Aluminium premiums hit record high on tight physical market

Last updated: January 16, 2014 12:38 pm

Aluminium premiums hit record high on tight physical market

By Neil Hume, Commodities Editor

“The Rime of the Ancient Mariner” is not the first thing that comes to mind when thinking of the aluminium market but industrial consumers of the metal have much in common with the seafarer. To paraphrase Samuel Coleridge, there’s “metal, metal all around but not a tonne to buy”.Actually, that’s not strictly true. There is some aluminium around but only if you are prepared to pay a hefty – and, some would say, prohibitive – premium to the price quoted on the London Metal Exchange, which is close to four-year lows.

Physical premiums – that is, the amount paid on top of the LME price for immediate delivery of metal – reached record highs this week in Europe, Japan and North America, even though there is 10m-15m tonnes of aluminium sitting in warehouses around the globe.

To put that figure in perspective, the stockpile is equivalent to 20-30 per cent of annual global refined aluminium output.

European duty unpaid premiums were trading in a record high range of $245-$265 per tonne earlier this week, according to Metal Bulletin, versus an LME cash price of around $1,700.

US Midwest premiums, meanwhile, reached a record of 15-16.5 US cents per pound at the end of last week and, according to a recent price assessment by Platts, have reached 19 cents, or a quarter of the exchange traded price of 80 cents.

So what gives? In broad terms, the surge in premiums reflects smelter closures, which have started to pick up pace in recent months, continued demand for physical metal in financing deals, low interest rates and a tight scrap market.

But other factors have been at play.

Premiums started to tick higher from November, says Eoin Dinsmore, senior analyst at CRU, as industrial consumers in North America decided to defer some of their purchases, betting that premiums would fall because of the LME’s proposed warehousing reforms. The new rules oblige warehouses with queues longer than 50 days to deliver more metal out than they bring in.

The big trading houses were happy to take on that excess tonnage from the producers because metal financing deals were – and remain – profitable.

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These complex transactions involve storing metal cheaply and taking advantage of the steep “contango” in aluminium, market jargon for when prices for future delivery exceed spot prices, to sell it forward immediately for a small profit.

Indeed, it is the profitability of metal financing deals that partly explains why the LME warehousing system remains bloated, with queues in Detroit’s warehouses at 650 calendar days, according to Morgan Stanley – around 100 days higher than when the exchange first floated its warehousing reforms last July.

As the US industrial consumers realised premiums were not coming off and metal was still locked up in warehouses, there was a rather unseemly scramble to buy aluminium. That saw the physical market tighten and premiums reach record levels in the US first and then elsewhere in the world.

The question now is what happens to premiums. Will they remain at or close to record levels or decline?

Many traders believe the physical market will remain tight. They say the market excluding China is in deficit, metal financing remains profitable and the LME rule changes, which come into force in May, will only have a limited impact over the next couple of years (and even then might be toothless if interest rates remain close to record lows and central banks continue to print money).

On top of that, demand for aluminium, which is used in everything from drinks cans to cars, continues to improve, particularly in North America.

Analysts are less sure. Those industrial consumers who were caught short at the end of last year are not likely to make the same mistake again and will be looking to pick up tonnage when second-quarter volumes are marketed.

They also question how many physical trades are being struck at the current high price.

However, one thing is clear: if high premiums persist, it will continue to keep many smelters in business and perpetuate one of the key structural problems in the global aluminium market – the stockpiles.

Or, as Morgan Stanley put it in a recent report: “There will be no market adjustment as long as the ‘all-in’ price incentivises output.”

Until more smelters close and the industry’s towering stocks are reduced from their sky-high levels, the investment community will remain unenthusiastic about aluminium – and the metal will continue to languish around four-year lows.