More than 630,000 tonnes of copper have been delivered on to the exchange so far in 2016, predominantly into warehouses in Asia, as Chinese smelters have worked alongside traders such as Trafigura to export cathode under tolling licences.
Traders and smelters have moved material away from China, the largest consumer market, as cheap freight rates, a positive arbitrage and strong warehouse incentives made delivering to the LME more attractive than selling into the domestic market, where premiums have been weak throughout the year.
But almost as quickly as the material has arrived, LME stocks have been cancelled and withdrawn, with outflows of more than 520,000 tonnes reducing the headline net stock increase to about 110,000 tonnes.
As Metal Bulletin reported in September, Glencore has been behind the large majority of those cancellations, as the company has been able to profitably withdraw material from the LME and deliver it to Chinese customers under long-term contracts referencing the benchmark premium of $98 per tonne set by Codelco for this year.
All change with lower annual premiums
But if Codelco reduces its contractual premium for next year considerably, as many market participants believe it will, the economics of that trade could break down overnight as the new year begins and contractual customers start paying lower annual premiums, sources told Metal Bulletin.
While spot premiums in Shanghai have rallied in the past three weeks, contractual customers are calling for a heavy reduction to this year’s $98-per-tonne benchmark, on the basis that the spot market has traded well below those levels throughout most of the year.
Spot premiums in Shanghai are currently around $70-85 on a cif basis, their highest level this year and up from $35 lows in August. In the year to date, they have averaged around $52.50, according to Metal Bulletin data.
“It’s not going to be $98 like it was this year,” Vivienne Lloyd, senior metals analyst at Macquarie, said in a media briefing in London on October 20. “I expect it will be at least sub-$90, but more like sub-$80.”
“If China’s at $70, it’s not going to make sense cancelling it, so I expect the material that’s been coming on to the LME this year will stay there for longer once the 2017 premium kicks in,” a physical trader told Metal Bulletin.
Rises in contractual TC/RCs
At the same time, the economics of exporting cathode from China to Asian LME warehouses could be bolstered by a rise in contractual treatment and refining charges (TC/RC) for copper concentrates, market sources also claim.
Macquarie is predicting that next year, TC/RCs will rise above $100 per dry metric tonne/10 cents per lb, Lloyd said. The 2016 benchmark was $97.35/9.735.
So far, the net stock increase of 110,000 tonnes seen this year has not weighed dramatically on prices, which, at $4,650 per tonne, are trading broadly flat compared with January levels.
But if the economics of cancelling stocks and delivering them into the Chinese market break down next year, sentiment may be dented badly if exports under tolling licences continue unabated, and prices may come under pressure as stocks rise, some sources also claimed.
“There are a lot of macro guys out there who only look at headline stock levels, so they’re not aware all these deliveries have been taking place. So they probably think the market is in a lot better shape than it is,” a source at a large trading house told Metal Bulletin.
“It could come as a bit of a shock to the market once the withdrawals stop,” he added.
However, the first trader cautioned that investors who take a bearish view on the market after seeing the deliveries could run into difficulty, as moves below $4,600 per tonne attracted strong buying interest throughout this year.
“The physical market is really bad, so structurally and fundamentally, things are bearish for copper, but I don’t think there’s actually a lot of downside on copper. Maybe someone will see material coming on [to the LME] and think the price is going to $4,000, but they’d be chasing the lows of the lows of the lows, and that’s a big call to make,” he said.
Copper inventories on the London Metal Exchange look set to rise sharply from January, as lower contractual premiums for 2017 will make the business of cancelling incoming material and shipping it to China uneconomical, market sources believe.