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Aluminum

RPT-COLUMN-Gloves off in LME's long battle with warehouse operators: Andy Home

(Repeats with no changes. The opinions expressed here are those of the author, a columnist for Reuters)

LONDON, Jan 7 (Reuters) - This is set to be the year in which the London Metal Exchange (LME) finally kills off the load-out queues that have plagued its physical delivery network over the last five years.

But the cost of doing so has just become apparent.

Average storage rents and load-out charges, weighted by stock levels at the end of November, will jump by 10 percent and 12 percent respectively from next April.

Some sort of warehouser reaction to the raft of rule changes targeting the load-out queues was always on the cards.

The scale of that reaction, however, was unexpected. Some of the increases in exchange storage costs are unprecedented.

Also unexpected was the identity of those challenging the LME with the most aggressive hikes in charges.

There is no doubt that some warehouse operators have thrown down the gauntlet. It only remains to be seen how the LME chooses to respond.

There are no easy options because now laid bare is the true heart of the LME’s warehousing problem. The cost of exchange storage has been a bone of contention for as long as anyone can remember.

The LME has on many occasions shied away from tackling it, fearing the legal consequences of doing so. But the latest rent increases may be the final straw for both exchange and users.

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Graphic on LME warehouse rents: tmsnrt.rs/1mI3K8L

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THE END OF RESTRAINT

The increases in rent and load-out charges for the financial year beginning April mark the opening of a new front in the long-running war between the LME and its warehouse operators.

The exchange had called for “restraint” in cost increases in the last two rent cycles and had been rewarded with stock-weighted average rent increases of three percent in both years.

Now, however, the gloves have come off.

This was always a possibility, as the LME itself has warned on several occasions.

The queue-based rent cap (QBRC) rule comes into effect in March. It will reduce by half the amount of rent payable on metal stuck in a queue longer than 30 days and eliminate rent completely after 50 days.

That of course fractures the revenue model of those operators with a long load-out queue and hiking rents and load-out charges was always the most likely response.

All eyes were on Pacorini, the LME warehousing arm of Swiss commodities giant Glencore.

Not only is Pacorini the largest storer of LME-registered metal, holding just over 53 percent as of the end of November, but it also “owns” the longest queue at the Dutch port of Vlissingen, 471 days for aluminium at the end of the same month.

Yet Pacorini seems to have carefully calibrated its rental and load-out charge increases for the coming financial year. Aluminium rental charges will rise from 49-51 cents per tonne per day to 50-54 cents, although no surprise that the top end of that range applies to Vlissingen.

Pacorini’s load-out charge, or the “free on truck” (FOT) charge as it is known in LME parlance, will increase by 6.44 percent to 31.40 euro per tonne at the Dutch port.

It’s of course possible that these relatively restrained increases are a compromise resulting from the annual December push-and-shove negotiations between the LME and its warehouse operators before rental and FOT charges are formally announced.

Evidently resistant to such soft coercion, however, was Metro, the operator of the original load-out queue at Detroit, once controversially owned by Goldman Sachs but since sold to the Reuben brothers.

It has raised aluminium rents by a third to 72 cents per tonne from 54 cents in the current rental year to March. It has also jacked up its FOT charges by 39 percent to $55.55 per tonne in the U.S. and by even more at its South Korean locations.

Metro’s super-charged increases are surprising.

After all, the Detroit load-out queue has been diminishing at a steady rate of around 30 days per month. As of the end of November it was “just” 206 days and, unlike Pacorini, there is relatively little uncancelled metal at Detroit, meaning the queue cannot flex significantly longer.

Indeed, at its current decay rate that queue should shorten to the LME’s targeted 50 days around May, limiting the likely hit from QBRC on rental revenue.

Metro doesn’t have any queues at any of its other locations and has seen its total share of LME storage slide to under 10 percent from close to 20 percent a year ago.

That, of course, may be one reason for its aggressive rental and FOT hikes.

INCENTIVES

It’s worth remembering that most owners of metal don’t actually pay these headline fees, which denote maximum chargeable costs.

Many users of the LME warehousing system negotiate discounts for metal in storage as part of a matrix of incentives offered by individual warehouse operators to attract metal to their sheds.

Evidently, though, the warehouse operator charging the highest rental can in theory offer the most enticing incentives for further deliveries.

Metro, which has seen its LME storage share shrink steadily over the last couple of years may be plotting just such a strategy.

And it may not be alone.

Another stand-out for its aggressive price hikes is ISTIM, the new warehousing incarnation of Bill Whelan, the face behind the original Metro.

ISTIM takes the award for the steepest rental rise of all. Its charge for storing lead at Detroit will increase by a staggering 43.6 percent to 56 cents per tonne per day.

What’s strange is that ISTIM doesn’t hold any LME-registered at lead at Detroit. Indeed, there’s isn’t any there at all.

“Yet” may be the missing word from both those statements.

In truth, Metro and ISTIM are just the extremes of a broader pattern. The average increase in rents in the coming year, unadjusted for stocks ownership, will range from 6.2 percent in the case of tin to 8.5 percent in the case of lead.

Only one operator seems to be experimenting with a different model. Edgemere has slashed by almost half its rental rates at Baltimore to 25 cents per tonne per day.

Only at Baltimore, mind you. It has increased rents at its sheds at the British port of Hull and Malaysia’s Port Klang.

CAUSE AND SYMPTOM

So what can the LME do?

Short term it is keeping its cards close to its chest. It will “carefully examine” the rationale cited by warehouse operators for the increases.

It will “investigate further” before deciding whether to step in and cap charges at specific locations.

The exchange is probably holding fire until it sees the impact on warehouse incentives, information which it will receive for the first time ever this month under another tweak of its rules.

But these latest storage cost hikes bring to a head the root problem of the exchange’s relationship with its warehousers, namely its inability to halt the widening disconnect between the cost of LME and non-LME storage.

The cumulative increase in LME average rental charges over the last 20 years has been 256 percent in the case of copper and 223 percent for aluminium.

There has been no comparable increase in the “fundamental” costs of warehousing metals over the same period. Off-exchange storage can be had for as little as 10 cents per tonne per day, even cheaper in some locations.

Remember it was that disparity that caused the load-out queues in the first place as financiers of metal chose to move large volumes of aluminium out of registered sheds in Detroit to cheaper storage.

That same disparity widens the discount of LME prices to “real-world” prices, “exerting a negative impact on the functioning of the LME market”, in the LME’s own words.

The LME has no current powers to cap rents and FOT charges and if it tries to do so, it will almost certainly face a legal challenge.

But the scale of increases just announced may leave it with little option but to throw the legal dice.

As long as it doesn’t, it will still be treating the symptoms not the root cause of its warehousing woes.

Editing by David Evans

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