CME has found the perfect setting in CRU aluminium conference to launch its North American aluminium contract which intends to solve the hedging issues created by rising physical aluminium premiums. It was the main focus of discussion in the CRU conference.
According to Barclays, who attended the CRU North American Aluminium Trends conference, this contract will not have any near-term effect on premiums. Moreover, if it can achieve financial and physical liquidity along with handling the delivery queue issues, then it can give a serious competition to LME in the North American market.
The conclusion drawn by the majority of consumer audience was that they welcomed the contract mostly because of the possible benefit it may bring regarding hedging issues created while using the LME benchmark. The general opinion was that achieving enough liquidity and participation to support its contracts along the aluminium supply chain and giving a competition to long dominant LME benchmark would take at least a few years.
In that context, the audience opined that the contract’s successful acceptance would require a system which will provide immediate access to locked metal in CME warehouses, against the present long delivery queue at LME’s Detroit location. The CME clarifies that if queues are longer than 20 business days, then the warehouse would have to justify this to an independent CME committee. Unless it is achieved, then either they will have to stop charging rent or stop accepting metal deliveries.
According to Barclays, any delivery queue over 50 business days would not be allowed full stop, irrespective of the warehouse’s explanation. Still, there are still possibilities of some lead time in meal delivery despite the new CME contract setup.
The discussions highlighted two major main worries:
1) Whether the contract would actually gain critical mass in liquidity, both financially and physically
2) Whether there would be any effect on the Midwest premia (MWP).
In the past, the CME has attempted aluminium contracts twice, both of which did not work. This new effort may work in the context of dissatisfaction, with the significant proportion of the total aluminium price that premiums make up (close to 20% in the US currently) rather than simply being in competition with the LME.
Producers and trading houses play a vital in liquidity generation as well as in attracting metal deliveries. The CME may start a market maker incentive programme to support liquidity. There was also a belief that physical deliveries could be achieved, particularly in the context of significant metal currently being cancelled from LME warehouses and financed off-warrant.
Barclays however does not consider the CME contract as a revolutionizing factor in regards to physical premium levels. This has been the source of the highest cost required to solve the US regional supply-demand balance, which Barclays expects to continue in the near future. In that sense, it is because of the new LME rules reducing delivery time which will pressurize MWP to fall over H2 2014 and into 2015.
