(The opinions expressed here are those of the author, a columnist for Reuters.)
LONDON, June 15 (Reuters) - Japanese aluminium buyers are locked in talks with producers over the level of physical premiums to be paid for shipments in the third quarter.
The opening salvoes suggest the premium PREM-ALUM-JP will fall slightly from the second-quarter level of $115-117 per tonne over London Metal Exchange (LME) cash prices. nL4N18Z2L4
Wherever it settles, it will be within the $90-117 range that has held since the third quarter of last year.
This marks a return to some sort of normality after premiums went supernova over the course of 2014. Japanese premiums hit a record high of $425 in the second quarter of 2015.
It’s the same with physical aluminium premiums elsewhere. The Midwest U.S. premium, as assessed by S&P Global Platts, is currently 7.75 cents per lb ($171 per tonne), down slightly from 8.90 cents at the start of the year. The decline has been both gradual and orderly.
That is also a far cry from the volatility of 2014 and 2015, when the Midwest premium peaked at over $500 per tonne.
Aluminium premiums show every sign of reverting to the relatively low, relatively stable conditions that prevailed prior to the fireworks of the last five years.
They have, in other words, fully de-linked from the queues to load out metal from LME warehouses.
Graphic on physical aluminium premiums:
ATTACKING THE QUEUES
The exact linkage between aluminium premiums and waiting times at key LME good-delivery locations such as Detroit and the Dutch port of Vlissingen remains a contested issue.
Aluminium users were never in any doubt that the aggressive queue-management schemes of LME warehouse operators such as Metro (Detroit) and Pacorini Metals (Vlissingen) were the direct cause of the explosion in physical premiums.
Producers and warehouse owners argued that there was more than just queues in the mix, pointing to both shifts in the physical market, such as the steady contraction of U.S. smelting capacity, and rampant demand for financing aluminium.
It was, after all, financiers rather than manufacturers who were caught in the queues as they sought to move large tonnages of metal to cheaper off-market storage.
The LME itself has always taken a cautious middle ground in the debate, accepting queues were indeed one element, but not necessarily the only one, in the premium explosion.
But the LME has repeatedly tweaked its rules to reduce and eliminate queues in its warehouse network, lifting load-out requirements, introducing a linked load-in-load-out obligation on operators with queues and more recently moving to cap the amount of rent payable in a queue.
The ratcheting up of these measures has largely worked. There is now only one load-out queue for aluminium in the system.
THE LAST QUEUE
As of the end of last month the queue to get aluminium out of warehouses operated by Pacorini Metals at Vlissingen stood at 336 days.
It has flexed considerably wider over the last couple of months from just 116 days at the end of February.
That’s down to the shuffling of metal in reaction to spread tightness on the LME’s aluminium contract over the course of February and March.
Vlissingen received 120,325 tonnes of fresh warranting activity in those two months, all of it flowing into Pacorini warehouses. At the same time 174,150 tonnes of aluminium was re-warranted, reducing the amount of metal in the load-out queue.
That pattern reversed once the spread tightness passed, the Dutch port seeing 656,000 tonnes of aluminium cancellations over the second half of March and April, all of them acting to lift load-out times again.
Vlissingen now holds 944,725 tonnes of aluminium, of which 756,325 tonnes, or 80 percent of the total, is in the form of cancelled warrants awaiting load-out.
The key take-away from all this toing and froing, however, is that there has been minimal impact on physical premium levels.
That may reflect a change of operating model by warehouse operators in reaction to the LME’s increasingly draconian measures.
Consider, for example, the other queue at Detroit, which has somewhat mysteriously disappeared over the last two months.
Detroit currently holds 189,825 tonnes of LME-registered aluminium, of which 154,200 tonnes is in the form of cancelled warrants.
The LME’s most recent monthly report detailing stocks by operator showed Metro holding 153,375 tonnes (all metals) at the end of May, by some margin the largest concentration in the city. Of that total all but 350 tonnes was in the form of cancelled warrants.
Quite evidently, Metro still has a lot of aluminium sitting in its sheds, most if not all of it in the form of cancelled warrants but certainly enough to form a load-out queue.
But as of the end of last month there was no queue at Detroit, according to the LME.
The only plausible inference is that the owners of that cancelled aluminium haven’t allocated delivery times to collect their metal.
Which suggests some sort of rental deal has been struck with the warehouse operator. That would be in stark contrast to the days when those in the queue would be forced to pay the maximum rental charge.
Queues, it seems, are no longer the only revenue metric when it comes to warehousing LME-registered aluminium.
A HEDGEABLE FUTURE
So is that it? Will premiums revert to their previous rather boring pre-queue norm, immensely important for physical buyers and sellers the world over but with only marginal influence on the “all-in” aluminium price?
Not quite because it is clear that it is not just warehouse operators who have changed their behaviour.
The new aluminium premium contracts launched by CME in response to manufacturers’ distress about the widening disconnect between LME basis and “all-in” price are flourishing.
The Midwest U.S. contract <0#AUP:>, for example, has already notched up 740,175 tonnes of trading in the first five months of this year.
Proof that the market has started to hedge its exposure to the physical premium despite the relative calm of the last few quarters.
And these contracts may yet prove to be valuable tools because the entire aluminium market is adjusting to life after the queues.
LME stocks are still steadily falling. Off-market inventory is almost certainly rising.
As these two trends play out, the aluminium market is becoming more opaque, which means that a physical squeeze, whatever its origins, may be hard to spot in advance.
At least if it does materialise at some future date, manufacturers now have a ready-made tool-kit to handle the consequences. (Editing by Alexander Smith)
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