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Aluminum industry wary of LME rules, probes

Keywords: Tags  CFTC, Commodity Futures Trading Commission, Federal Reserve, Senate subcommittee, banking committee, Sherrod Brown, Saule Omarova, Davenport & Co. Llloyd O'Carroll

CHICAGO — Some aluminum producers and traders are urging caution as Federal authorities examine the role of financial institutions in physical commodity trading and the London Metal Exchange proposes rule changes on load-out rates.

"Aluminum prices are about 40 percent below pre-crisis levels and over half of the producers are losing money or are marginally profitable. Any rule changes must result in fair pricing and be phased in gradually over time so as to minimize disruptions to what is already a very volatile market," a spokeswoman for Pittsburgh-based Alcoa Inc. said via e-mail July 22.

The LME’s cash aluminum contract closed the official session July 22 at $1,794.50 per tonne (81.4 cents per pound), down 15.5 percent from a 2013 high of $2,123 per tonne (96.3 cents per pound) recorded Feb. 15.

Some market sources have argued that high premiums, resulting from metal being tied up in warehousing queues, have made the difference between profits and losses at aluminum producers (, July 11).

Such reactions come amid a July 23 Senate committee hearing on the intersection of banking and commodity trading, as well as a reported U.S. Commodity Futures Trading Commission (CFTC) investigation on the issue (, July 22), a review by the Federal Reserve of rules governing banks and their physical commodity businesses, and proposed new rules by the LME aimed at limiting long waits for metals at some of its warehouse locations (, July 1).

The possible CFTC probe is a "bank witch hunt," one trader said, contending that consumers, who have lambasted long waits for metal at LME warehouses and high premiums, are talking with "forked tongues."

"Consumers should have no problem buying from producers," the trader said.

A CFTC spokesman on July 22 declined to confirm or comment on the rumored investigation.

Lloyd T. O’Carroll and John F. Ockerman, analysts at Davenport & Co. LLC, Richmond, Va., criticized the proposed LME rules as not addressing root causes—such as an aluminum market in contango, which makes warehousing deals attractive to investors—and likely to have unintended consequences like higher premiums. "We believe that the metal in queues, canceled warrants, is not headed to the physical market but is merely moving from one stock financing location to another one," the analysts said in a research note July 22.

Every time a customer calls looking for metal, a trader owning stocks can choose either to part with material or, more likely, continue to enter into financing arrangements. The latter might be more appealing, assuming higher future aluminum prices, the analysts said. "Warehouses have not engaged in either illegal behavior or violated LME rules, though there may be instances of aggressive actions to increase profits—but what else is new in the business of commodity trading?" they asked.

While the legality of these actions hasn’t been questioned, the Federal Reserve has acknowledged that it is reviewing banks’ roles in trading physical commodities. "The Federal Reserve regularly monitors the commodity activities of supervised firms and is reviewing the 2003 determination that certain commodity activities are complementary to financial activities and thus permissible for bank holding companies," an agency spokesman told AMM via e-mail.

That 2003 decision allowed banks to participate in physical commodity markets.

The July 23 Senate subcommittee hearing will specifically look at the role of banks in warehouses and other commodity storage sectors.

"American manufacturers and consumers should not have the price of their gas, canned food and beverages, or electricity driven up by Wall Street speculators. When Wall Street banks control the supply of both commodities and financial products, there’s a potential for anti-competitive behavior and manipulation. It also exposes these megabanks—and the entire financial system—to undue risk." Sen. Sherrod Brown (D., Ohio) told AMM July 22. Brown is also chairman of the Senate banking subcommittee on financial institutions and consumer protection, which is holding the July 23 hearing aimed at examining whether banks should control power plants, warehouses and oil refineries.

Among those expected to speak are an executive from Chicago-based brewer MillerCoors LLC and Saule T. Omarova, a professor at the University of North Carolina at Chapel Hill law school, who has questioned the role of banks in the commodities sector.

"Large U.S. bank holding companies ... have since the early 2000s been moving aggressively into the purely commercial businesses of mining, processing, transporting, storing and trading a wide range of vitally important physical commodities. And, equally surprisingly, it is virtually impossible under the current system of public disclosure and regulatory reporting to understand the true nature and scope of these institutions’ commodity activities," Omarova wrote in the abstract to her book "The Merchants of Wall Street: Banking, Commerc, and Commodities."

Some industry analysts agree that change is necessary.

Most current aluminum warehousing business is "not really warehousing in the traditional sense of the word, but rather a massive financial trade conducted by companies who have access to cheap money and who are using metal (and the warehouses they own) as a conduit through which to lock in returns afforded them by the LME markets," Edward Meir, analyst at New York-based INTL FCStone Inc., said in a July 22 research note. "None of this is illegal, but to the extent that consumers get caught up in this by waiting months on end for metal or paying higher premiums in the process ... the system has to be re-evaluated."

Everdeen Mason, New York, contributed to this story.

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