September 13, 2012

Contango Financing for Commodities: Metals, Aluminium

Contango financing for commodities: metals, aluminium.

5 Year Aluminium Spot Prices via Kitco

FT on UC Rusal’s comments on Aluminium squeeze
What we feel Deripaska is outing here is the commodity industry’s (especially metal commodities) growing dependence and reliance on so-called contango financing, which holds back supply from the market via securitisations that allow banks to pocket yield in return for financing inventory.
The general idea is simple. There’s a glut of supply, which creates a contango forward structure. Producers, who would otherwise be tempted to cut supply and suffer income loss, are encouraged by banks to keep producing on the basis that they can use their inventory as collateral for secured financing.

The encumbered collateral is kept off market — (much like ECB periphery bonds) — and hedged which derivatives, which due to the contango structure, end up yielding a positive return for banks.

You could call it balance sheet rental to producers and traders for the sake of funding inventory (and/or contango positions in their own right) to take advantage of the mispricing of the curve. After all, the reason banks are able to make these deals profitable is because they bridge the difference between the physical reality and financial investors’ (especially passive ones) overpriced expectations of where commodity prices will be in the future.

5 Year LME Aluminium Warehouse Stock Levels via Kitco

The banks can lock in a guaranteed return by storing the metal in giant warehouses, allowing them to bid up prices for the metal and remove supplies from the market. The process has pushed premiums for physical aluminium to record highs in excess of $250 a tonne, up by more than half since the start of the year. As a percentage of the aluminium LME price, global premiums are at a record 13 per cent, after averaging 5 per cent between 2007 and 2011.

Tags: rusal aluminum prices, aluminium contango financing, commodities contango financing, aluminium spot prices, london metals exchange aluminium price