2017 PREVIEW: Dubious ‘shadow stocks’ could keep US aluminium premiums weighed down

The global aluminium supply outlook for 2017 is expected to be a worldwide deficit, which may create the proper market conditions for “shadow stocks” to enter the US market, thereby keeping pressure on regional premiums throughout next year.

“Do I see the premium shooting up alarmingly – say above 10 cents per lb? No, because of the release of shadow stocks,” John Mothersole, director of research, pricing and purchasing service at UK-based IHS Markit, said.

The onset of tightness in P1020 aluminium late in 2016 has been the leading reason for the rise in the premium after it hit a six-year low in September. It has since recovered by more than 40% to a range of 8.0-8.5 cents per lb as of December 15.

Market participants said the movement of the premium stems from limited supply of P1020, thanks to both a limited number of US smelters still doing business and low premiums making importing metal from other nations less cost-effective.

In response to supply tightness, smelters such as Rio Tinto’s in the Canadian province of British Columbia, have begun to sell production into the US Midwest, in lieu of the Asian Pacific area.

With this tightness expected to continue into 2017, prices appear to be set to rise – IHS Markit projects a primary deficit of around 500,000 tonnes in 2017. But these same conditions may be the cause for unaccounted-for metal, otherwise known as shadow stocks, to enter the supply stream to take advantage of higher prices.

“I do think metal flowing out of these so called shadow stocks will help prevent the Midwest US premium from rising too strongly,” Mothersole said.

Another issue that may cap rising prices is the unanswered question of what the administration of president-elect Donald Trump may mean for the economy.

Mothersole expects the Fed to implement three interest rate increases in 2017, due to an expected higher national deficit under Trump. Should these take place, financing metal will become more difficult, leading more participants to jettison their metal supply, including shadow stocks.

The question of how much unaccounted-for aluminium exists globally only yields a dubious answer. Earlier this year, it was estimated there were approximately 6 million tonnes of unreported aluminium inventories worldwide.

US suppliers are aware of the potential for shadow stocks to fill domestic demand, and factor it into their outlook on the market for 2017.

“What you’re calling ‘shadow,’ I’d call off-warrant – there is a very large supply of that,” one supplier told Metal Bulletin sister title AMM, adding that any global producer looking to offload units would want to take advantage of higher US premiums, which could in turn keep the market flat thanks to the sudden rush of metal.

Market participants already believe that the current elevation of the premium is in itself temporary, one buyer said, with a multitude of shipping vessels already heading to the USA to take advantage of the higher premiums.

But whether that cycle continues throughout the year – the premium being regulated by a flow of import material arriving on US shores – paradoxically depends on whether or not the USA remains the most desirable market for aluminium on a worldwide scale.

“If there’s demand everywhere, it would support the premium,” a second supplier suggested. “[But] we still have to be competitive, we have to do something to be the best – If too much starts coming here, and Europe is short, then people deliver there.”

Another question may be: whose is control of these stocks?

“I don’t think it’s going to hit the market – who has that kind of inventories?” a third supplier claimed. According to the supplier, the kind of traders who possesses large portions of off-warrant material in their inventory – the likes of Glencore and other major participants – would be very careful not to flood the market with stocks if the premium spikes.

“[They] all have steady hands; they don’t scare easily,” explained the supplier. “Those players who have the units – they’re not dumb.”

What these players may do instead, according to the third supplier, is keep inventories in the LME low by not depositing stocks into warehouses other than in small volumes at a time. This way, they can maintain high-percentage shares of aluminium on the change, wielding greater influence on aluminium’s price for less money than it would take on an LME with a bursting inventory.

Supply-demand fundamentals appear to largely unchanged, according to a base metal outlook for 2017 issued by Moody’s Investors Service, with aluminium continuing to face a capacity overhang exacerbated by Chinese smelter production outpacing reductions in the rest of the world.

Additionally, LME aluminium inventories have declined since 2014 while the Midwest premium soared in January 2014, jumping 77.7% from 11.5-12 cents per lb on January 3, 2014 to 20.75-21 cents per lb by January 31.

“We need metal here,” a fourth supplier said. “Until you show me business volumes are coming off, then nothing has changed.”