While the premiums paid for physical delivery of aluminium against the LME benchmark is going up and industrial users are trying to protect themselves against further rise in premium, CME Group Inc’s nascent aluminium premium contract is picking up in the market during the beginning of the year.
According to Reuter report, 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.
Market activity has also picked up with 215 contracts exchanging hands in nine days between Jan 16th to 24th. Though it is not a huge volume, the sudden rise in interest is quite substantial for a contract that has hardly seen any trading for two years since its launch.
End users who are desperate to protect themselves against rising premiums paid for physical delivery of alumium are partly responsible for this sudden rise in premiums, according to a Midwest aluminium user. The Midwest premium almost increased to double during the first two weeks of 2014, reaching a record high of 20.5 cents per lb.
According to Reuters, 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.
The increased interest in CME contracts is a sign that end users such as carmakers and can makers are dumping old practices and using new methods to protect against a strong rise in their costs, market participants said. Aluminium end users have been complaining that premiums are surging to an abnormally high level due to LME warehousing rules and financing deals that keep metal hoarded in the warehouse.
While the LME price is keeping low due to a supply overhaul, the premium accounts for just under a quarter of the gross cost of buying a tonne of aluminum. That is pretty high compared to a historic average of 10%. Till now metal- users have hedged their base price exposure in the LME market and opted for fixed or floating terms set against published prices of their premiums.
Recently, many banks have offered on the spot deals to their customers to help them cover costs.
But the unexpected rise in premiums last month caught even some U.S. banks, including Citigroup, off guard.
The rise could be beneficial to CME and give it a "headstart" over LME as both exchanges compete to launch the first product that would allow end users to hedge the "all-in" cost of buying a tonne of aluminum, a source said.
The CME is planning to launch a physically deliverable U.S. aluminum futures contract to compete with the LME’s global contract.
The interest may fade if premiums come down later in the year after the new LME rules come into practice after April which will hasten the delivery period of the metal.
