Alumina derivatives must wait, market lacks volume

Creating a derivatives product for the alumina market would be premature and is probably a long way off, as the physical market still lacks adequate liquidity to support it.

Conferees at last week's MetalBulletin Bauxite and Alumina Seminar were hopeful that alumina swaps or another derivative instrument could help provide liquidity to the market.

But most were doubtful that such an market could thrive.

Speaking at the conference, Tjeerd Konst, director of commodities at Credit Suisse in London, stressed that the key to a successful alumina instrument is a robust and trusted settlement mechanism.

Though many people regard derivatives as complex financial instruments, Konst said swaps are simple bilateral deals in which the buyer and seller agree on a fixed price. The key is the mechanism by which the two sides settle the transaction.

"The key to the success of any sort of financial market that comes along is the establishment of a robust physical market pricing mechanism," Konst said.

Several indexes, developed and published by MetalBulletin and Platts, provide a reference price for the spot alumina market. But producers and consumers of alumina acknowledge their flaws.

Alumina, made from raw material bauxite, is refined into aluminum metal. For more than two decades, third-party or independent aluminum smelters generally bought their alumina supplies through multi-year contracts, with the price set as a percentage of the London Metal Exchange aluminum metal price.

Last year, producers switched to indexes based on the spot alumina market to price those supply contracts.

Buyers at aluminum smelters have been unhappy with the change. They are unable to hedge their alumina costs and they think the indexes do not accurately reflect the price.

Konst offered coal and iron ore as examples of two other commodities that have gone through a similar pricing shift.

"The coal market has developed very strongly in the last few years to the point where the volumes of transactions traded on the swap market, on the financial market, is now something like three times the physical volume of coal that gets shipped around the world," the banker said.

Iron ore swaps remain more of a fledgling market, but Konst said its volume has grown rapidly every quarter, "with a 1.5 billion tonne market with about 80 million tonnes in financial instruments traded last year."

Skeptics told Reuters the global alumina market has much less volume overall than either coal or iron ore, and the spot market, on which the pricing indexes are based, represents only about 5 percent of total alumina sales.

They argued that lower alumina liquidity calls into question the pricing mechanism that Konst said was key to the success of alumina swaps as well as its credibility.

Banks like Credit Suisse could add liquidity by bringing financial market players to the alumina market and by taking on some of the risk by making prices, said Konst.

"Where banks in general can be useful to this process is in bringing the liquidity that's needed to make these financial products and make hedging possible and more importantly to make forward pricing possible," he said.

But many industry participants, on both the producer and consumer sides, were not convinced.（Reuters）