In October, the London Metal Exchange (LME) will decide on a proposal to shorten delays in delivery of aluminium from the exchange’s warehouses. Investors would do well to keep a watch, as it could affect the performance of aluminium companies.
Aluminium buyers, such as beverage can makers in the US and Europe, have nursed a grudge that they are paying higher prices. Though metal prices have declined due to global economic conditions and sufficient capacity, their grouse is rising regional metal premiums are negating the benefits. These premiums depend on regional demand-supply conditions. As of end-June, spot aluminium price on LME had declined by 7.8% over last year, but regional metal premiums for Europe were up by 12% and up by 16% for midwest US, according to Alcoa Inc., the world’s third-largest producer of aluminium. In absolute terms, the premium is significant at about 16.5% of the spot price.
Buyers blame intermediaries such as large banks and traders who own these warehouses, and allege an artificial scarcity. Inventories in LME warehouses have risen to 5.5 million tonnes as of June, compared with 1 million tonnes in early 2008. Buyers say these delays have caused premiums to rise. Their persistent lobbying has led to regulators turning their attention to this issue and some lawsuits have been filed as well.
Meanwhile, LME floated a proposal to respond to these concerns. This will force warehouses facing more than a 100-day queue to deliver more metal than they take in. This is expected to lower delays, and ease the pressure on rising premiums. Buyers say this is not enough and want more steps.
Even aluminium producers are unhappy. Alcoa has said the warehouse queue issue is a red herring and instead blames the problem on speculative trading. It fears that the proposed rule change will only shift aluminium inventory to non-LME controlled warehouses, resulting in less transparency on inventory holdings.
Alcoa wants the current system to continue, but there should be more transparency so that the extent of financial investor participation becomes clear. At present, only estimates are possible. It has also asked LME to establish a regional premium contract, thereby providing a risk-hedging mechanism.
The underlying fear of the producers, perhaps, is that if LME’s proposal goes through, regional premiums will fall and affect their realizations. A recent Reuters report talks about waiting times falling at certain LME warehouses and also of a decline in metal premiums. Market participants will readjust their strategies in response to changes, so this may not be a permanent trend. But if metal premiums continue to decline and metal prices do not rise to compensate, then it is likely to hurt the domestic performance of producers such as Hindalco Industries Ltd and Sesa Industries Ltd.