LONDON: The aluminium market is in the grips of a major supply squeeze fuelled by declining stockpiles of the crucial industrial commodity, as buyers face rising prices for spot metal and little immediate prospect of relief.
The crunch is playing out on exchanges in London and Shanghai, with both markets exhibiting a pricing structure known as backwardation, where spot metal trades at premiums to later-dated futures due to constraints on immediate delivery.
The pressure comes after a sharp decline in inventories backing the contracts, with London Metal Exchange (LME) stockpiles slumping 56% this year to the lowest level since 1990.
Traders and manufacturers in the aluminium industry are being whipsawed by the moves, as buyers await a surge in output from Indonesia that’s set to push the global market into surplus in the coming years.
That prospect has weighed heavily on prices over the past few months, but the reality for buyers in need of spot metal is that supply constraints could yet get worse before the new shipments arrive.
“The backwardation is really a reflection of how tight the physical market is right now,” said Ewa Manthey, commodities strategist at ING Bank NV.
“There aren’t many obvious sources of metal that can quickly make their way onto the LME.”
On the LME, spot contracts have surged this month and were trading at a premium of US$92 a tonne over three-month futures on Monday, nearing a multiyear high seen earlier this year as the outbreak of war in the Middle East throttled shipments from the region.
Gulf suppliers have since found logistical workarounds that have softened the supply blow, but export routes are now costlier, riskier and longer.
Some smelters in the region are still recovering from direct attacks on their plants in the early stages of the war.
Typically, steep spot premiums fuel a scramble to deliver metal into exchange warehouses, as the high prices create an incentive for traders to offload any surplus metal on to the LME.
But lingering constraints on Middle Eastern supplies – combined with a regulatory cap on Chinese aluminium production and trade barriers that are also fuelling tightness in the United Statesf and Europe – mean that there’s little excess stock available in the physical market to replenish supplies.
While Indonesian supply is already starting to surge – helping to tilt the physical market towards surplus – its metal isn’t yet registered for delivery on the LME.
And for now, producers elsewhere can still make bigger profits selling to end users in Europe and the United States, who are paying large premiums on top of futures to secure supplies, even in a lacklustre environment for demand.
“That could mean the backwardation needs to widen further to attract metal into LME warehouses,” said Manthey at ING.
“Further out, though, we see more downside risks for aluminium prices.”
For holders of short positions, backwardations can prove painful by forcing them to roll contracts at a loss if they’re unable to deliver metal against them.
But the pricing structure is a boon for holders of long positions, who can make big profits by rolling them forward. — Bloomberg
