(Repeats story published on June 4 with no changes to text. The opinions expressed here are those of the author, a columnist for Reuters.)
* LME Warehousing Capacity 2015-2020: tmsnrt.rs/2MrCL0t
* Change by location since 2019: tmsnrt.rs/2Y20CJs
By Andy Home
LONDON, June 4 (Reuters) - Where’s the metal?
Global manufacturing activity is experiencing the most severe contraction since the Financial Crisis of 2008-2009 but signs of surplus metal are conspicuous by their absence.
Total stocks registered with the London Metal Exchange (LME) ended May at 2.2 million tonnes, up just 260,000 tonnes on the start of 2020.
Aluminium stocks increased by a net 23,000 tonnes over the first five months of the year, a counterintuitive outcome given the size of the market - 65 million tonnes per year - and the total implosion of demand from the automotive and aerospace sectors.
But in metals storage, appearances are always deceptive. Surplus stocks are accumulating in the statistical shadows and more is on its way.
Unfortunately, there is no way of seeing this metal since the LME only counts what is on warrant. That is about to change. The exchange has for several months been collating statistics on what it calls its shadow warehousing network with the aim of boosting transparency.
For now, though, trust the LME warehousing companies themselves. They have been lifting capacity to handle the looming glut of surplus metal.
LME warehouse operators have increased total storage capacity by almost 180,000 square metres, or 4.5%, over the last three months, the largest quarterly rise since the exchange began publishing capacity figures in 2015.
It’s a dramatic turnaround. Capacity was more than 5.3 million square metres in 2015. It has been shrinking ever since as metal, largely aluminium, accumulated during the last manufacturing crisis a decade ago has been steadily worked off.
The process has been tortuous because of the long load-out queues that bedevilled the LME warehouse network over the first part of the decade.
Metal was fast to arrive after the last crisis but slow to leave as storage operators gamed the LME system to maximise revenues.
The exchange responded with multiple rule changes to facilitate the faster delivery of metal from its system.
The new regulatory framework is set for a severe stress test since warehouse operators are gearing up for a new wave of metal.
Warehousing is a cut-throat business and storage companies don’t spend money on leasing extra space unless they have clear indications they’re going to need it.
After the last crisis the main destination for aluminium deliveries into LME storage was Detroit.
LME-registered stocks grew from just over 50,000 tonnes at the start of 2008 to a 2014 peak of 1.6 million tonnes. They currently stand at zero.
Unsurprisingly, storage capacity in Motown has shrunk accordingly from 779,000 square metres in June 2015 to just 118,500 tonnes.
The Dutch port of Vlissingen became a secondary and even larger hub for aluminium storage over the same period, registered stocks peaking at 2.1 million tonnes in 2014 before subsiding to the present 38,650 tonnes. Here too capacity has shrunk from 557,000 square metres in 2015 to 119,000.
It’s clear from the capacity build that Malaysia’s Port Klang will be the delivery hub for the 2020 metals surge.
The port has emerged as the storage battle-ground for aluminium over the last couple of years and capacity totals 549,000 square metres, up from 144,000 in June 2015.
Another 41,500 square metres have been added in the last three months and capacity at Port Klang is now the third highest in the LME delivery network after Rotterdam and the South Korean port of Busan.
Both those locations have also seen significant capacity increases over the last year as have Malaysia’s Johor and Baltimore in the United States.
Capacity build does not necessarily mean that LME-registered stocks will increase in the way they did in the early part of the last decade.
Firstly, it’s easy to forget that the last manufacturing crisis was a result of a global credit crisis.
That made it impossible for metal producers to finance their accumulating stocks of unsold metal. They therefore sold to the market of last resort, the LME, where banks and merchants took up the financing slack.
The movement of inventory on to exchange was an accelerated process born out of the necessity of severely constricted credit lines.
There is no comparable breakdown of global credit markets this time around.
More importantly, there is an intermediate buffer zone between the physical and exchange market in the form of the LME’s shadow storage market.
This has always existed but has grown to industrial scale over the last decade, partly because of the very problems caused by the last crisis.
The high costs of LME storage relative to off-market storage have been compounded by the load-out queues at locations such as Detroit and Vlissingen.
The storage market has evolved in favour of a look-a-like LME system, whereby metal is stored off-market at, or in close proximity, to registered LME warehouses.
The LME itself spelt out these dynamics in its July 2019 consultation on warehouse reform.
“The warehousing network has evolved significantly over recent years, and the historical need for LME warranting (driven often by the requirements of financing banks and insurers) have been diminished by the rise of so-called ‘shadow LME warehousing’, being an off-warrant metal storage service offered by warehouses, combining the benefits of private store (in particular, significantly lower charges compared to LME warranting, and no requirement to report stocks) with the advantages of LME warranting (in particular, a commitment that metal can be placed on-warrant within a certain time period if needed for Exchange delivery).”
This win-win situation for warehouse operators and stocks financiers means the LME shadow storage system is the market of last resort with LME warranting being the market of last, last resort.
It is, however, not a win for market transparency. LME stocks do not appear to be signalling any surplus right now even though everyone knows there is one.
The metal will only move onto LME warrant if there is a credit meltdown similar to that seen 10 years ago.
This is why the exchange is planning to publish monthly figures on its shadow stocks, defined as those financed under contracts that in one form or another explicitly reference the option of exchange warranting.
Watch this space. The first report should be due out in a month or so.
In the interim, trust the warehouse operators to understand their business. They are lifting capacity for a very good reason.
Editing by Barbara Lewis