Happy New Year? LME Warehouse Challenges Continue

LME Warehouse ChallengesUnfortunately, from the perspectives of supply chain security and anomalous market premiums, 2013 has begun even less favorably than last year. London Metal Exchange (LME) stocks are now at the highest level in history whilst Regional Market Premiums are too. The LME announced some adjustments to its warehouse minimum load out rates late last year but steered clear of aluminum. The consumer segment of the industry had hoped for a change in approach from the LME following its takeover by the Hong Kong Exchange (HKE)  but I’m doubtful that anything will change. If you are new to this controversial matter, Jack Farchy from Financial Times helped explain the aluminum warehouse issue in 2011.

I picked up the news items below recently. The first relates to Bob Kickham of Luvata who is the first person/company that I have seen publicly protesting the situation since we started speaking out in 2011. It is coincidental that on the same day, I also picked up an article (below) by the insightful Andrea Hotter saying “put up or shut up.” One thing that I am sure will not happen this year is that consumers will “shut up!”

An excerpt from the Metal Bulletin article featuring Luvata, “LME warehouse system still broken- Luvata’s Kickham”:

The London Metal Exchange’s warehousing system is still broken, despite efforts to fix delays in accessing metal, Bob Kickham, Luvata’s senior vice president of procurement, told Metal Bulletin in an interview. Luvata has tried to get metal out of LME-approved warehouses in Johor, but was told that it had to wait three months as a result of the queues.

“We can’t be in a position where we seek to get materials out of warehouses and three months later we might get it,” Bob Kickham said. Luvata was forced to use an alternative route to get metal – buying it in the market. Kickham stated that the company has made its views on warehousing known at meetings of the LME copper committee, on which it is represented. “We are big supporters of the LME in general and have a good relationship with them; that’s why we feel confident in making this statement,” He also stated, “We can’t have queues like they are at the moment – we want to be able to get material out of the warehouses in a practical time frame. We want a warehouse system that works, and at the moment it doesn’t.”

And from Andrea Hotter’s Metal Bulletin article, “Warehouse Wars: Put up or shut up”:

It is the best possible time for those who feel they have a gripe, against anything whatsoever related to the LME, to take action – the new exchange owner, Hong Kong Exchanges & Clearing (HKEx), is listening. HKEx ceo Charles Li says he will take a bazooka to the problem if he has proof that warehouse queues are being deliberately created. He also says that despite the industry’s negative focus on warehousing, nobody has yet articulated a problem that suggests the system is broken.

My personal challenge to the industry is to stop whining and do something about it. Man up, in other words. If you are so sure that warehouse firms are breaking LME rules, then . . . prove it. Otherwise change the record, let the warehouse firms to do what they do, and get on with your daily business.

What do you think? Leave your opinion in the comments section below.

  • http://twitter.com/jinenj Jinen

    Nick, below are a few thoughts and comments on the warehouse queue challenges.

    Warehouse Rules (Load Out Rates)
    - Were based earlier on the LME Warehouse capacity and not based on the metal inventory at the warehouse. 
    - Queue wait goes as much as 55 weeks to obtain metal at Dutch port of Vlissingen, accounting for 55 percent of European stocks and 26 % of global stocks. Therefore, Cancelled Warrants not a true proxy for determining stocks at specific locations. Queues if any, need to be factored in.
    - Hence, the long queues lead to increase in premiums for prompt delivery in certain locations such as Johor, Malaysia. In turn, increases the acquisition cost of the consumer. Cyclically, this further impacts delivery of other metals, those that are not dominant.

    One alternative that I can think of is, if the Cancelled Warrant is held by a Producer and can be certified for its use (and not mere transfer to another storage location), then they should be given higher priority in terms of loading out the metal as against the metal that is locked in a financing deal. LME is reviewing its Warehouse rule and amendments if any, will be effective from 1-Apr-2013.

    Warehouse Ownerships & Anti-competitve practices
    - Some of the key exchange members/Traders are also owners of the warehouses leading to conflict of interest. One of the key players owns more than 33% of the LME registered warehouse in Malaysia – which provides larger rental incomes. Hence there is vested interest if the queue is longer.
    - Regional Anti-competition agencies should oversee such issues and monitor them, in order to give sanctity to exchange based delivery mechanisms.

    Regards,
    Jinendra Subash Jain
    Linkedin: http://www.linkedin.com/in/jinendrasubash

  • Nick_Madden

    Jinen
    Many thanks for your feedback. You mention that ”long queues lead to increase in premiums for prompt delivery”. It is my view that the principal driver of the premiums is the ability of the warehouses to offer incentive payments. The Mid West premium in the US has risen as the queue in Detroit lengthened and the incentive offered increased. The warehouse was able to increase their offer because they could count on the stocks remaining in place for a certain period and could thus estimate the rent that would be earned.
     
    I believe that two rule changes by the LME would eliminate the issue:
     
    1. Prohibit the warehouses from charging rent after one month following the cancellation of a warrant.
    2. Increase the minimum load-out rate to 9,000 tonnes per day.
     
    There are other, complementary remedies but these two would have the most immediate, positive impact and are within the LME’s authority to implement.

    • http://twitter.com/JvB_MetalPrices JvB at MetalPrices

      Hi Nick (long time), isn’t the flaw in the first of your suggestions that a cancelled warrant need not necessarily be withdrawn by its owner from the warehouse at all?

      • Nick_Madden

        Good point. I refer to material where the warrant has been cancelled and
        an appointment has been sought to remove the material.

        • http://twitter.com/JvB_MetalPrices JvB at MetalPrices

          Perhaps the LME should introduce a new warrant category, “queued”.

    • http://twitter.com/alexharrison_mb Alex Harrison

      Hi Nick,
      On the first proposed rule change: as the LME does not control or set rents would it be able to impose such a suggestion?

      • Nick_Madden

        Alex,
        Thanks for your question. I believe so, but you may want to verify this independently with the LME.

  • http://twitter.com/szfst SF

    Hi Nick, great idea to start a blog.
    Despite the comment in Andrea’s article, we know that several parties have articulated the issue to the LME and expressed genuine concerns over the operation of the market (without whining!).

    I agree with your comments that the only real way to resolve this issue is to ban warehouses from charging rental on cancelled warrants after a specified period of time. Ideally, to make this a fair commodity exchange, this would be 30 days. However, it could be phased in so that the warehouses would have time to arrange logistics accordingly (start at a 60 day period in March / reduce to a 45 day period in June etc).
    Interestingly, the Europe Economics report released in June 2011 recommended rent rebates should be discussed further as a potential solution. I wonder whether this is actually under review (!).

    The EE report also recommended an initial load out rate of 1,500t per 300,000t of stock, to be reviewed at 6 month intervals as ”it would be irresponsible for the LME as a regulator to maintain such a policy were lengthy, persistent queues to remain”. The LME actually implemented a rate of 1,000t per 300,000t so there should definitely be scope for the LME to do more here.

    Sadly, I am not convinced that users of aluminium (who require aluminium to manufacture products and therefore pay for this market distortion) are seen as stakeholders by the LME. Getting the LME to take further action may require something more extreme than an official complaint ie;
    - A consumer buys a warrant and brings legal action when they can’t access the product to which they hold title.
    - Another exchange launches an alternative aluminium contract with a functional settlement and physical delivery system.

  • Nick_Madden

    It was interesting to read the commentary on the LME warehouse issue from the Platts Symposium. Chris Evans of the LME has made it crystal clear that the LME does not see this as their issue and will take no further action. He rejected our proposal that the load-out rate for the warehouses carrying the largest stockpiles should be trebled, citing costs and logistics. This repeats feedback that Novelis has received directly from the LME. However, if Metro has 20+ locations in Detroit, this would equate to 18 shipments per day per site. If they introduced even one extra shift, this would spread the burden. Is this so impractical? We don’t think so.
     
    Also interesting is the perspective that this is not the LME’s issue to resolve, and in Chris Evans’ words “the solution must come from the market itself.” If the LME really believes this, why did they commission the Europe Economics study of the warehousing system and why did the LME change the load out rates in April 2012 and announce further adjustments for April 2013?
     
    The LME’s stated position is a challenge for the consumer end of the value chain which bears $3 billion in anomalous premium charges which flows through to the primary producers. Clearly the approach taken to date of engaging the LME in debate has failed. The only path forward will have to be through other stakeholders.

    Here is the article quoting Chris Evans, published with permission from Platts:

    Solution to aluminum warehousing issues must come from market itself: LME execSan Diego (Platts)–21Jan2013/330 pm EST/2030 GMTAny solution to the London Metal Exchange aluminum warehouse situationwill have to come from the “market itself,” rather than the exchange, ChrisEvans, LME head of business development, told the Platts Aluminum Symposiumin San Diego Monday.”I have not come here with a solution. It’s clearly a tough situation.We have enormous sympathy with people who have struggled to get access totheir metal. I’m not sure there is a solution that the LME can provide to themarket. Ultimately the solution has to come from the market itself,” Evanssaid.Evans said that the situation had been simplified to a scenario wherealuminum tied up in warehouse financing deals is seen as “good versus evil.” However, Evans said that sensible consumers are still able to get holdof metal.”There is plenty of metal available, but its more expensive than youshould have to pay for it. Sensible consumers have always gone directly tosmelters for their aluminum. Those that have done so have had no troublegetting aluminum,” Evans said. He said that there have been calls for the LME to allow 9,000 mt/day ofaluminum to be unloaded from LME warehouses.Evans said that this was not logistically possible and that if metal wasreleased at this rate it would go back to banks and was likely to be storedin non-LME warehouses.He added that there were rumors that up to 8 million mt was locked up innon-LME warehouse stock financing deals.”There would be an enormous rise in warehouse rent prices if you increasedelivery out to this level,” Evans added. Evans stated that under EU antitrust laws the LME could not fix rentprices and that it was also unable to control the amount of metal thatentered warehouses. He noted that there was a lot of excess aluminum in the market, but thatthere did not appear to be any consumers willing to take the material.”The LME does not make a judgment over who should own something … Weare being held accountable over part of the market that we have no control”of, Evans said.He said that one solution that the LME may consider is a Midwest premiumaluminum contract.However, the source of the problem was “hot money” that had beeninjected into the economy since the economic downturn.In a summary of the situation, Evans made an analogy with the US series,Baywatch, which was filmed in San Diego. ”We see ourselves as the coastguards of the market. Here to receive comments on the market and through the framework of the law, we will look tosee that the market behaves as it should do … A degree of patience andrealism is needed over the next couple of years,” Evans said.

  • http://twitter.com/szfst SF

    Nick,

    I read the Chris Evans
    dialogue with interest. There was also a very similar interview with Metal Bulletin.

    On an optimistic note, the LME acknowledge there is a problem. However, despite the clear message that they have consulted with the ‘best brains’ and concluded there is nothing that can or should be done, the article left me with questions and concerns.

    Itis true that a number of factors such as low interest rates; highglobal stocks of aluminium and concentration of warehouse ownership have contributed to the current situation. Whilst these are not the LME’s fault, every organisation must adapt in order to remain fit for purpose within the environment which it operates.

    Back in September 2011, Martin Abbott told the Metal Bulletin conference in Paris that ‘the problems of warehousing in Detroit are the result of financial deals that weren’t envisaged when the system was set up’. At the time I thought, well, it’s not quite that simple but the comment seemed to imply there would be some changes in the system.

    There are now many market participants who believe that the delivery rate increase was not enough and that the LME is no longer fit for purpose. Despite the clear message from Chris Evans that there is no viable solution, many are not convinced the LME has done the necessary due diligence analysis to judge whether the system can / should change. I have two specific questions that you or another reader may be able to answer;

    1. Has there been some sort of analysis to determine what is achievable as
    a delivery rate at each warehouse location given comments from the
    LME that 9,000t per day is not logistically possible? (If not, I
    know a very good LEAN logistics consultancy and I am sure there are
    global companies operating very complex supply chains who are
    willing to offer up logistics and warehouse expertise to assist!).

    2. On this thread, we have spoken about a potential solution whereby
    warehouses are prohibited from charging rental on cancelled warrants
    after a period of 30 days. Is this illegal? The LME clearly state
    that capping rent is illegal but we are not talking about a price
    cap here. We are talking about a time limit mechanism that would
    encourage the market back to a state whereby the derivative position
    you buy matches the period in which the underlying product is
    available.

    The function of the LME as a market of last resort is a key issue and a subject that has been commented on regularly in the press. Last week, a senior exec of a large metal producer quite rightly pointed out that the LME is meant to be a market of last and not first resort.

    The obligation to make or take physical delivery of the underlying product or pay the difference between the price at inception and the price when the contract expires or is closed out is the foundation of every commodity futures contract. On the LME website, it clearly states ‘In
    reality, physical delivery occurs in a very small percentage of cases on the LME as most organisations use the Exchange for hedging purposes. However, the small percentage which does result in delivery plays a vital role in creating price convergence’.

    Currently there seems to be a debate on whether this axiom is important. Well, frankly it is in order to achieve true price discovery

    Going back to the four things in the Chris Evans dialogue that I find rather concerning;

    1. An exchange is telling us what is a cheap or expensive price for
    aluminium when they should be focused on exchange infrastructure.
    (The following statement I find not only disturbing, but also
    bizarre –

    Premiums have risen to represent an “uncomfortably high” percentage of the base price, Evans said. But this base price is substantially lower than before the 2008 downturn, even when higher premiums are taken into account.“So we have a very weird situation, where consumers
    are actually complaining about low prices,” )

    2. The LME is on one hand claiming that the market should resolve the
    situation, but on the other hand will not raise delivery rate because it would cause an enormous rise in warehouse rent and / or
    metal would flow to non-LME warehouses. This is a very capricious
    attitude – for the market to resolve itself, doesn’t the metal
    waiting in queues need to be released? Once again, very
    worrying.3. The statement in the MB interview that ‘the real problem is that there is overcapacity that needs to be shut down’. Surely it is true market prices that needs to determine this and not the LME’s  conclusion. (If the market was not distorted, this would happen, right?).

    T4. he LME’s constant
    referral back to financing deals as the main cause of the problem.
    It is not so simple and this is always used as a detraction from
    the issue in hand. Financing deals have indeed existed for years. We
    are talking here about a long queue of cancelled warrants, that are
    incurring storage revenue. For those people who work in the real
    free business world, and who, for example, gave notice to take
    something from a warehouse and the warehouse replied, oh no sorry it
    is in a queue (effectively you can’t have it even though you own
    it), this is very bizarre – these people would not be paying the
    bill!!!

    In conclusion to my very
    long blog (sorry Nick), I would probably say that the LME need to
    grow up with the times, otherwise another exchange will (hopefully)
    launch an alternative contract and then the market will genuinely be
    able to sort out the problem by voting with their feet.

    Currently, there is
    obviously a large split between those who think the LME is broken and
    those who think there is no problem. This is the best opportunity
    another exchange has ever had. For the medium term, LME should not
    forget that on hedging volumes, it is always the consumer that
    dictates contract terms, and it generally feeds upstream. At present,
    consumers are probably the most dissatisfied with LME operations and
    attitude.