Is It Impossible to Manage US Midwest Aluminum Premium Risk?

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Source: Alcoa (Jan. 9, 2014, 4th Quarter Earnings Conference)

If a picture tells a thousand words, then we’ll summarize this now outdated Midwest (MW) aluminum premium price chart with just these two: anxiety-laden.

(Prices have actually moved higher recently, up to $0.20-0.21/lb or $450/mt.)

Many argue that the total price an industrial buyer pays for the metal portion of its aluminum products remain somewhat “in check” (LME $0.7614/lb + MW premium $0.21/lb = $0.9714/lb, or $2,141/mt – let’s say in range with the five-year historical average). At first blush, this appears to be an accurate statement.

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But in fact, it’s wildly wrong. Why?

The reason why it’s wildly wrong has little to do with the “total metal portion” of the price paid by the aluminum buyer, but 100% to do with one simple fact:

There is not one single risk mitigation technique that a metal buyer can deploy to manage the MW premium portion of its aluminum spend.

Actually, that statement requires modification. One can financially hedge the Aluminum MW US transaction premium via the CME Group and its AUP contract (the contract settled Jan. 29 at $0.18818 and has experienced a noticeable uptick in volume with between 50-60 lots/day this month), but that contract does not provide a complete solution. We will come back to this shortly.

How Aluminum Buyers Operate

Large aluminum buyers hedge up nearly all of their metal spend to reduce their price risk and smooth out volatility. (We use the strict definition of the term “hedge,” i.e. using a financial product.) Smaller buyers, who typically don’t hedge, may, at best, be able to fix prices for some period of time with their supplier, but generally remain beholden to supplier price increases that typically look something like this:

Because of rising costs, we need to raise our aluminum prices by $0.10/lb.

And it’s up to the aluminum buyer to determine if the cost increase remains justified. Consider the following cost breakdown:

LME price + MW premium + Conversion cost + Freight = total price per pound

We urge buyers to analyze this formula with regard to their own price paid and when receiving price increases from suppliers. Most buyers typically know their total delivered aluminum price per pound (for the semi-finished form of what they buy), but fail to ask their suppliers to break down the cost structure.

A $0.10/lb price increase may or may not be justified based upon 1) a sliding LME price, 2) the degree of the MW premium increase since the last quotation from the supplier, and 3) what should be a fixed conversion cost.

But we digress.

Up Next: MetalMiner has exclusive details on how the CME’s newest offering will function for metal buyers.

Find out more about MetalMiner’s aluminum price forecasting capability to help your metal sourcing efforts.

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