivery and move it on.

Such a situation is untenable in the long term and something will have to give.

The CME sees this as an opportunity to provide an alternative market with easier access to metal.

Of course, a North American aluminum contract would not be new ground — Comex launched one in 1983 and delisted it by 1990 due to low trading volumes. Nymex, which merged with Comex in 1994, tried again in 1999, and it lasted a decade before also ending due to poor liquidity. Would a contract now fare any better?

The Deal With CME Aluminum Swaps

CME launched a swaps contract in April this year, but it has yet to trade. The swaps contract is a financially settled product based on the Midwest Premium — it will not allow physical delivery or access to metal, so valuable as the swap could be to companies looking to hedge their price risk it will not provide traders, producers or consumers with an alternative to the LME for physical delivery.

The Reuters article makes the point that the CME has not made any formal announcement, and so far, rumors are based on talks the group is said to have had with leading market place traders; but one can see the case could be compelling and metal consumers and traders could benefit from better access to metal than is currently the case with the LME.

The LME handles some 40 million tons of aluminum transactions, according to Reuters, a market worth some $80 billion a year. The physical premiums buyers have to stump up to take prompt delivery of metal in North America could be considerably lower if the CME rolled out a decent geographic spread of delivery locations and could generate sufficient liquidity to achieve a widely accepted market price.

Liquidity would be the key; hence no doubt CME’s early discussions to test the major player’s interest. Warehousing has proved extremely lucrative for LME-approved premises, so finding delivery options is not likely to be an issue, but with modern financial deals so intricately co-related to insurance products and finance covenants, traders will have to show the CME’s prices are as reliable as the LME’s in reflecting a true and fair market price – even if some would argue the LME no longer does that for spot prices anyway.

So watch this space. Maybe the CME will make the third time the lucky charm with their North American aluminum contract, or maybe just the realistic threat of it will be enough to shake up the complacency at the LME to get them to sort out the warehousing debacle.

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