Aluminum-delivery bottlenecks at warehouses that raised buyer costs and dragged the world’s biggest metals exchange into 26 U.S. lawsuits will last longer, after a plan to ease delays April 1 was tossed out by a judge.
Wait times for shipments will remain long, keeping premiums high for deliveries from London Metal Exchange warehouses, according to London-based researcher CRU. The LME said new stockpiling rules will be delayed after a U.K. judge ruled them “unfair and unlawful” because the exchange’s consultations should have considered other options.
Metal users including beer-maker MillerCoors LLC complain the LME allowed warehouse owners including Goldman Sachs Group Inc. to create long queues that inflate costs. The practice prompted reviews by U.S. regulators and a congressional hearing last year. The exchange is a global pricing benchmark, trading aluminum contracts equal to 1.6 billion metric tons a year, or 31 times more than world output. The ruling sent Alcoa Inc. (AA:US), the largest U.S. aluminum producer, to its highest since 2011.
“The verdict means the LME is stuck,” said Marco Georgiou, an aluminum analyst at CRU. “The LME can’t go ahead with that rule change now. There is no pressure or force to try to bring those queues down in the warehouse. The queues can stay high, and metal can still flow into LME warehouses.”
It takes about 19.2 months to get aluminum out of Vlissingen, Netherlands, home to warehouses holding the biggest combined inventory of LME aluminum, and the wait time is 20.7 months at locations in Detroit, the second-biggest, Austin, Texas-based researcher Harbor Intelligence said in a report yesterday. Premiums added to the LME aluminum price reached a record in Europe and the U.S. in the first two months of 2014, and they’re at an all-time high in Japan, Harbor said.
After the LME announced changes that it said would ease the bottlenecks, the move was challenged by United Co. Rusal, the world’s largest aluminum producer. The Moscow-based metals company argued that the exchange didn’t properly examine alternatives, which it said would cause tens of millions of pounds in losses.
Judge Stephen Phillips ordered a review of the LME’s decision. The exchange, in a statement, said the ruling reflected “one specific procedural issue, that the consultation should have encompassed or made reference to the option of banning or capping rent in queues.”
“As I read matters, the lesson is that poor process produces poor performance,” Christopher Lovell, an attorney who filed the first of the U.S. lawsuits against warehouse operators on Aug. 1 on behalf of Gwinn, Michigan-based aluminum fabricator Superior Extrusion Inc., said in an e-mail. “Had the process included meaningful consideration of alternatives, then the results well could have been upheld.”
The exchange said it’s seeking legal advice on options including appeal or “re-consultation.” Under the most likely scenario, the bourse will implement the rule between July and December, according to Harbor.
“We know now the rule changes won’t go ahead,” said Colin Hamilton, global head of commodity research at Macquarie Group Ltd. in London. “Producers will feel a bit more comfort in the short-term. Warehouses will probably be looking for more material again. They will be reversing their strategy. Consumers will be complaining. Regulators will be listening.”
The LME said in November it would require storage operators with delivery delays exceeding 50 calendar days to deliver out more than they take in, as part of a package of warehousing reforms. The changes, which include adding logistical and legal reviews and a daily delivery requirement for steel from warehouses, called the load-out rate, are still coming into effect next week, the LME said in a statement.
The exchange may still implement the load-out requirement as part of a new market consultation or its appeal. The preliminary calculation period for measuring warehouses’ delivery requirements starting on July 1, 2013, will run until the eventual introduction of the rule, the LME said.
The court ruling may boost the “bullish tone” among producers, which benefit from higher premiums, and “frighten” consumers, according to Harbor.
“Consumers may now feel compelled to buy as they hadn’t committed to much on contract as the general market consensus had been for premiums to fall,” Gayle Berry, a Barclays Plc analyst in London, said by e-mail.
Aluminum rose 1.2 percent to $1,759.25 a ton today on the LME. New York-based Alcoa fell 0.5 percent after surging 6.2 percent yesterday.
The ruling will push aluminum prices lower and premiums higher, said Nic Brown, head of commodities research at Natixis SA in London. The U.S. Midwest premium rose to as much as 21 cents a pound on Jan. 17, while the European surcharge peaked at $295 to $315 a ton on Jan 27, Jorge Vazquez, Harbor’s managing director, said by e-mail. The U.S. premium now accounts for about 19 percent of the total aluminum price, according to calculations based on Metal Bulletin data.
“The all-in price is unlikely to change,” Brown said. “The fundamentals have not changed. What we are doing here, we are altering the split between the LME price and the physical premium.”
The Beer Institute, whose members include MillerCoors and Anheuser-Busch InBev NV, said yesterday it is asking U.S. policymakers and regulators to increase oversight of LME warehousing as the exchange has “difficulty self-regulating.” The exchange may face more government scrutiny after the rule was blocked, according to Hamilton of Macquarie.
“The regulators gave the LME a bit of leeway, because the LME was making efforts,” Hamilton said. “Now that’s been overturned, the regulatory pressure will come back.”
High premiums after the LME plan was put on hold will be “beneficial” for the aluminum contract planned by CME Group Inc. (CME:US), owner of the world’s biggest futures exchange, according to Craig Pirrong, a finance professor at the University of Houston.
CME said this month it will start physically-delivered North American aluminum futures on May 5. The contract was endorsed by MillerCoors.
“This is their best opportunity to try and grab some liquidity from the LME,” Natixis’ Brown said. “At the moment, the liquidity is still firmly with the LME.”
The CME started aluminum premium swap futures in 2012 that are cash-settled. The LME will continue working on a potential contract to hedge premiums, it said in notice to members yesterday.
Aluminum is the most-active contract on the LME, with 66.6 million futures and options traded last year, according to the exchange. Each futures contract is for 25 tons.
“This really constrains what the LME can do,” Pirrong of Houston University said. “It gives the producers a veto. The bottlenecks are likely to persist and premiums are likely to remain elevated.”
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