From the humble garden chair to the advanced jet fighter, aluminum is a commodity in great demand the world over. But lately the metal seems to act more like kryptonite for market participants because of the chaos it has created in global commodities markets.
It’s all about Midwest aluminum premiums, which have soared with claims and counterclaims that too much of the stuff is being socked away in warehouses instead of being delivered on a timely basis to customers.
There are accusations that the delivery process is being subverted and diluting the effectiveness of aluminum contracts, offered by the London Metal Exchange. The critics charge the current benchmark is broken while others contend that financial reform and cheap money have conspired to squelch market liquidity
Most importantly, the end user is bearing an increased cost they are currently unable to hedge. So who will come to the rescue? Market forces, of course, possibly with a helping hand from the venerable CME Group. Market players are clamoring for the CME to offer an “all in” aluminum contract that will allow purchasing managers, scrap dealers and manufacturers to protect themselves from runaway costs. Why CME? Many worry the London bourse won’t be able to fix its product anytime soon.
“We believe there is a huge opportunity for the CME to be successful because the sheer volume of inventory in LME warehouses and in off-warrant warehouses has skyrocketed,” says Lisa Reisman, Managing Editor of the MetalMiner.
The industry, however, needs to move quickly to support such an initiative and build a liquidity pool that will benefit all.
“If the CME can get that piece right, they can be hugely successful,” Reisman says, adding that the CME is attractive for U.S. industrial users because it is based here and has global appeal because of its distribution network and proven track record.
High Prices, Big Problems
Market players are frustrated because while the cash price of aluminum has fallen the premium has doubled in the past few weeks. The problem is the slow delivery of aluminum from the big warehouses in places such as Detroit.
“It’s driving up costs for the consumers in North America and it’s not being driven up because there is a true shortage in the market. It’s because of an issue of accessing metal … in Detroit warehouses,” Nick Madden, chief procurement officer for Novelis, the world’s biggest maker of rolled aluminum products, recently told Reuters.
This surging premium quickly spreads around the world and results in higher costs for all consumers. In a recent article, The New York Times, quoting market and industry sources, estimated the out-of-whack premiums have cost American consumers more than $5 billion over the past three years.
“The premium goes up four times and the price of aluminum goes down? It’s not logical,” says Mark Bodner, a trade and consultant with MB Consulting LLC in New York. He was at Gerald Metals in 1978 when the LME first launched its aluminum contract.
Bodner believes CME has an opportunity to launch a contract that “helps out the consumers who until now” have been suffering. But like other market analysts, he believes CME needs to strike soon, well before year-end in the launching of the new contract.
A top official at CME agrees. “There is specific interest in an aluminum contract that provides an ‘all-in’ price,” says Harriet Hunnable, Managing Director of Metals Products at CME Group. “Consumers are looking for a fair, balanced and liquid option to the products they currently trade.”
She maintains that CME Group has a long history of providing a level playing field that facilitates efficient price discovery and physically delivered futures contracts that converge with the cash market.
“We expect to provide an ‘all-in’ solution to the aluminum market in the very near future,” Hunnable says.
Analysts believe CME should model its product on its success in other physically delivered products, which range from metals to grain including benchmark products for precious and base metals. Their relatively new AUP contract, which isolates the Midwest premium, has seen a dramatic rise in interest as it provides commercial players with safe harbor to weather the current storm. As of Feb. 19 open interest in the contract had soared more than a 1,000 percent to 562 contracts over several delivery months from just a handful of contracts at the end of 2013.
Reisman of the MetalMiner says the CME contract needs very simple warehousing rules that even the layman can understand. She agrees that if the new CME aluminum contract offered an all-in solution that had lower maintenance margins than the LME, CME would have a winner on its hands.
So while CME’s new contract need not leap tall buildings, it is hoped by some that the product will help participants in the aluminum market to manage the volatility that is making it so hard for both producers and purchasers to plan for the future.