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.
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.
How Producers Benefit From Premiums
Alcoa, like UC Rusal and other producers, has benefited from the physical delivery premium on top of the LME quoted prices in recent years particularly as, at times, the LME price has been below the cost of production. The addition of the delivery premium has allowed Western smelters to break even and even post profits while achieving no more than the traditional LME price would have given them at a loss.
Currently, with falling LME prices and much-reduced physical delivery premiums even a combined all in price is below cost for many smelters, hence Alcoa’s concern that the LME’s rule changes are not drastic enough to precipitate further falls. The same worries were behind Rusal’s challenge to earlier proposed rule changes last year, a challenge that eventually failed in the English High Courts.
Alcoa’s action is, as you would expect, executed with more decorum and took the step of requesting information and records pertaining to the LME’s application to be a foreign board of trade according to a Metal Bulletin article and is said to have come after a leaked letter from the CFTC to the LME revealed that the regulator had deferred its review of the exchange’s application to register as a foreign board of trade while it evaluated the LME’s warehouse reforms.
What CFTC Wants
The LME needs CFTC approval to act as a foreign board of trade if it is to effectively operate in the US market, so the CFTC could be said to have the exchange over a barrel in terms of forcing them to accept CFTC suggestions or guidelines regarding rule changes. According to the article, the CFTC offered the exchange its “opinion” of the reforms, including that the possibility of capping or banning rents and inducements saying such reforms “show promise.”
Alcoa’s position is the CFTC has no authority to intervene in such a contentious issue and, as such, should refrain from getting involved, preferring an open dialogue with industry members (obviously meaning Alcoa among others) to arrive at solutions.
What Alcoa Wants
Alcoa is quoted as saying “We believe that the CFTC should refrain from any comment or judgment on, or interference with, LME rule changes, and that the CFTC should examine any LME aluminum contract performance issues only through an open, inclusive and transparent process where all affected market participants have the opportunity to present their views.”
You can see where Alcoa is coming from, but, surely, the CFTC also has a responsibility to consumers affected by rule changes and the impact they may have on prices. Consumers have been so damaged by the physical delivery premiums that they have attempted legal action to address the issue but without being able to gain any traction through the courts.
The physical delivery premium is a distortion in the market that serves no party well, it would be better for producers, consumers and the trade if aluminum prices could return to a more historic norm of an LME price plus a small delivery premium reflecting no more than the logistic cost for delivery. If the CFTC’s pressure on the LME helps achieve that it’s all well and good, whether they have the authority to use the LME’s license application as a means to achieve that, we will leave to the courts to decide.