What Do Physical Delivery Premiums Tell us About the Aluminum Market?

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With the closure of western aluminum smelters and widely reported global growth in demand of 5 to 6% per year, why have London Metal Exchange aluminum prices remained rangebound in the mid-1600s per metric ton? Why do physical delivery premiums continue to fall?

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Thomson Reuters recently reported that Japanese buyers have agreed quarterly premiums of $75 dollars per ton over the LME cash price for the shipments in the fourth quarter of this year. This will be the lowest premiums have been since Q3 2009 and a massive drop from the level Japanese buyers were paying in Q1 2015 when premiums reached $425 a ton.

True local demand in Southeast Asia is running at subdued levels while at the same time freight rates, a key component of physical market premiums, are running at historically low levels as a result of massive overcapacity in the shipping industry.

Experts on Exports

But another factor is also at play, China is pumping out around 350,000 mt per month of aluminum products, material that is displacing production from the Southeast Asia region and freeing up primary metal.

At the same time, a less visible trend has been running in the background. The stock and finance trade needs a sufficiently wide contango on the LME to cover the costs of storage. Currently the cash to three-month spread is valued at only about an $8 contango.

This time last month, Reuters reports it was running at $19/mt. Just a year ago, the spread was as wide as $40. As stock and finance deals come to maturity, the existence of a tight spread is not sufficient to finance a rollover and, as a result, metal is gradually leaking out of the multi-million mt off market stock and finance inventory depresses physical delivery premiums in the marketplace.

Where’s All This Metal Going?

As much of this metal was held in North America and Europe, you would expect the greater impact to be on North American and European physical delivery premiums. Southeast Asian LME warehouse companies, however, continue to offer incentives to store primary metal in their warehouses, whereas traditional stock and finance locations such as Vlissingen in the Netherlands and Detroit in North America are actively discouraging large deliveries by no longer offering the incentives they once did.

The LME’s rule changes are finally having some effect. Reuters reports that headline LME stocks have fallen by 755,000 mt this year largely as a result of a 780,000 mt outflow from Vlissingen, while stocks in the U.S. have also fallen by some 168,000 mt with Metro in Detroit effectively out of the aluminum game.

Meanwhile, stocks held in Asia have risen by nearly 251,000 mt with the in-flow largely concentrated in Singapore and South Korea. That greater availability of metal in the region is contributing to the lower physical delivery premiums available in that part of the world.

Estimates of how much metal remains off-market are difficult to establish, but, suffice it to say, there is enough metal to continue to keep the physical market well supplied providing LME spreads remain too tight to finance rollovers of maturing contracts.

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But if spreads balloon back out to levels seen last year it is possible the market could tighten as those production cuts are allowed to have some impact and we might see firmer physical delivery premiums. For the time being, though, that seems unlikely. While producers would no doubt like to see some gain from the pain they have taken in closing smelters, they can at least console themselves that the Armageddon once predicted when stock and finance deals began to unravel has not, in practice, played out. The market is absorbing releases without disruption and that is to be welcomed.

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