(The author is a Reuters Breakingviews columnist. The
opinions expressed are his own.)
By Kevin Allison
LONDON, Aug 15 (Reuters Breakingviews) - Drab sheds full of
aluminium ingots aren't a natural place to go looking for a
financial conspiracy. But industrial users say the warehouses -
or more exactly the way they are used by big traders which own
them - have artificially inflated prices for the metal. A flurry
of class action lawsuits have accused Goldman Sachs (GS.N),
JPMorgan (JPM.N), and Glencore (GLEN.L) of manipulating prices
by encouraging big stockpiles and long wait times.
Complaints about long storage queues have been around since
2010, but they gained more attention this month in a U.S. Senate
hearing on banks' commodity business. Along with the lawsuits,
the U.S. Department of Justice and Commodity Futures Trading
Commission have launched investigations - and the U.S. political
comedy television programme, The Daily Show, did a parody
Breakingviews explains how slick middlemen managed to turn a
once-sleepy utility into a money-spinner.
How does metal warehousing work?
The London Metal Exchange, the world's biggest marketplace
for industrial metals such as aluminium and zinc, maintains a
list of approved warehouses that act as delivery points of last
resort for metal producers. The LME doesn't own the buildings,
but licenses them and sets rules for how they operate. Suppliers
who drop off metal at an approved location receive warrants that
can be presented to satisfy LME futures contracts. That makes
the warehouses a crucial bridge between physical and financial
Warehousing used to be a sleepy affair dominated by a
handful of independent companies. That changed in 2010, when
JPMorgan, Goldman and Glencore all bought leading warehouse
operators. Today big commodity traders and banks dominate the
business, although LME rules require warehousing subsidiaries to
be operated at arm's length, with information barriers to avoid
conflicts of interest.
What's behind the long warehouse queues?
Long warehouse queues are a result of perverse incentives
and rent-seeking by warehouse owners. LME inventories soared
after the financial crisis, as metal producers and industrial
users responded to weak demand by socking surplus product into
storage. So far so good – that's how the LME system is supposed
to work. But central banks' ultra-low interest rates also
promoted hoarding. Quirks of geography and financial incentives
offered by warehouse owners encouraged the concentration of
metal in a handful of sites – aluminium in Detroit and
Vlissingen, Netherlands; zinc in New Orleans; and copper in
Antwerp and Johor, Malaysia, according to Morgan Stanley (MS.N).
Low rates also encouraged a speculative carry trade - buying
metal at depressed spot prices, selling it forward at higher
prices, and pocketing a profit, even after storage costs.Goldman
says long queues at its Detroit warehouses came when financial
speculators started clamouring to pull metal out of its
LME-approved facilities and put it into lower-cost sheds. But
Goldman also exacerbated the problem by taking advantage of
arcane LME rules that meant it only had to release a small
amount of metal from approved facilities each day, no matter how
many customers were asking for it.
What is the effect on prices?
The price of aluminium has fallen 40 percent since the
financial crisis, and 10 percent since complaints about long
warehouse queues first surfaced three years ago. But end users
are still paying more for the metal than they otherwise might.
Long waits at the warehouse gate increase competition for metal
for immediate delivery – pushing up the premium that beverage
can makers and other final users have to pay to get their hands
on prompt supplies.
How do commodity traders make money from the warehouse game?
Warehouse owners collect rent as long as metal sits on site
– so they have an incentive to encourage long queues. Last month
in Detroit, wait times for metal were around 470 calendar days.
At the prevailing rental rate of 48 cents per tonne per day,
Detroit's aluminium queue alone was worth $220 million,
according to Reuters calculations. Traders with ready access to
metal benefitted from high premiums for current delivery over a
future promise. That's on top of any money they make on carry
trades and financing deals.
What happens now?
Whatever the outcome of the U.S. investigations and
lawsuits, the warehouse wheeze is probably coming to an end.
Goldman and JPMorgan are both thought to be looking for buyers
for their warehouse businesses now that owning them has become a
public relations headache. Under its new owner, Hong Kong
Exchanges and Clearing Limited (0388.HK), the LME has proposed
rule changes that should eliminate long queues – Detroit wait
times have already fallen to about 300 days in anticipation.
Eventually, higher interest rates will make it more
profitable to sell metal promptly and invest the proceeds than
to hoard it. Then the traders' lucrative but socially useless
warehouse game will be over for good.
SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS:
- The U.S. Commodity Futures Trading Commission subpoenaed a
number of major metals warehousing firms last week, according to
sources familiar with the matter.
- The main U.S. commodities regulator is seeking documents
and communications sent over the past three years as it looks
into allegations that warehousing firms, many of which are owned
by big banks and trading houses, have made it more expensive for
industrial users to buy metal by trapping it inside warehouses.
- The U.S. Department of Justice is also probing warehouse
practices, and several aluminium users have filed class action
lawsuits in recent days. JPMorgan, Goldman and the LME have all
said the legal action lacks merit. Glencore hasn't commented.
- Reuters: CFTC subpoenas Glencore, others as metals inquiry
heats up [ID:nL2N0GD1PK]
- For previous columns by the author, Reuters customers can
click on [ALLISON/]
(Editing by Edward Hadas and Viktoria Dendrinou)
Keywords: BREAKINGVIEWS METALS/
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