Free market forces have combined to create the debate about London Metal Exchange warehousing, but that does not necessarily mean there is a problem, a senior Alcoa executive has said.
“To have a solution [for the warehousing queues], there needs to be a problem, and I don’t think this is actually a problem,” Tim Reyes, head of materials management at the US producer, told Metal Bulletin in an interview.
“We’ve got a series of free market forces at work that have led us to where we are,” he said.
These forces stem from the downturn of 2008, which caused a slump in demand for aluminium in key consuming markets and led to metal flowing into warehouses as low interest rates and a contango market structure encouraged financing deals.
Lengthy queues to get material out of warehouses have arisen in locations including Detroit, New Orleans and Vlissingen, leading to a huge industry debate over who is to blame and what can be done about it.
A significant portion of metal is sitting off warrant and not in warehouses approved for storage by the LME, according to Reyes, and is therefore not tied up in a queue.
But this metal is still being held in financing deals that financiers are not willing to break unless the premium provides them with enough of an incentive.
“The LME has taken steps to try to mitigate the impact of the queues on other metals, which everybody seems to agree is a good idea, but ultimately I don’t know that the game changes significantly if the LME changes the rules,” he said.
Warehouse queues have not fallen away since the LME raised the delivery-out rate; if anything, they have lengthened.
But, according to Reyes, it is not the job of the LME to control metal prices or physical premiums: “It’s just a forum.”
“There’s plenty of metal outside the LME, and that leads you back to the incentive that’s required for a financier to give up the metal. Eventually, consumption is what is going to drive the inventories away,” Reyes added.
Last week, the LME’s head of business development, Chris Evans, said that aluminium producers need to curtail production to reduce physical premiums and, potentially, reduce warehouse queues.
Alcoa estimates that about 30% of Chinese smelting capacity is operating at a loss, while that figure falls to about 8-10% for the rest of the world.
Warehouse inventories are high – with an equal amount of stock estimated to be off warrant ¬– but Alcoa believes the market is balanced, Reyes said.
“When we [Alcoa] measure inventory as a ratio to consumption, inventory has fallen significantly from a high of about 102 days [worth] of consumption in 2009 to about 74 days today,” Reyes said.
This means production cuts would “eat into inventories” and push the aluminium market into deficit, he added.
Premiums for the physical delivery of aluminium have skyrocketed to all-time highs, and the blame for this is usually pinned on warehousing queues.
But the majority of the metal caught up in warehouse queues is not going to consumers, Reyes said.
“I don’t think the queues are causing the high premiums at all - there’s metal available out there. Metal in the queue is probably set to go off warrant to low-cost storage; I don’t think that the majority of the metal in the queue has a customer’s name already attached to it,” he said.
“I think it’s still a matter of where do you find that price point where somebody who’s financing metal is willing to give it up,” he added.
Premiums are starting to strengthen once more, he noted.
A number of large banks and industry merchants – including Glencore, Trafigura, JP Morgan and Goldman Sachs – have been accused of using their ownership of LME warehouse firms to give them a competitive advantage against the rest of the market.
Warehouse owners have also been accused of deliberately creating queues by methods including using their trading divisions to increase the amount of metal in delivery lines.
No evidence for this has been presented to date, and Reyes said the issue of bank ownership of warehouses has been confusingly comingled into the issue of delivery queues.
“We don’t see a different behaviour from a warehouse just because it’s owned by a bank,” he said.