By Stuart Burns
Rather than reduce physical premiums as the LME’s load-out rule changes approach in April, the market is perversely experiencing rising physical delivery premiums, increasing pain for consumers as the premium approaches 20% of the cost of the metal.
A Reuters article this week reports the U.S. Midwest aluminum premium over the LME cash price jumped by 3 cents to 15 cents per pound on Jan. 3, and then extended its rally to 17.5 cents last week. Small tonnages are reported to have transacted at even higher numbers.
The LME and much of the market had hoped the rule changes would free up more metal and ease physical delivery premiums, but after a brief drop during the summer, the reverse has happened. As Reuters observes, the rules appear to have spurred a shift of more LME stocks into a new round of long-term financing deals in storage sheds outside of the exchange’s vast U.S. network.
Back in the summer, the LME received some criticism for saying they had been reluctant to change rules because every time a rule was changed there were unexpected consequences – and indeed that seems to be the case here.
In addition, production cuts in North America, coupled with an increased uptake in metal from sectors like automotive and aerospace, have added to pressure on available supplies and driving up physical premiums, while the underlying LME price has, if anything, fallen back from the mid-$1,800s per metric ton to the mid-$1,700s.
This disconnect is all the more painful for consumers as they try to hedge their price risk; while LME prices have a ready forward market, the physical premium currently does not. When that premium was 10% of the total cost, it was bad enough, but at 20% it exposes consumers to enormous price risk.
Both the LME and US rival CME have announced they are looking at solutions, CME with a deliverable contract including the physical delivery premium and the LME announcing this month they would have a draft proposal available for consultation by the month-end. The new product would be for a tradable U.S. Midwest premium contract and operate similar to a swap, Reuters says.
In spite of rising physical delivery premiums underlining how tight the short-term availability is getting, the LME base price is languishing between $1,700 and $1,850 per metric ton with the price falling below $1,800 for much of this month.
As if to underline the firm’s lack of faith in the metal’s ability to recover anytime soon, Alcoa (NYSE:AA) booked a massive $1.7 billion non-cash goodwill write-down on its smelting assets last week, based on discounted cash flow, margins and LME prices and physical premiums for the next three years, pushing the company into a fourth-quarter net loss of over $2 billion, according to Reuters.
What This Means for Metal Buyers
With the LME’s rule changes just two months away from implementation and fully factored into the market’s calculations, you have to say the physical delivery premiums are unlikely to fall in April when the new rules come into play.