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LME Warehousing Presentation at Arabal Conference 2013
- 1. Arabal Conference 2013 Nick Madden, SVP and Chief Supply Chain Officer ©2013 Novelis Inc.
- 2. Three Questions How did this situation develop? What are the key problems? What are the potential solutions?
- 3. Novelis in One Slide! 80% Novelis #1 Rolled Products Supplier Worldwide 14% GOAL 80% by 2020 10% 5% 57% 4% 4% 4% 33% in 2010 3 Source: Novelis estimates, 2012 data 43% 39% in 2013 in 2012 50% by 2015 World’s largest recycler of aluminum
- 4. Why has Novelis been so vocal about the LME warehousing issue? We are the world’s largest buyer of aluminum. Today we are sourcing about 3 million tonnes of primary and recycled aluminum. 4
- 5. How did the warehousing situation develop? 20% decline in global consumption 5 $3300 to $1300/t
- 6. Issue of Over-Supply W. Europe E. Europe/ CIS N. America Asia China Africa L. America Production Consumption Australia
- 7. Detroit, MI Oswego, New York 2 New Automotive Finishing Lines LME had rules which required the warehouse to ship Detroit Stock Depletion and Revenue Jan/2012 a minimum of 1,500 tonnes per day 7
- 8. Problem Number One: Inflated Premiums Rise in MWP from 7c/lb to over 12 c/lb 8
- 9. Problem Number Two: Supply Chain Risk September 2011 Wait Time: 5 months June 2013 Wait Time: 19 months 9
- 10. Consumers over paying for metal by $3 billion per year “[Al Producers] Are Beneficiaries of Warehouse Logjam” October 24, 2013 10
- 11. What are the potential solutions? Aluminumbe There should Users Group no queue. 11
- 12. “You consumers should be careful what you wish for…” -Former Senior LME Executive 12 blog.novelis.com
- 13. Competition from warehouse incentives was a significant driver of premium escalation LME warehouses should not charge rent once a warrant is cancelled There should be no queues 13
Editor's Notes
- In the short amount of time that we have together I want to cover, I would like to address three questions.How did this situation develop?, What are the key problems?, What are the potential solutions?The other speakers will cover a range of angles and so I want to paint the picture that we see from a consumer perspective but I will be fact based and balanced.
- Before I begin I would just like to introduce Novelis to you with just one slide!Novelis is the world’s number one supplier of flat rolled aluminium and the world’s largest recycler of aluminium. We are the leading global supplier to the beverage can and automotive sectors, and a key supplier of speciality products around the world. Two years ago we announced our goal to supply products with 80% recycle content by 2020. We are well on the way to that target and will surpass 50% recycle content next year when our new recycling center, the world’s largest, opens in Germany.
- Why has Novelis been so vocal about the LME warehousing issue? It is because we are the world’s largest buyer of aluminium. Today we are sourcing about 3 million tonnes of primary and recycled aluminium and with our expansions in Asia, S. America and N. America, and with this our appetite will grow by a further 6-700,000 tonnes. As the officer in Novelis responsible for supply, I take any market anomaly seriously. And when I see inflated premiums and a threat to our supply chain and that of our customers, it would be delinquent of me to sit back and allow the situation to unfold without an attempt to intervene.
- So how did the warehousing situation develop?I have to take you back to 2008 when the commodity boom ended abruptly and the financial crisis was triggered by the failure of Lehman Bros. You will recall the catastrophic drop in the aluminium price from $3300 to $1300/t in the space of 7 months. Accompanying this was a 20% decline in global consumption of aluminium. BUT the producers kept on producing. There was a dip for about 12 months.
- But if you look at world excluding China statistics, whilst consumption dropped by 5 million tonnes, production only reduced by 2 million. In China demand and supply continued to grow together. So I believe the issue of over-supply was a world excl. China issue.In the past when there was such a huge drop in consumption, you would expect to see cutbacks because at some point the world runs out of people interested in buying aluminium. This was not the case during the financial crisis. With ultra low interest rates and a wide contango, the opportunity emerged to stockpile aluminium, and generate a handsome return through cash and carry deals. Some of these were in LME warehouses and others in non-LME locations.
- If I focus on North America, there was a massive increase in stocks in the Metro warehouse complex in Detroit. The reason the metal was moving to Detroit was that Detroit had become the equivalent of a competitive buyer in the market. They sought to lure aluminium into their premises, gambling that the metal would remain there for a long time. They took a portion of the forecast rent that they would earn and offered this as an incentive to primary producers in N. America to attract the aluminum. As the stock pile grew, the warehouse was able to increase the incentive offered because they knew that the metal would be there for some time.How did they know that the metal would be there for a while? Well, because the LME had rules which required the warehouse to ship a minimum of 1500 tonnes per day. So think about it. How long would it take to empty the warehouse if the warehouse company chose to release metal at the minimum rate?Well if you have 1 million tonnes, it would have taken 133 weeks….so about two and a half years. How much rent could they earn over that period? Well at 42 cents per day, the last tonne to be removed would pay about $392 in rent. So, why do the warehouses pay and incentive and where does the money come from? That’s your answer. Projected rental income.Now the LME did double the load out rate in April 2012 following the recommendations from a study by Europe Economics…so this would obviously reduce the potential, but it was on a sliding scale.Take a look at this chart which I prepared way back in early 2012. With the new load out regulations, if the Detroit warehouse had closed its doors to inputs on 31 Jan, it would have taken 2.5 years to empty and the rental income that I estimated at the time would have been about $230m! It is for this reason that we said at the time that the steps that the LME took were inadequate and would not resolve the issues of getting access to metal not the rising premiums. We said, and Jack quoted us in an article in the FT, “Too little too late”
- What are the key problems? Number one – Inflated PremiumsIt is our view that the ability of the warehouse to bid for metal by offering incentives was the direct driver of the increase in the MWP from 7c/lb to over 12 c/lb at the peak. And it quickly became obvious to all, especially the producers, that as long as the warehouse was bidding competitive numbers with the rising premium, it provided a nice outlet for excess production, keeping the market balanced. Ask yourself how could the premium rise to 12 c/lb? It was simply because the offer from the warehouse was driven by a completely different business model – rental income and the time the metal would stay in storage. This is how the premium could rise to unprecedented levels.Now today, this may no longer be the case. But if you want to get metal out of the LME today, you will be offered locations with no queue – like Johor - at warrant premiums which simply reflect the already inflated market. OR you join the queue in Detroit and pay rent and insurance and finance for 16 months whilst you wait for the metal. And if you reverse the calculation now and ask what it would cost to get metal out of Detroit, you have to account for the penalty of the rent.
- This brings me problem number 2, supply chain risk.Novelis tested the queue back in September 2011. We bought 4 lots in Detroit and waited until February the following year for the metal to be delivered. So this was 5 months. If you go back to June this year, the wait time was 19 months in both Detroit and Vlissingen. To me, this is absolutely incredible. No manufacturing business has the working capital flexibility to sit on dead inventory for 19 months. Can anybody in this room think of another example where it is acceptable to take cash delivery of a derivative and then wait 19 months to get your hands on the asset? Does it seem fair? Even in the rules of the SIB in the UK, this contradicts one of the prerequisites for a recognized investment exchange. In my blog, [check it out at blog.novelis.com], I gave the illustration of our new automotive expansion in Oswego New York. We are currently bringing into production a $200mio expansion of our automotive capacity. The growth in that sector is expected to explode as more, larger vehicles convert to aluminium bodies. Imagine if we cannot supply our auto customers in Detroit and they stop production because we can’t get aluminum from a warehouse in Detroit because the LME does not require the warehouse to make metal available immediately.
- Tim Weiner from Miller Coors, in a senate banking hearing talked about consumers over paying for metal by $3bln per year. I agree with this number…but it is conservative. It is simply an estimate or the artificial inflation of let’s say $120/t compared with normal premium levels, multiplied by WW annual production of about 25 million tonnes. In reality, all metal outside China, including inventories in warehousing deals and scrap, are impacted. So if you wonder why some people are strongly opposed to any change in the status quo, you just have to think about where that $3bn is going. It is not going to the people who own the warehouses, they have a different business model. It goes to the primary producers. And if you want to know how much, just multiply their primary production by $120/t and it will give you an idea. For instance, one of the larger producers with say 4 miotonnes of capacity, is benefiting by $400-$500m per year. No wonder they don’t want to see a change in the status quo.The benefit of the LME log jams to primary producers was analysed by the Wall Street Journal in an article on 24 October. The WSJ compared premium revenues over the last 10 or 11 quarters with more normal levels of 6 cents per pound. They estimated that two producers were earning between $650 and $790m more than they would be in normal circumstances.And when these producers talk about the price being 40% lower than it was 5 years ago don’t give that too much attention. That was when the price reached an all time high at the end of the commodity boom. In fact, the average price over the last 20 years is about where we are today…. $1800/t.
- What are the potential solutions?Novelis has collaborated with a broad range of customers and other consumers in beverage packaging, flexible packaging, automotive and aerospace sectors under the umbrella of the Aluminum User Group. We responded with recommendations to the LME proposal to amend warehouse rules. At the heart of our feedback lies a simple concept. There should be no queue. When a buyer of any futures contract takes delivery and requests access to the asset, it should be immediately available.Now, let me be the first to say that we are pleased to see that the LME is finally taking steps to address the warehousing issue. I do believe that seeking more equilibrium between a warehouse’s ability to intake metal and the obligation to release metal makes a lot of sense. But I do not believe that this should only apply to a warehouse with a queue of 3 months. There should not be any queue. The queue creates a divergence between the derivative and physical market and undermines the global pricing structure in aluminium.There is a solution however, and it is DEAD SIMPLE. Come on Nick, how can there be a simple solution? No really, there is. Imagine if a warehouse was no longer allowed to charge rent once a warrant is cancelled? So, Novelis takes delivery of warrants in Detroit and is told we have to wait. What reason would the warehouse have to hang onto the metal if there was no return? None. And if the warehouse was unable to charge rent whilst metal is stuck in a queue, what incentives would they offer? Little, if any. And take the warehouses’ incentive out of the market and watch the premiums slide. As I mentioned earlier, it is our belief that it was the increasing bid from the warehouse, driven by lengthening storage queues that drove premiums to unprecedented levels. If this anomaly is removed from the market, it is our view that the premiums would decline. The Aluminum User Group provided language from the CME to help the LME think through how this “no queue” rule should be worded.
- There is a challenge to this view. And this was part of the LME’s defense of the status quo over the last couple of years. To quote a former senior LME executive “you consumers should be careful what you wish for” and I will paraphrase,…”if the LME metal is released, it will simply move into storage deals in non-LME warehouses where it will cease to be visible to the market”. That is of course possible. However, it is certainly not the LME’s responsibility to regulate the physical market outside its domain. We, the consumers understand well that risk and will manage our positions accordingly. And don’t forget the well publicized scrutiny by the Fed and the senate banking committee of banks activities in the commodities sector. It remains quite credible that the banks might have les appetite today than in the recent past to amass further volumes of base metals in storage deals if they are to be taxed on these or forced to reduce their exposures.The AUG presented a range of recommendations seeking increased transparency, broader industry representation on committees and increased regulation over the warehousing area. If you are interested in understanding the AUG’s recommendations, you can find them on my blog at blog.novelis.com