LME alumina contract provides new hedging tool for volatile market
The new London Metal Exchange alumina cash-settled contract, which was launched on Monday March 11, will provide the market with a new hedging tool after a year of dramatic price movements.
With Norsk Hydro’s Alunorte refinery in Brazil still producing at just 50% capacity, the alumina market is susceptible to more extreme volatility in the year ahead.
The LME alumina contract is settled against Fastmarkets MB’s benchmark daily fob Australia alumina index in a basket alongside CRU’s alumina index. Equal weighting is given to each index.
The contract will give traders a new opportunity to hedge their risk against price movements and to trade the alumina forward curve.
“The alumina market remains unstable due to Alunorte’s curtailment. A single deal can move the market price by $200 per tonne at a time. People need to cover themselves,” a trader said.
In March 2018, Hydro’s Alunorte alumina refinery declared force majeure after it was ordered by Brazilian national authorities to reduce output by 50%. It has been operating at 50% capacity since then, which has led to a large reduction in the number of available alumina cargoes.
Consequently, Fastmarkets’ benchmark daily alumina index fob Australia reached $707.75 per tonne in April, the highest level since the index was launched in August 2010 and 75% higher than at the start of 2018.
Liquidity indicator of the Fastmarkets fob Australia index
Traders had to pay record fees to secure material and aluminium smelters ran at a loss with margins squeezed.
“It hurt because people weren’t prepared,” a consumer said. “We were exposed to the price moves, and nobody in their wildest dreams at the start of 2018 thought that alumina would trade at $700 per tonne.”
Throughout 2018’s rally in alumina prices, the LME aluminium price became disconnected from the market.
Instead of rallying alongside raw materials, the three-month price remained flat, trading between $2,000 and $2,100 per tonne. On some occasions, alumina was trading at 30% of the outright aluminium price.
Smelters report that when the alumina price trades at more than 19% of the aluminium price, they start to lose money.
“You can no longer look at the LME aluminium price for alumina. It is its own market, and the disconnect between the two made some people lose a lot of money,” a second trader said.
“It caused a lot of trouble for smelters when they were paying $600 per tonne for alumina, and aluminium was only selling at $2,000 per tonne. The maths doesn’t make sense,” he added.
Historically, the alumina market was priced as a percentage of the outright aluminium price on the LME, but physical contracts have since changed to being based on price-reporting agency (PRA) indices.
Some companies, however, remain bound to long-term LME-based contracts, which have caused them to lose money.
Rio Tinto’s most recent earnings report from February 17 said it has legacy contracts which are fixed to the LME price until 2030, which had a negative effect on its corporate results.
“We are exposed to approximately 2.2 million tonnes of legacy alumina sales contracts which have a fixed linkage to the LME price. These contracts date back to 2005 or earlier, and the majority expire between 2023 and 2030,” Rio Tinto said.
“The negative effect on Ebitda [earnings before interest, taxes, depreciation and amortization] of these legacy contracts, following significant escalation in the alumina index due to industry supply disruptions, was $460 million in 2018. This was $300 million higher than in 2017,” it added.
A further escalation in the alumina index is not unlikely, with the timeline for Alunorte’s return still uncertain. The majority of the alumina market remains cautiously bullish.
“Everyone remains on edge. One announcement can change everything in either direction. There is a lot at stake,” a third trader said.
The new LME contract will also mean that traders can hedge themselves against downside risk should Alunorte’s return send alumina prices plummeting.
September 2018 showed how quickly the alumina market can change. The fob Australia index hit a high of $652.92 per tonne on September 17 before dropping by 28% to a low of $468.40 per tonne on October 1, due to a number of cargoes trading lower.
Price change percentage in the Fastmarkets fob Australia index
The end of a workers’ strike at aluminium producer Alcoa’s operations in Western Australia and the extension of the US deadline on sanctions against Russian producer Rusal, which helped to push the index higher alongside the Alunorte issues, added to the bearish sentiment.
“The reality is that we could wake up tomorrow morning to a Hydro press release that says ‘Alunorte is back at full capacity’ and things will fall off a cliff,” a fourth trader said.
The index was assessed at $391.38 per tonne on Friday March 8, with the most recent 30,000-tonne tender from Nalco concluding at $390 per tonne.
The year 2018 showed how quickly a market can change, due to sanctions, strikes or force majeures, and showed the need for further hedging tools.
“Last year was a learning curve for a lot of people,” the first trader said. “But now we have to be a bit more sensible, and look at the bigger picture, because one little thing can turn the market on its head.”
You can see the LME alumina contract specifications here.
Fastmarkets will host a free webinar with the LME on March 18 to introduce the new Fastmarkets-settled alumina and European duty-unpaid aluminium contracts. You can register for this webinar here.