Wall Street Gets Eyed in Metal Squeeze

The Wall Street Journal

Goldman Sachs Group Inc. and other owners of large metals warehouses are being scrutinized by the London Metal Exchange after being accused by users like Coca-Cola Co. of restricting the amount of metal they release to customers, inflating prices.

The board of the LME met on Thursday to discuss complaints from aluminum users and market traders, who say operators of warehouses, which also include J.P. Morgan Chase & Co. and Glencore International PLC, should be forced to allow the metal out more quickly to meet demand.
More from WSJ.com:

Gambler or Investor?

Tata Steel to Sell Riversdale Stake

The Hidden Costs of Telecommuting

Aluminum prices have jumped 13% since the start of 2010 even though economic growth had been tapering off. Aluminum for delivery in three months on Thursday closed at $2,557 a metric ton on the LME, down 1.3% on the day.

Goldman, through its Metro International Trade Services unit, owns the biggest warehouse complex in the LME system, a series of 19 buildings in Detroit that house about a quarter of the aluminum stored in LME facilities.

Coca-Cola and other consumers say that Metro in particular is allowing the minimum amount of aluminum allowed by the LME—1,500 metric tons a day—to leave its facilities, and that Metro could remove much more, erasing supply bottlenecks and lowering premiums for physical delivery in the process.

Coca-Cola, which has complained to the LME, says it can take months to get the metal the company needs, even though warehouses are allowing aluminum to come in much more quickly. Warehouses, meantime, collect rent and other fees.

"The situation has been organized artificially to drive premiums up," said Dave Smith, Atlanta-based Coca-Cola's strategic procurement manager. "It takes two weeks to put aluminum in, and six months to get it out."

As a result of the complaints, the LME is considering changing its rules for warehouses, which would effectively double the minimum daily amount of metal that must be released.

"Metro has followed and will continue to follow the LME's possessive rules," said a Goldman Sachs spokesman. J.P. Morgan and Glencore declined to comment.

In recent years, major investment banks like Goldman and J.P. Morgan and commodities houses like Glencore have been snapping up warehouses around the world, turning the industry from a disperse grouping of independent operators into another arm of Wall Street. The LME has licensed about 600 warehouses around the world.

Glencore bought the metals-warehousing operations of Italian family-owned Pacorini Group and J.P. Morgan bought Henry Bath as part of its purchase of some of the commodities assets of RBS Sempra.

The transformation has raised questions about whether the investment banks, which also have big commodity-trading arms, are able to use their position as owners of warehouses to manipulate prices to their advantage.

The warehousing issue alarmed one trader enough to seek government intervention. Anthony Lipmann, managing director of metals trader Lipmann Walton & Co. Ltd., gave evidence to the U.K. House of Commons Select Committee in May 2011, raising concern about large banks and trading houses owning facilities that store other people's metal.

The banks have said they have walls between their various operations.

It also has raised questions about how they handle the materials, said Edward Meir, senior commodity analyst at MF Global. "Who's watching over situations involving whose metal is getting in and out first?" said Mr. Meir. "Who has priority?"

The U.K.'s Office of Fair Trading dismissed concerns that ownership of warehouses gives certain market players an unfair advantage, saying on Tuesday that there were no "obvious competition issues that would merit further investigation at this stage."
currency.jpg
Click here for the Currency Center.

Goldman's Detroit warehouse holds about 1.15 million tons out of a total 4.62 million tons in LME-approved warehouses.

Since Goldman bought Metro early last year, the wait time for aluminum delivery in Detroit has increased to about seven months.

Metro charges its customers 42 cents a day for storing one metric ton of aluminum in Detroit, which is about the industry average. At 900,000 tons in the warehouses, Goldman is earning $378,000 a day on rental costs, or about $79 million in seven months.

"Warehouses are making a lot more money," said Jorge Vazquez, managing director of aluminum at Harbor Commodity Research. Goldman is "really the winner clearly, because if you want to take metal away from the location, you have to wait up to 10 months to get your metal out, and in the meantime you're paying rent."

Metro, meantime, is taking in metal. Metro also offers cash incentives to producers like Rio Tinto Alcan to store their metal in Metro's sheds for contracted periods, sometimes as much as $150 a ton, according to traders.

Once the metal is in the warehouse, the producers sell ownership to this metal on the open market. The new owner can't collect his metal for seven months because of the bottleneck. For that period, the new owner is stuck paying rent to Metro.

"The system is set up like a funnel, so you can dump large amounts of metal in the front end and only get a little out at the back end," said David Wilson, director of metals research at Société Générale SA. "It enables a situation where the rules of the warehousing system are taken advantage of."

Aside from warehouses, producers of the metal are benefiting, because they are able to charge more for their metal. Klaus Kleinfeld, chief executive of Alcoa Inc., said in an interview that supply-and-demand factors are leading prices higher.

"You can't blame the warehouses," Mr. Kleinfeld said.

U.S. aluminum sheet maker Novelis sent a letter to the LME in May "expressing concerns" about the warehousing situation, a company spokesman said.

The complaints led the LME to commission an independent study into the issue last July. That study recommended a sliding scale be adopted, rather than the fixed minimum of 1,500 tons a day. That would result in larger warehouse complexes being required to release more metal.

It effectively doubles the minimum amount required to be relinquished by Metro each day. The ruling would go into effect in April. The LME board on Thursday, however, failed to reach a consensus on the recommendations.

The LME warehousing system is designed to be the market of "last resort," meaning that industry can use it to sell excess stock in times of oversupply and as a source of material in times of extreme shortage.

But it has become the go-to market, in part because of the hefty cash incentives being offered by warehouses to store the metal.

The situation is made more aggravating for metal consumers because supply has far outweighed demand for most of the last decade, and there is more than 4.5 million metric tons of surplus metal stored in LME's warehouse system.

-- Matt Day and Liam Pleven contributed to this article.

Write to Tatyana Shumsky at tatyana.shumsky@dowjones.com and Andrea Hotter at andrea.hotter@dowjones.com

Rates

View Comments (0)