Storage Wars Seize Metals Market

September 30, 2013, 5:58 p.m. ET

Storage Wars Seize Metals Market

London Metal Exchange Gears Up to Change Storage Rules

TATYANA SHUMSKY

Controversy over the role of warehouses overshadowed the metals market, and traders and analysts are debating the likely impact of changes to storage rules now in the works. Metal-warehouse owners, which include banks and commodity-trading firms, are under increased scrutiny as the London Metal Exchange gears up to make a decision on metal-storage rules for its warehouse system. This warehouse network stretches from Detroit to Malaysia and is the world’s largest.On July 1, the LME proposed sweeping changes aimed at easing bottlenecks of aluminum, copper and zinc that have led to long wait times for industrial consumers seeking to retrieve metal from the exchange’s warehouses. The LME has said its board would meet in October to make a final decision. If adopted, any new rules would go into effect on April 1, 2014.

“We are encouraging market users to contact us with their views, but we will be making no official comment until the conclusion of the consultation” on Sept. 30, an LME spokeswoman said.

For years, aluminum producers were able to sell to big commodity-trading firms, which then put the metal in storage. This “warehouse” trade was profitable for producers because traders offered them cash incentives, in addition to the prevailing market price. Meanwhile, commodity traders benefited by pocketing the difference between futures prices and the price of metal for immediate delivery, which tends to be cheaper.

Even though any rule changes are months away, analysts and traders already are trying to gauge their potential impact on the metals market.

In a research note circulated in August titled “Beginning of the End to Metals Warehousing Trades,” analysts at Morgan Stanley said if the LME requires some warehouse operators to deliver more metal than is taken in, as is now proposed by the bourse, that could exert downward pressure on aluminum prices in the short term. “Given the substantial amount of metal in these warehouses, the LME system would temporarily become a supplier” to the market, the analysts said.

Aluminum prices rose 4.1% in the third quarter compared with a 6.7% increase for the LME Index, which reflects performance of the nonferrous metals traded on the LME. Aluminum fell 6.9% in the second quarter.

Copper prices climbed 8.2%, amid a rebound in Chinese manufacturing activity and higher copper imports by the world’s largest user of the industrial metal. And tin soared 19%, mostly due to moves by the government of Indonesia in September to require exporters to first trade the metal, widely used to connect wires in electronics, on local exchanges before shipping it out of the country. The regulatory change forced some producers to cancel tin shipments headed for export as they scrambled to comply with the new rule.

Unlike other metals, the aluminum market has been in a state of oversupply since 2005, according to Morgan Stanley, as China ramped up production.

Aluminum stockpiles on the LME hit a record high of 5.486 million metric tons in early July. That is enough aluminum to manufacture 59,308 Boeing 777 jets, or about 52 times the number of these jets delivered since they were introduced in 1995.

About 40% of the aluminum in storage has been earmarked to leave warehouses. But at the current rate of deliveries out of some warehouses, metal owners are facing waits of a year or more.

The LME’s proposed rule changes would see this metal swiftly pumped into the market, said Oleg Deripaska, chief executive of the world’s largest aluminum producer, United Co. Rusal PLC. Mr. Deripaska called the effort “an unprecedented intervention and one that Rusal strongly objects to,” according to a letter Rusal sent to the LME last week.

By contrast, a group of industrial aluminum users comprised of U.S. beer and beverage makers such as Dr Pepper Snapple Group Inc. and MillerCoors LLC said the new rules don’t go far enough.

“Left uncorrected, the deficiencies in the current system could cause long-term harm to the entire aluminum market,” they said in a letter sent to the LME in early September.