LONDON (Reuters) - Reforms to the London Metal Exchange’s global warehouse network have, as planned, cut the amount of metal trapped in storage, but the unintended consequence is a distorted fundamental picture and more pressure on already tumbling volumes.
Since 2013, the LME has implemented measures aimed at reducing queues for aluminum as it leaves warehouses after banks and traders that own them profited from letting long queues build up while charging rent.
Aluminum is a key raw material for cars, airplanes and bicycles and in packaging items such as cans and foil.
Measures to cut queues included higher load-out rates for metal to leave warehouses and a freeze on maximum rental rates.
Most effective so far has been the cap on rents. The rent payable on metal stuck in a queue longer than 30 days drops by half and after 50 days no rent is payable on LME metal.
“The rent capping is why so much aluminum has left the exchange, warehouses don’t want the metal in case they have to store it for free,” the head of one commodities brokerage said.
“The drawdown in LME stocks to an outsider would suggest a tighter market, but that’s only on the LME.”
Stocks of aluminum in LME-approved warehouses have fallen more than 60 percent to 2.14 million tonnes from a record high of 5.49 million tonnes in January 2014.
“Warehouses without queues have experienced an increase in stocks throughout much of 2016 ... when there is tightness in the market stocks are drawn into the LME system,” the LME said.
“(The non-queued) market may be tighter than for queued warrants, given that non-queued warrants can be immediately withdrawn from warehouses and sold on the physical market.”
Global aluminum stocks estimated at around 15 million tonnes are expected to increase due to rising output in top producer China. They are substantial compared to global consumption estimated at around 58 million tonnes this year.
Despite expectations of large surpluses this year and next aluminum prices have hit 15-month highs above $1,700 a tonne.
“A global benchmark should reflect supplies, output is rising, inventories are huge, there’s no shortage of aluminum,” an Europe-based aluminum consumer said.
LME volumes are down overall due to a variety of reasons including a hefty 31 percent average trading fee hike at the start of 2015, which persuaded some to go over-the-counter, slow demand growth in top consumer China and rival exchanges grazing on LME territory.
For aluminum the damage has been exacerbated by lower stocks.
Volumes in tom/next — buying today and selling the day after – have crashed nearly 60 percent since the first quarter of 2014 to around just above 328,000 lots or 8.2 million tonnes in the third quarter of this year.
Put simply, the mechanism works as follows; all the aluminum in LME warehouses is owned by someone and if a company doesn’t want to take delivery when the contract matures, it can sell and buy back for a future date.
Frequently the trade of choice was tom/next but lower stocks mean there is now less metal to roll over.
“Where people might once have done tom/next, they are now trading for longer periods to save money,” a senior aluminum trader said. “(Think of) stocks as liquidity, it’s getting tighter, so people borrow and lend at ever decreasing rates — a vicious circle.”
Reporting by Pratima Desai; Editing by Veronica Brown