The Aluminum Warehousing Racket Turns Out to Be Really Good for Aluminum Companies
And Goldman Sachs makes money too!
A few months I wrote a series of posts about Goldman Sachs' purchase of an aluminum warehousing business called Metro International. Their strategy, inexplicably, was to deliberately slow down deliveries of aluminum, thus driving up both the spot price and the storage premium they charge customers. The New York Times reported that over the course of three years, the wait time for aluminum deliveries had increased from six weeks to 16 months even though warehouses were bulging with ingots.
But how exactly did Goldman make money off this? It was nothing crude like speculating directly on the price of aluminum. The answer turned out to be insanely complicated—but completely legal. So the London Metal Exchange, which regulates aluminum warehousing and trading, has proposed new rules. Reuters reports that this would be terrible news for aluminum companies:
Two-thirds of aluminum producers would be losing money because of lower premiums paid on top of exchange benchmarks if the world’s biggest metals bourse approves rules to cut waiting times at its warehouses, according to JPMorgan Chase & Co. Premiums to obtain the metal will drop 60 percent to about $100 a metric ton as a result of the new rules the London Metal Exchange is expected to approve in October, Benjamin Defay, an analyst at the bank in London, wrote in a report e-mailed today. The LME proposed to oblige warehouses where waits extend for 100 days or more to let more metal out than they take in.
Hmmm. So if the rules were changed, it would hurt not just Goldman and its insanely complicated financing business, but also the aluminum producers, who benefit in a very un-complicated way from higher prices. For example, the Wall Street Journal estimates today that thanks to the warehousing logjam, Alcoa alone has earned an extra $649 million in premiums over the past three years—and that doesn't even count extra profits from higher spot prices. Perhaps, then, you can guess just what the aluminum industry thinks of the LME's new rules?
On Friday, Alcoa sent a letter to the U.S. Commodity Futures Trading Commission and the U.K. Financial Conduct Authority calling the LME proposal a "misguided" effort that would disrupt the market. Alcoa, which is based in Pittsburgh, said the LME should halt any plans to implement the changes.
Last month, Oleg Deripaska, chief executive of Rusal, the world's biggest aluminum producer by volume, said in a letter released publicly that the LME proposal "is an unprecedented intervention and one that Rusal strongly objects to."
That's a shocker, isn't it? Among other things, the LME's new rules would require warehouses to ship out more aluminum than they take in if wait times increase beyond 100 days. Presumably the rules would also tighten up the definitions of "ship" and "warehouse," since Goldman's warehouses are already in the habit of "shipping" aluminum from one building to another in order to evade current LME rules. Sadly, though, Goldman's financing racket may well continue, since its actions are beyond the purview of the LME.
We should have a decision on all this later this month. Stay tuned.