Following a ruling by the UK High Court last week, The London Metal Exchange was forced to put on hold new rules to tackle the long warehouse queue problem that aluminum buyers have long blamed for increasing the price of the products they need. The new rules were due to take effect at the start of April, but have now been entirely scrapped, as the court said the consultation procedure for LME’s new “linked” load-in, load-out rules was “unfair and unlawful.” UC Rusal, the world’s largest aluminum producer, filed the lawsuit against the LME. Only a few days before the ruling, CME Group, the owner of the Chicago Mercantile Exchange, announced that it would begin trading aluminum futures this May. This is the CME’s third attempt at an aluminum futures contract.
We here at MetalMiner have been aggressively reporting the load-in, load-out problem story since last summer. This Q&A with Managing Editor Lisa Reisman and Contributing Editor Stuart Burns examines all of the issues surrounding aluminum warehousing and what CME’s new exchange means to the market. We previously discussed the issues that created the warehousing problem.
Jeff Yoders: The CME Group’s new aluminum futures contract has already received an application for one of the same warehouses as the LME’s. Can market competition end the queueing problem?
Stuart Burns: Probably, eventually. There are huge question marks over whether the CME will be able to generate sufficient volume and, hence, liquidity to create an effective alternative to the LME. If they do, then certainly competition would have a profound impact on the aluminum price and from the consumer’s point of view, we hope they are successful.
It won’t necessarily end the queues, or certainly not during the course of this year, but in time it could create an aluminum price that incorporates the physical delivery premium and gives consumers the chance to hedge the totality of their exposure in one transaction, on one exchange.
Lisa Reisman: Despite the question marks regarding the CME’s new contract, we can say that the CME has struck while the iron is hot and this specific case means no imminent solution will change the situation. This provides the CME with a runway to gain support and build necessary liquidity to make their contract successful.
JY: Lengthy delays since banking institutions purchased aluminum warehouses are one of the reasons the premium on all aluminum sold in the spot market has doubled since 2010, yet the extra costs due to lengthy load-out delays, as you’ve shown, do not all end up in the pockets of the owners of warehouses. Are producers taking advantage of the current movement rules at the expense of customers and refiners?
SB: There are several parties taking advantage of the current situation, certainly primary producers are one as we mentioned above, so are the warehouse operators – you only have to look at the unprecedented rate at which the likes of Pacorini, Metro and so on have added new warehouse sheds to see they are making substantial profits out of this situation.
But so too are the hedge funds, investment banks and traders who are driving this stock and finance trade, the warehouse queues haven’t helped them but they are a reflection of the strain and distortion their activities are putting the aluminum market under.
JY: Nick Madden, chief procurement officer of Novelis, said this in December: “We’re relieved that the LME is finally taking an action that ultimately will help the market normalize,” he said. “However, we’re going to take another year of inflated premiums and supply chain risk.” Novelis President/CEO Phil Martens also recently said: “We are very disappointed with the outcome of the legal process in the UK.” Does this push market normalization back further into 2015? Or beyond?
SB: Yes, premiums may even spike higher as a result of Rusal’s action and the LME’s inability to implement changes. Certainly they will remain higher for longer than would otherwise be the case and may encourage the warehouse operators to suck more metal into their warehouses whilst the rule changes are held in abeyance.
LR: Nick Madden has undoubtedly served as the most outspoken critic of the current scheme. But the reality is that this case doesn’t help the Novelis position at all. And in fact, the courts have made it more difficult for end users.
If we were Novelis, the CME aluminum contract looks potentially a lot more attractive. Another challenge for the CME however, involves identifying a set of producers also willing to supply metal to CME warehouses under CME rules. We will watch these developments closely.