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Lucrative aluminium financing deals amplify physical premiums in Europe

LONDON (Reuters) - The large amount of aluminium tied up in financing deals, made more lucrative by cheaper credit, has eroded the benefits of lower benchmark prices for European consumers needing to buy on the spot market.

FILE PHOTO: Workers are seen next to aluminium rolls at a plant in Binzhou, Shandong province, China

Financing deals involve buying aluminium now and selling it forward for a higher price after storage, insurance and interest have been deducted.

The volume of metal locked up in these deals has pushed up premiums in the physical spot market, which consumers pay above the benchmark London Metal Exchange price, mostly to cover costs of transport and insurance.

Duty-unpaid premiums in Europe are the highest since June 2018 at above $100 a tonne, up nearly 70% since January, when markets were anticipating the removal of sanctions on Russian aluminium giant Rusal.

Over the same period benchmark prices have fallen some 7% to around $1,750 a tonne, close to a 2-1/2 year low, due largely to the protracted U.S.-China trade war. But higher premiums have eaten into the saving from that drop for spot buyers.

Aluminium is a vital material for the transport and packaging industries and is mostly sold on annual contracts with prices determined on a quarterly basis.

Higher premiums will only impact European consumers that have to buy on the spot physical market because they need more than expected.

“Metal is locked in financing deals and so is not readily available to the physical market. It is a shortage driven by demand from financial participation rather than physical demand,” said Wood Mackenzie analyst Kamil Wlazly.

Typically, financing deals are rolled over on a monthly basis, but some recent deals are for longer periods and will not mature until later this year or in 2020.

Weak demand for aluminium in the spot market is in itself feeding into higher premiums. Financing deals have the potential to make more money when the contango in the market - the discount for the cash over longer-term contracts - is strong.

A deeper discount tends to reflect weakness in near-term demand, which holds cash prices down.

The discount for the cash over the three-month contract on the LME is currently at around $30 a tonne, while the three-month contract is some $61 a tonne below August 2020 metal.

“Those numbers are significant, given the costs of financing came down again,” a physical aluminium trader said referring to an interest rate cut by the U.S. Federal Reserve at the end of July.

“The premium moved over $100 after the rate cut and now I can’t find any offers below $115. There is a lot of metal very tightly held in these cash and carry deals.”

Analysts estimate total global aluminium stocks have risen to nearly 11 million tonnes from below 10 million tonnes in May. Most of that is held in financing deals, much of it in Europe, aluminium trading sources say.

Reporting by Pratima Desai; Editing by Jan Harvey