LME changes will push metal off-warrant: Rusal

The new London Metal Exchange warehouse rules will lead to a flow of aluminum to off-warrant storage, but won’t address consumers’ complaints against high physical premiums, United Co. Rusal (UC Rusal) has said.

The warehouse reforms will not have a fundamental effect on the price for producers, UC Rusal deputy chief executive officer and director for strategy and business development Oleg Mukhamedshin said.

This is due to the positive returns aluminum continues to provide for investors through financing deals, along with growing supply-demand tightness, he said.

"Metal currently sitting in LME warehouses is mostly owned by financial investors, which makes a good return of 8 percent per year out of the contango," Mukhamedshin said.

"Investors’ interest and profit is driven not only by low interest rates, but also by the ability to store this metal at a cheap warehouse fee, especially for those that own their own warehouses," he added.

"So now the LME rules are pushing metal out of certain warehouses in order to reduce the queues. Our view is that this metal will not go to the market but will go to off-warrant stock and will still be financed by the same financial investors, but at a cheaper cost because the rent of non-LME warehouses is cheaper than that of LME-registered warehouses," Mukhamedshin said.

The real problem for consumers, he said, is their inability to hedge the premium component, which has reached record highs in the past year. In contrast, the LME price has fallen to four-year lows.

"Basically, what happened after the 2008 financial crisis is that the LME didn’t reflect the economics of the market, just a fraction of it," Mukhamedshin said.

"Consumers obviously want to hedge the overall price, but in reality they can only hedge a fraction of it, which is the LME price and not the premium," he added.

During the recent LME warehousing consultation, which led to the introduction of higher delivery-out rates for warehouses with queues of more than 50 days, UC Rusal proposed that the exchange introduce instruments to hedge the premium. The LME has since said it is now considering this.

Premiums aren’t high just because there are long lead times to access metal from warehouses, Mukhamedshin said. "Consumers do not buy metal from LME warehouses; they buy it from producers and traders," he said.

Even if metal is released from financing deals, positions tend to be drip fed into the market over time as financiers choose to reduce their exposure while preserving the premium value, according to Mukhamedshin.

At the same time, when stocks fall, prices typically rise.

"If premiums fall, the LME price rises, and the overall price is the same or even higher because of the supply-demand deficit that is emerging," Mukhamedshin said. "As a result ... we believe it’ll be higher still because of the market deficit."