Aluminum is everywhere. It pretties up our buildings, lightens our vehicles and, as the comedian John Oliver once observed, prevents us from sipping beer out of our hands. This should be the best of times for both the consumer and producer for the metal, if it wasn’t for a recurring nightmare: the metal had become almost impossible to hedge over the past several months due to a surge in the Midwest premium.
“What has really changed in terms of the risk profile is how to manage the premium,” said Steve Hodgson, Director Sales and Marketing for UC Rusal.
“The premium today is 20-22 percent of total price and generally un-hedgable.”
There is, however, light at the end of the beer can, as it were, due to a confluence of international factors including steady demand, faster movement of the commodity out of warehouses and a spanking new contract in Chicago.
First some fundamentals. Aluminum is in hot demand. The metal has hit a 17-month high on the market and supply is forecast to be in deficit this year, for the first time in five years, according to Goldman Sachs.
You can attribute some of the growth to China but aluminum is clearly in vogue globally, cherished now to make cell phones look better, roof tops ever shinier and in a huge development, it is sought after to slash the carbon foot print of your motor vehicle.
Primary production of aluminum in North America rose 16 percent from 2009 to 2012. At the same time, North American imports for consumption have also increased, rising 22 percent in that same time period.
From Ford to Jaguar
The industry was initially abuzz with Ford turning to the metal for its 2015 F-150 truck, but the move is now seen as part of a larger trend in the auto industry. Jaguar Land Rover, for instance, has just announced that its XE sedan will soon have body of more than 75 percent aluminum.
“The last two or three years — it has been fantastic,” said Andy Massey, Director of Aluminum, Transportation, and Procurement at Bonnel Aluminum, who sees aluminum as the building material of the future.
“Because nowadays people are looking for more fancy looking buildings, more color, more pizzazz and demand for aluminum continues to increase because of that,” he told OpenMarkets in recent interview.
So heavy demand and prices can be great for producers and manageable for consumers in an efficient marketplace. But it is well known that there are big problems surrounding the once sturdy and reliable Midwest premium.
Some market users perceive much of the blame on how the metal was stored in London Metal Exchange (LME) warehouses and the slowness of shipping to the customer in need, according to published reports. Many criticized big Wall Street firms for gaming the storage business for outsized profits.
Tim Weiner, a global risk manager at Chicago-based MillerCoors, says as one of the biggest consumers of aluminum in the world, the metal became has one of the company’s biggest risks.
“So we buy futures contracts today for next year, the year after maybe even two or three years out to basically minimize that risk – to give the CFO a little bit more price certainty.
“With the disassociation between the underlying LME futures contract and then the Midwest premium component – without them being joined together – it becomes very difficult to manage that price risk,” he says.
Bonnel’s Massey figures the premium should be about 8 cents a pound, compared to about 20 cents, which it hit in July.
“So that means consumers are paying almost 12 cents a pound more than they should right at the moment so there is definitely an imbalance in the market,” Massey says.
But there is gathering evidence premiums may have peaked. Premiums hit a record 20.875 cents in January and could drop to 14 cents a pound by year-end, according to Tim Hayes, a Richmond, Virginia-based principal at Lawrence Capita, as reported by Bloomberg.
“The appetite to finance the inventory is going to lessen a bit,” Hayes, who has been tracking the aluminum market for two decades, told Bloomberg. “When that happens, the metal comes out of the warehouses, and that will mean lower premiums.”
New Contract to the Rescue?
Industry players are also increasingly optimistic about another important element in the market this year: the new futures contract at CME Group.
After a buildup and consultation with market players, CME Group announced that the first North American physically delivered Aluminum futures contracts were traded on May 6, by Macquarie Bank Limited, the executing firm.
“We’re pleased to see broad-based support for our new North American physical aluminum futures contract on day one,” says Derek Sammann, CME Group’s Senior Managing Director of FX, Metals and Options Solutions.
“By working with key producers, consumers and merchant traders in the aluminum market to develop this product, we believe that it will allow participants to better manage their price risk and will serve as the premier price reference for the North American aluminum industry.”
At Coors, Weiner was also waxing optimistic. “It’s highly likely that we are going to be one of the biggest users of the CME North American aluminum contract.”
The CME contract offers two important “distinctions,” according to Hodgson of UC Rusal. The new contract is “highly regionalized” which helps consumers in the local environment and it offers a new platform outside of the LME.
“It does give consumers the option, the choice, to use a different platform” he says.