Two years ago, premiums on warehoused aluminum became such a problem that one major producer called the metal “un-hedgable”. The Midwest premium peaked between 20-30 percent of the all-in cost of the metal for firms looking to move aluminum out of warehouses. Though the premium has dropped significantly since then, the high premiums led to some lasting changes in the way major aluminum producers and commercial firms hedge their costs for the metal.
One of the key drivers was a series of new futures contracts that allowed firms to hedge their premium costs. As premiums fluctuated, firms understood they needed to hedge. Volatility remained high until early 2016 when premiums declined to 7-8 percent of the all-in cost. You might think that once volatility decreases, trading volume decreases with it. But over the last several months, we have witnessed the opposite effect.
Across CME Group’s four regional aluminum premium contracts, 9 historical records for volume and open interest were reached in June. Open interest accumulated to more than one million metric tons.
We often look at hedging as something that fluctuates only as fundamentals change. But in the aluminum market over the last two years, many commercial firms have realized that hedging aluminum costs is now part of life in their business. They have found CME Group’s suite of aluminum futures to be a fitting solution in this environment, in part because it offers a cash settlement. Some firms pledged to use our new contracts two years ago, and today finally have systems in place to make that a reality. Once a few major firms made the jump, many others followed.
Volatility has declined, but a new normal has set in for aluminum market participants. The result is record interest in managing price risk.