Industry Info

Aluminium producers vent fury at LME changes to warehousing rules

Goldman Sachs and JPMorgan have been the focus of a storm of criticism of their metals warehouses during the summer. However, aluminium smelters such as Alcoa and Rusal may bear the brunt of the financial impact.

The companies – the world’s top two producers of aluminium – have reacted furiously to a proposal by the London Metal Exchange, where benchmark prices for aluminium are set, to change its warehousing rules.

Long queues to take delivery of aluminium from LME-registered warehouses, many of which are owned by banks, have triggered a series of complaints by metal users, criticism by senators and investigations by US regulators. In response, the LME has proposed a change of rules that would eventually bring down the length of queues.

Klaus Kleinfeld, Alcoa chief executive, this week attacked the LME’s actions as “very irresponsible”, saying the rules were a “major market intervention”.

The unspoken fear of aluminium producers and their investors is that the rule change will cause the price of aluminium to fall. That could be the last straw for an industry that has been struggling for years with oversupply amid large expansions by Chinese producers and an enormous overhang of stock since the financial crisis.

At issue is the “premium” – the cost of physical aluminium over and above the LME futures price. Since queues started to form at LME warehouses in mid-2009, premiums worldwide have jumped, with benchmark US premiums rising from $93 to a record $265 a tonne this year, according to Metal Bulletin data.

That is still only a small part of the overall cost of aluminium, with futures prices trading at $1,874 a tonne on Thursday.

But it has been a lifeline for aluminium producers, struggling with prices trading at near four-year lows.

Analysts at Deutsche Bank estimate that more than 80 per cent of aluminium production in the US and China, and most of the production in Australia and India, would be lossmaking without the premium.

The LME’s new rule, which still must be confirmed by its board later this month, is intended to bring down the length of the queues. As a result, most analysts and traders forecast, it will probably also bring down premiums.

“We believe that physical premiums will inevitably fall,” say analysts at Barclays.

That bodes ill for aluminium smelters. Beyond Alcoa and Rusal, Rio Tinto, Chalco and Norsk Hydro are also likely to be affected.
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Indeed, Alcoa this week says it believes the announcement of the proposed rule has already had an impact on the market. Since the LME made the announcement in July, premiums in the US and Europe have fallen by 13-15 per cent.

“We believe the decline in premiums is largely a result of the confusion caused by the LME’s major market intervention from their July 1 announcement of proposed warehouse rule changes,” says William Oplinger, Alcoa’s finance chief.

Investors have taken note. Analysts at Deutsche Bank recently downgraded Alcoa’s shares, already languishing at close to four-year lows, to a “sell” rating. Last month, Alcoa was dropped from the Dow Jones Industrial Average after 54 years.

Rusal shares have been under even greater pressure, dropping 53 per cent since the start of the year.

Not everyone agrees that the change in the LME rules will necessarily have a negative impact. Oleg Mukhamedshin, deputy chief executive of Rusal, argues any fall in the premium ought to be offset by a rise in the LME price. If queues were to fall, he says, the stock of aluminium available to the market would also fall, leading to an increase in prices.

“We believe that the effective price should be pretty much the same,” Mr Mukhamedshin says. “Price-wise nothing is going to change.”

While many traders are persuaded by that argument, most believe that it could take some time for the market to reach equilibrium. In the meantime, as the roughly 2m tonnes of aluminium currently stuck in LME queues is released, premiums and prices could both fall.

As one senior aluminium trader puts it: “The producers are the ones who are panicking. If the premium disappears, there’s trouble.”

Source: The Financial Times