United Co. Rusal, the largest aluminum producer, said new rules on warehousing threaten to worsen a supply shortfall, helping drive up the premiums buyers pay for swift delivery to 50 percent of the market price.
The London Metal Exchange’s rules, forcing warehouses with long waiting times to ship out more metal than they take in each day, may compound the supply deficit as volumes will simply move to unofficial storage sites, leaving wait-times unchanged, Rusal First Deputy Chief Executive Officer Vladislav Soloviev said.
“The LME price should be the price-setting instrument,” Soloviev said in an interview in Moscow. The regulations, due to take effect April 1, will make the market less transparent as metal is removed from official warehouses, he said.
The LME, the world’s biggest industrial-metals marketplace, is speeding up withdrawals from warehoused stockpiles following users’ complaints that led to scrutiny from U.S. regulators. Warehouses with waiting times of more than 50 days will be required to ship out more metal than they take in.
The LME’s decision is “irrational and disproportionate,” Rusal said in a lawsuit filed in the U.K. on Dec. 23, which called for a judicial review of the new rules. The case is due to be heard at the end of this month, according to Soloviev.
Buyers of aluminum, used in drink cans to aircraft, usually obtain the metal at an exchange price plus a premium, which covers a particular type of metal at a specific location. While LME aluminum futures slumped more than 14 percent in the past year, premiums in Europe and the U.S. surged by as much as 74 percent and touched records last month.
“Should the metal deficit remain on the market, premiums may reach as much as 50 percent of the price, destabilizing the situation for clients,” Soloviev said this week. The shortfall worldwide, excluding China, is about 500,000 tons, and may grow to 1.5 million tons by December, he said, suggesting the LME failed to conduct enough analysis before announcing the rules.
“As a result, the premiums started to rise and instead of 10 percent of the LME price they’ve now reached about 20 percent,” he said. Rusal, led by billionaire Oleg Deripaska, is calling for the regulations to be delayed so they can be reconsidered or even scrapped.
Buyers are unable to hedge the premiums, which hampers their business planning, Soloviev said. “Should the situation remain as it is now, we may shift to contracts with a fixed price or set the price on the basis of indexes, as in the iron-ore industry,” he said.
“Premiums can become 50 percent of the price,” Jorge Vazquez, managing director of Harbor Intelligence, an Austin, Texas-based researcher, said by phone Feb. 19. “I am not convinced that the premiums will continue to be the main mechanism in which the physical tightness is going to be reflected.”
Miriam Heywood, a spokeswoman for the LME, declined to comment. The exchange said Feb. 11 that the metals market faces “challenges with respect to queue-related premiums due to a number of factors.” Premiums are also driven by market supply and demand, it said.
“If you have got longer queues at warehouses you could have the premium potentially rising,” Michael Widmer, an analyst at Bank of America Merrill Lynch in London, said by phone today. “Having said that, I think the queues right now would justify premium at around $200, not more. So it’s possible to go up there to 50 percent of the price, but I don’t think that they will.”
The premium added to aluminum for immediate delivery on the LME rose 35 percent this year to $297.50 a ton in Europe, excluding duty, according to Metal Bulletin data. Aluminum for immediate delivery on the LME declined 1.2 percent this year to $1,734 a ton.
Rusal shares have risen 21 percent this year in Hong Kong to HK$2.78 per share.
The company has idled smelting capacity in the past year, taking its most inefficient plants offline. As a result, its volumes are forecast to fall 10 percent in 2014 to 3.5 million tons, the lowest output in at least eight years. While the Moscow-based company doesn’t plan to shutter further capacity, it may consider doing so if the market worsens, Soloviev said.
Aluminum prices may also be bolstered by an increase in costs for raw materials such as alumina, whose output has also been curtailed by capacity cuts. Rusal itself has idled the Friguia alumina plant in Guinea and the Eurallumina site in Italy, and may consider closing the Windalco complex in Jamaica.
The risk of further plant shutdowns would be diminished if Russia approved a proposal to set up a 1 million-ton aluminum state reserve fund this quarter, according to Soloviev.
The government is considering a suggestion from Rusal to establish a such a reserve to support the market, Deputy Prime Minister Arkady Dvorkovich said on state television Rossiya 24 in December.
The proposed fund may start buying aluminum at the market price in July or August, and sell it back to Rusal at the same price after seven years, Soloviev said. Such funds in China have helped buoy the industry, and they may be opened in the Middle East, he said.
State lender Vnesheconombank is being considered to manage the fund, the bank’s Chairman Vladimir Dmitriev said this week. Aliya Samigullina, Dvorkovich’s press secretary, declined to comment.