LME European aluminium contract to give participants additional hedging tool in risky market

The London Metal Exchange’s new cash-settled European aluminium duty-unpaid contract, launched on Monday March 11, will give market participants an additional way to hedge in a historically volatile market.

The contract will be settled against Fastmarkets MB’s benchmark Rotterdam duty-unpaid P1020 in-warehouse premium. Click here to see the LME contract specification.

Physical aluminium premiums in Europe have been susceptible to extreme price swings in the past decade. Having more options, such as the LME cash-settled contracts, will give market participants more opportunities to mitigate risk during volatile market events.

“The new contract is good for a guide and it’s good for hedging premium risk,” one aluminium source said.

Hedging against shocks
This year, hedging would have mostly helped market participants mitigate against upside risk in the aluminium premium.

The benchmark P1020 Rotterdam duty-unpaid spot market premium shot up 8% to its highest in three years on April 12, 2018, to $150-165 per tonne when the US government sanctioned Russian aluminium producer UC Rusal.

Rusal is responsible for 7% of global aluminium production. During the nine months that the sanctions were enforced on Rusal, the Rotterdam premium fluctuated in time with news of developments and market sentiment on whether sanctions would be lifted.

More instruments would also help reduce risk on the downside, market participants said.

Since the US lifted sanctions on the major producer, the Rotterdam duty-unpaid premium has eased. It was most recently assessed at $82-92 per tonne Friday March 7, down 4.4% from its sanctioned-fueled highs almost one year ago.

Although the volatility surrounding the sanctions have largely dissipated, the market is still vulnerable to shocks and uncertainty, placing more value on hedging instruments.

“Right now it’s difficult to read the market the right way, taking a position is not easy,” a second source said.

Overall, LME stocks remain historically low at around 1.2 million tonnes, which can result in spreads flipping between contangoes and backwardations more often, ultimately moving premiums more often. Having more hedging options will allow participants to hedge against any downside risk if spreads on the LME flip into a backwardation.

In December, the Rotterdam duty-unpaid premium touched a nine-year low after a backwardation in December and January forced participants to flood the European market with metal, which in turn pushed the premium lower. Before this in July 2018, the cash/three-month spread hit its widest backwardation in nearly 12 years, which also put downward pressure on the premium.

At the time of the July backwardation, one market participant told Fastmarkets that although he had a good grasp of where the market was headed, he was forced to “gamble” when it came to setting premiums for the long term.

Since 2015, participants have also had the ability to hedge the Rotterdam premium on the Chicago Mercantile Exchange. Volumes of the Rotterdam duty-unpaid premium contract traded on the CME doubled year on year in February.

The LME said in 2017 it had plans to launch a European duty-paid P1020 contract, though no new updates have been announced for that contract.

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. Register here.