NEW YORK, Feb 3 (Reuters) - Turnover in the CME Group Inc's nascent aluminum premium contract has picked up since the start of the year as industrial users seek to protect themselves against further increases in physical prices, data and market participants said on Monday.
Open interest, a reflection of market liquidity, has hit 242 lots, worth about $10 million and equivalent to 6,050 tonnes of aluminum, almost five times as much as at the start of the year, exchange data shows.
Activity has also increased with 215 contracts changing hands in nine days between Jan. 16 and last Friday.
While those volumes are still low, the sudden spike in interest is significant for a contract that has barely traded since its launch almost two years ago.
Until Jan. 16, the contract had only traded on six days with just 155 contracts changing hands.
One mid-sized Midwest aluminum user said the interest was likely a "kneejerk" reaction by end users who scrambled to protect themselves against soaring premiums, which are paid for physical delivery on top of the London Metal Exchange benchmark.
The Midwest premium almost doubled in the first two weeks of the year, hitting a record high of 20.5 cents per lb.
To be sure, the CME volumes are still tiny compared with the LME's dominant aluminum futures contract, which has open interest of about 1.1 million lots - equivalent to 29 million tonnes of metal worth $48 billion - and had turnover of almost 64 million lots in 2013.
"We've been watching (the CME), but in the bigger picture it's still small volumes. It'd need to increase more before we'd participate," said a source at a medium-sized U.S. brokerage.
The increased usage is the strongest sign yet that end users such as carmakers and brewers, which use aluminum to make drinks cans, are upending decades-old practices and using new methods to protect against wild gyrations in their costs, market participants said.
Industrial users have complained that premiums have surged in recent years to artificially high levels due to LME warehousing rules and financing deals that keep metal locked up in long-term storage deals.
While the LME price has remained under pressure due to a surplus of metal, the premium now accounts for just under a quarter of the total "all-in" cost of buying a tonne of aluminum. That compares with an historic average of around 10 percent.
Until now, industrial users have hedged their base price exposure in the LME futures market and agreed to fixed or floating terms set against published prices for their premiums.
In recent years, many banks have offered over-the-counter swap deals to their customers to help them cover their costs.
But the unexpected jump in surcharges last month caught even some U.S. banks, including Citigroup, off guard.
The rise could also give the CME a "headstart" over its London rival as both exchanges race to launch the first product that would allow end users to hedge the "all-in" cost of buying a tonne of aluminum, the source at the broker said.
The CME is planning to launch a physically deliverable U.S. aluminum futures contract to compete with the LME's deeply entrenched global contract.
Last month, the LME told Reuters it is preparing a specification for a new physically deliverable contract that would reflect the cash premium.
The interest may wane if premiums come under pressure later in the year after new LME rules, which come into effect in April, increase delivery rates out of its vast warehousing network.
"I wonder whether this (interest) is sustainable. I would be more comfortable if it was the LME. That's got the biggest level of liquidity," the Midwest end user said.