Aluminium premiums in Europe has soared to record high

The cost paid to secure aluminium supplies in Europe has soared to record highs, with the metal still being used chiefly as a financing tool of choice for investors, leaving manufacturers and smaller merchants scrambling for stocks.

Aluminium premiums - money paid over and above the benchmark London Metal Exchange cash price to secure physical delivery - are supposed to reflect regional supply and demand trends.

But they have been increasingly disconnected from such trends ever since banks and trading houses took a shine to the light metal after the 2008 crisis, buying up stocks as well as warehouses.

Regulations on the LME, the world's premier metals marketplace, allow companies operating warehouses to release only a fraction of their inventories each day - much less than is regularly taken in for storage.

At warehouses owned by banks and trading houses, this fraction is rarely exceeded and backlogs persist.

The warehouse operators blame logistical factors for the backlogs but critics say it is a tactic to increase rental income, given clients of the exchange have to pay rent to warehouses while they wait in queues to collect the metal.

Warehouse ownership by banks has come under increased scrutiny of late as critics charge that those who speculate on price should not at the same time own sheds that store one of the key drivers of price, namely, metal stocks.

Trading sources say the premium for duty-paid aluminium on the physical spot market in Rotterdam is at $240-260 a tonne, more than 10 percent over the London Metal Exchange cash price and at its highest ever level according to Reuters data.

There are currently months or even year-long queues to get metal out of LME-monitored warehouses in the Dutch port of Vlissingen, the Malaysian port of Johor, and in the U.S. port of Detroit.

The backlogs have developed largely since investment bank Goldman Sachs (GS.N) and the top commodity trader Glencore (GLEN.L) bought up most the LME-registered sheds in these ports.

Bottlenecks aside, the millions of tonnes of metal dotted around the LME warehouse network is in any case unavailable, held mostly by investment banks and trading houses who have sold the metal forward at a wide profit on the futures market.

This so called aluminium 'financing deal' has, along with warehouse queues, exacerbated supply tightness in aluminium and helped pit manufacturers against investors in the global fight for supplies.

Financing deals are particularly profitable for the likes of Goldman Sachs, JP Morgan (JPM.N), Barclays (BARC.L), Glencore and Trafigura TRAFG.UL, in part because their warehouse ownership allows them to pay extremely low rental costs.

"The rise in premiums is due to the usual games. It's a cumulative problem and it will only get worse. The LME is becoming more de-correlated with the physical market and is becoming a non efficient hedging instrument as a result," said another industry source.

The LME says its hands are tied as far as warehouse backlogs and financing deals are concerned. The matter is in any case on hold as the board last month recommended Hong Kong Exchanges and Clearing's (0388.HK) (HKEx) $2.2 billion (1.4 billion pound) takeover bid.

The soaring aluminium premiums are particularly irksome for manufacturers because aluminium is on paper at least, in chronic oversupply, with LME stocks near a record 5 million tonnes and off-exchange stocks said to be around similar levels.

In other words premiums should be low and supply plentiful. However, with the prevalence of aluminium financing deals and warehouse backlogs supply is tight and set to get tighter. Ironically, producers, benefiting as they are from soaring premiums, are more likely than not to curtail production because LME base prices are plummeting, making margins tight or non-existent, even with the soaring premiums.