By Eric Onstad
LONDON (Reuters) - New rules taking effect in May to slash delivery backlogs at the London Metal Exchange's (LME) network of warehouses have inadvertently lengthened queues to get metal out of storage.
The wait to take delivery of aluminium at a key Dutch warehouse has more than doubled to some eight months since the end of February, as metal owners rushed to take advantage of a quirk in the rules.
Owners of aluminium parked in LME warehouses in the Dutch port of Vlissingen scrambled to give delivery notices ahead of the new rules taking effect, hoping for a period of free or reduced warehouse rent, analysts and traders said.
"There can be unintended consequences of any reforms," said Robin Bhar, head of metals research at Societe Generale (PA:SOGN) in London.
"There's been massive cancellations coming through in anticipation of the queue-based rent capping (QBRC) and also some of the other reforms."
Inventories are "cancelled" when owners have signalled they want to remove metal from depots.
The new regulations are the latest element of an LME reform package designed to lessen distortions after big banks and traders that own, or owned, warehouses profited from letting long queues build up, sparking complaints from consumers.
The new rules impose rent caps to remove the financial incentive to maintain or create queues, halving rent after a queue of 30 days and scrapping all rent after a wait of 50 days.
The LME said it had been aware of the potential for a short-term setback resulting from the latest reform for its global network of more than 650 storage facilities across 38 locations in 15 countries.
"The short-term impact of increased cancellations is outweighed by the medium-term benefit of the protections afforded by QBRC, particularly as QBRC provides relief from the effects of any queues that might be created," the LME said in an emailed statement.
KNOCK-ON IMPACTS
The LME, owned by Hong Kong Exchanges and Clearing Ltd (HK:0388), added an "anti-abuse" mechanism to its rules after fears that QBRC would allow metal owners to get free storage at the expense of warehouse firms.
Knock-on effects have been volatile movements in spreads between LME futures contracts for the metal, mainly used in transport and packaging, as well as uncertainty about the direction in surcharges for physical metal. [L5N17S485]
The level of cancelled inventories has nearly tripled at Vlissingen to 885,400 tonnes since March 15.
With only 4,000 tonnes of aluminium shipped out per day at Vlissingen, the queue to remove metal has shot up to 183 calendar days at the end of March from 116 days a month earlier, according to LME official data, released monthly.
Since then, more metal has been cancelled, extending the queue further to around 255 days, according to Reuters calculations.
The heavy cancellations at Vlissingen have likely run their course ahead of the new rules on May 1, but flows of metal are due to continue into non-LME warehouses where rents are cheaper, analysts said.
"Given that LME-off warrant rent differentials continue to grow and incentivise the flow of metal off-exchange, the addition of QBRC (queue-based rent capping) into the mix means more uncertainty in dynamics and continued elevated volatility in aluminium spreads," analyst Nicholas Snowdon at Standard Chartered (LON:STAN) said in a note.
The benchmark aluminium spread has been volatile, with the LME cash contract surging to a premium of $23.25 a tonne over the three-month contract at the end of February before sliding to a discount of $24.50 in mid-March and continuing to fluctuate since then.