Aluminium Premiums Rise; Supplies Tight in Europe

LONDON, Dec. 7 -- Premiums for physical aluminium are rising in Europe as much of the record high inventory in London Metal Exchange warehouses is tied up in financing deals that are not likely to suddenly be unwound.

Also pushing them up, Alcoa (AA.N: Quote) is planning to idle nearly 200,000 tonnes of capacity in Italy, while trading house Glencore is said to be holding more than a million tonnes of output it bought from UC RUSAL earlier this year.

This, coupled with the financing deals -- which have seen banks buying cash aluminium on the LME and selling it 12 months forward at a profit -- have left traders competing for the little material left at producer warehouses.

"I've been snooping around to see if I can get some (aluminium) and there's nothing around. You have to go to the producer basically and pay whatever they ask," said a Europe-based trader.

Premiums are the charges paid by the consumer, on top of the LME cash price MCU0, to cover the costs of shipping and delivering metal. They are currently at around $90-$100 for duty paid aluminium in Rotterdam, compared with $60-$70 in September.

LME aluminium inventories are near record levels of 4.6 million tonnes, but about 70 percent of that stock -- around 3.15 million tonnes -- is tied up in financing deals until May 2010.

The deals came about because producers needed cash and banks found it profitable to take the stock off their hands in May, when three-month aluminium prices were about $150 below May 2010 futures contracts.

"The deals will carry on as long as rates remain low and banks aren't forced to lend money. The deals have created an artificial aluminium consumer," another Europe-based trader said.

"Aluminium is becoming like gold - it's sitting in vaults, you can't use it but its got perceived value. Industry has got to compete with financing boys for material," he added.

MARKET TIGHTENS

Also pushing up premiums are plans by Alcoa to temporarily idle its two smelters in Italy following a dispute with the European Commission over state subsidies and power supplies.

The Fusina and Portovesme smelters have a combined capacity of 194,000 metric tonnes a year. The global aluminium market is estimated at around 37 million tonnes, but traders say the shutdown is significant given all the tied-up material.

Meanwhile, trading house Glencore is believed to have bought over 1 million tonnes of aluminium this year alone from Russia's UC RUSAL, the world's biggest aluminium producer, keeping even more supply off the market.

When the first leg of the deal took place in June, Japanese third-quarter term premiums rose 30 percent after RUSAL told consumers it could not supply them. They are seen jumping 10 percent next quarter on tight supply.
 
"There is a fundamental basis for support for physical premiums because the market is relatively tight. We have a positive view on recovery in OECD demand," said Barclays Capital analyst Nicholas Snowdon.

But he added that while recovery will push premiums up initially, it will at some point be more profitable for banks to sell the metal and pocket the premium, rather than hold it in financing deals.

As such, there is a risk that eventually, financing deals will be unwound, but Snowdon believes they will be unwound gradually, so that aluminium premiums and benchmark prices level off but do not collapse.