London 17/03/2016 - The collapse in the backwardation in LME aluminium's nearby forward curve and the impending launch of new warehouse regulations triggered a spike in cancellations on Thursday - and more are expected, market participants said.
Cancelled warrants jumped 143,850 tonnes to 705,450 tonnes on Wednesday, according to today's LME data. Fresh cancellations soared 150,000 tonnes in Vlissingen to 446,450 tonnes.
LME inventories have fallen to 2.8 million tonnes from more than 5.4 million tonnes in 2014. But there is still an abundance of material held off-exchange - earlier this week Macquarie pegged invisible inventories at around 15 million tonnes.
The metals forward spreads have been volatile, with cash/threes flaring out to a backwardation at the start of the month of more than $25. But material was swiftly delivered into LME-listed warehouses against this, triggering a swing to a contago - cash/threes was last at $19, with contangos all along the nearby curve.
The large warrant holders have also eased their grip - LME data showed there is now just one in the 50-79 percent bracket. While JP Morgan has previously been identified as the holder, sources said a trading house and another bank are also having a play.
"I bet on recancelling after the backwardation as this makes sense the most. Soon there will be a free ride on that queue," a warehouse source said.
Under the LME's queue-based rent cap (QBRC) measures, which are set to come into force on May 1, warehouse companies that fail to deliver out metal held in queues within 30 calendar days would be required to halve the maximum published rent charged to the affected metal owners.
After 50 calendar days, no rent could be charged at all. This would remove any economic benefit for warehouse companies in maintaining a queue.
In a consultation, warehouse operators voiced their concern that the rent cap was open to abuse, fearing it would result in large tonnages of cancellations as metal owners take advantage of the new measures.
Following feedback from its members, the LME implemented a 10,000-tonne limit on the amount of material that can be in a queue for the QBRC rule to be applicable.
But with QBRC looming, market participants said more material will move off-exchange, adding to the perceived tightness. This could exacerbate spread and inventory moves.
"People are trying to take advantage and cancel the material. It is not surprising and there will be more cancellations if spreads are supportive," one trader said.
"There has been a lot of talk that even more material will move off LME... It is creating a secondary market as the metal can still be tied up in financing deals and not be subject to the new LME regulations," a warrant trader said. "We know there is zero demand for it so it is not that - people are just playing the finance game."
Historically, banks prefer to finance metal in LME warehouses because it is protected by tougher regulations. But FastMarkets understands that there is still off-exchange financing available, particularly if the metal is held in Pacorini or Steinweig sheds.
"Queue financing has previously been restricted to large banks but with the anticipation that the queue will eventually get shorter - as warehouse operators are incentivised to load out faster - people who had previously been excluded will now jump in and we will see a wider range of participants," the trader predicted.
"There will be a lower hurdle to borrow spreads and keep stocks in finance - the cost to hold off-LME needs a contango of around $5 while on the LME it is at least $20 to break even," he added.
The spread structure is susceptible to further technical tightness every few months, traders said. More material will move off LME because the cost to hold stocks will get narrower.
"The LME will then function as a magnet to attract metal in periods of tightness but the wider the contango, the more will be cancelled as people work around the new rules,” the second trader warned.
The market will now waits to see if warehouse operators will be unwilling to have queues of metal that are paying a reduced or free rent or if their comparatively low overheads enable them to absorb lower margins.
But as periods of tightness wax and wane, warehouse operators such as Pacorini and Metro will benefit from rewarranting fees.
At Pacorini, for example, aluminium rewarranting incurs a fee of $8 if the load-out slot had already been scheduled or $4 per tonne if a slot had not been scheduled. The difference in the two charges is reportedly due to the additional administration required.
Charging a fee for rewarranting could deter metal owners from cancelling material and taking advantage of QBRC.
Three-month aluminium was last at $1,530 per tonne, up $21 on Wednesday's close.
(Editing by Mark Shaw)