Analysis: Record spike in U.S. aluminum premiums stokes LME overhaul worries
12/01/2014 12:00
By Josephine Mason NEW YORK, Jan 12 (Reuters) - U.S. aluminum physical prices surged to record highs last week, reinforcing concerns about volatile supplies and reigniting the debate over the London Metal Exchange's sweeping reforms to its storage rules, analysts and traders said. Traders and consumers have scrambled for prompt material as hopes for lower prices abruptly turned into fears of tight supplies. While exchange stocks remain near all-time highs, traders say immediately available metal is surprisingly scarce. The U.S. Midwest aluminium premium AL-PREM over the LME cash price CMAL0 jumped by 3 cents to 15 cents per pound on Jan. 3, and extended that rally to 17.5 cents last week. Small tonnages transacted at even higher numbers. ID:nL6N0KH2CJ That is exactly the opposite of what traders expected to happen after the world's biggest and oldest metals market overhauled its warehousing rules meant to reduce congestion in the LME warehouses, which come into effect on April 1. Instead of freeing up more metal on the spot market, the rules appear to have spurred a shift of some LME stocks into a new round of long-term financing deals in storage sheds outside of the exchange's vast U.S. network. That means they have sold it forward at a profit due to low borrowing costs as well as the wide forward price structure, known as the "contango." "The market didn't seem to anticipate quite how much metal would go into off warrant LME and didn't really understand the implication of the LME rule changes," said Leon Westgate, an analyst with Standard Bank. Non-exchange warehouses charge lower rent and banks can store metal for months or years in so-called financing deals without worries about securing speedy access. One medium-sized U.S. consumer said one or several players have launched "one last-ditch attempt" to push premiums. Production cuts in North America due to weak LME prices and better demand from the automotive and aerospace sectors have also contributed to the move upward. While the sudden surge may be a short-term blip, it has underscored concerns about dwindling nearby availability. The shift has accelerated since the exchange announced in November even more stringent changes to its rules. The price spike also highlights the LME's limited ability to cool a market where low interest rates continue to whet appetites for locking up aluminum as a form of investment. It is likely to top the agenda at the Platts aluminum symposium in Fort Lauderdale, Florida, this week. LOW VOLUMES, BIG SPIKE After years of complaints about long queues and high premiums, the LME announced plans last year to slash waiting times to a maximum of 50 days, a move analysts and manufacturers had hoped would lead to lower premiums, especially given that the aluminum market is oversupplied. ID:nL5N0IS27D Instead, premiums have staged their biggest surge ever, more than reversing the 3-cent drop seen in the second half of last year following the LME's initial warehouse plans announced in July. "The market found producers did not have metal for the first five months of the year, business was moving higher for some time, it was only a matter of time before we saw the premium move," said a senior executive at a major merchant. Most big end users, who use aluminum to make beverage cans and automotive sheet, buy raw material on long-term contracts with a premium set by published prices. With cash LME around $1,700 per tonne, the premium now accounts for almost a quarter of the price, compared with about 10 percent historically. The LME has cautioned it will take years for queues to disappear when new rules sharply increase delivery rates. In Detroit, which is holding more than quarter of total LME stocks, it will take two years for the wait time to vanish. Even as the market took off last week, Alcoa Inc AA.N reined in its expectations for prices over the coming years. On Thursday the U.S. producer, one of the most bullish voices in the industry, booked a massive $1.7 billion non-cash goodwill writedown on smelting assets, based on discounted cash flow, margins and LME prices and physical premiums for the next three years. ID:nL2N0KJ2D2 That pushed the company into a fourth-quarter net loss of over $2 billion. "If you listen to Alcoa, they're very bullish on the aluminum market. The reality is there's a huge amount of excess metal in the market that will take three years to deplete," said Curt Woodworth, equity analyst at Nomura Securities. RUFFLED FEATHERS The LME overhaul has polarized the industry. Loss-making producers Alcoa and Rusal RUSL.MM worry the changes will damage premiums, a key support while LME prices are close to or below the cost of production. End users such as the big brewers say the new rules are necessary to ease the long wait times they say have distorted supplies and driven up prices. LME-registered stocks are close to record highs around 5.5 million tonnes, with some 66 percent of that total stored in Detroit, Michigan and Vlissingen, Netherlands. Almost half of that total has been canceled, which means it is due to be delivered out of the warehouses. Traders must wait as long as a year to take delivery of physical metal out of Detroit. The size of the off-exchange stock is unknown. Alcoa estimated it was over 2 million tonnes at the end of last year and will increase in 2014, while analysts say it could be as much as 6 million tonnes. The stakes for the LME are high as it considers launching its own cleared premium contract and tries to head off U.S. rival CME Group CME.O , which plans to launch a U.S. contract that would include the underlying price and the physical premium. "This could be the one to annoy people enough to listen to people with other ideas," said a U.S.-based trader. (Editing by Jonathan Leff, G Crosse) ((Josephine.Mason@thomsonreuters.com)(+1-646-223-8925)(Reuters Messaging: josephine.mason.reuters.com@reuters.net)) Keywords: METALS ALUMINIUM/PREMIUMS