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Winter Park, Florida 25/05/2016 - The CME Group will launch its new aluminium A380 alloy futures contract next week but the seeds were planted seven years ago when the first queue formed at London Metal Exchange-bonded warehouses in Detroit.
The LME was the first exchange to venture into the US alloys market in 2002 with the North American Special Alloy Aluminum Contract (Nasaac), which catered to die-casters, automakers and original equipment manufacturers (OEMs) that used 380, 319 and 356 alloys.
And in the early days, this niche offering was welcomed with open arms by the market. Most notably, Ford and General Motors supported a Nasaac-based pricing system. And with their backing, volumes peaked at 1.5 million lots in 2008.
But then the Great Recession hit. Demand and prices collapsed, while metal holders turned to the LME as the market of last resort. Primary aluminium (P1020) stocks in Detroit rose to 1.5 million tonnes in 2013 from just 64,000 tonnes in January 2008. The queue to remove metal from the Motor City grew to more than a year.
Nasaac warehouse flows were slightly more nuanced but just as interesting. LME-registered Nasaac stocks in January 2009 climbed to 245,000 tonnes, a 145-percent year-on-year increase, which was not surprising given the depth of the downturn.
But Nasaac was not directly part of the inventory financing and queue-building game so its volumes were split over several locations, with Chicago, Detroit and Baltimore holding 110,000 tonnes, 47,000 tonnes and 57,000 tonnes respectively at that time.
But in the five subsequent years, Nasaac metal exited Chicago and Baltimore but stocks increased in Detroit where aluminium alloy was trapped behind the P1020 queue. In January 2014, Detroit held 74,000 tonnes of Nasaac material while Chicago and Baltimore stored only about 10,000 tonnes combined.
A lack of free-flowing metal distorted the Nasaac price, leading many market participants to openly question the effectiveness of the contract. Aleris announced publicly in 2012 that it stopped using Nasaac in multi-month physical metal contracts.
The next year, the North American Die Casting Association (Nadca) encouraged its members to discontinue using Nasaac for pricing finished aluminium parts and suggested that die-casters switch to the Platts Midwest US A380 alloy index, which remains the most popular reference price today.
"The [warehousing] situation led to a lack of correlation between the LME Nasaac price and the physical price of 380 aluminium alloy," Nadca, which represents about 95 percent of US die-casting capacity, said in a May 2013 letter to the LME Warehousing Committee.
This industry-wide shift in pricing strategy took liquidity out of the Nasaac market, which has been in decline since 2008. Volumes fell to 546,355 lots in 2015 - a 64-percent drop over an eight year period, according to LME data.
The LME has made some attempts to rescue the contract. Last year, it implemented a rule that requires Detroit warehouses to load out an additional 500 tonnes of Nasaac per day if requested.
"We've recommitted ourselves to Nasaac," Matthew Chamberlain, LME head of business development, told FastMarkets in March 2015. "It really won't take that long to bring down the Nasaac stocks and restore price convergence to the contract. This will remove a core barrier to the broader re-uptake of the contract by participants."
But the LME's efforts might be a case of too little and too late. Trading volumes remain lacklustre and stock outflows from Detroit totalled only about 9,000 tonnes over the past year.
Many players along the automotive supply chain are happy using Platts in their contracts and the LME will struggle to win them back given its high fee structure and modest Nasaac open interest.
But there has been one key downside to using Platts to price contracts exclusively - namely, consumers that abandoned Nasaac have not been able to hedge price risk easily via a like-for-like exchange-traded futures contract. But that is also about to change.
CME will expand its base metals suite by introducing an aluminum A380 alloy futures contract on June 6. This 20-tonne Comex product will be financially settled against the S&P Global Platts assessment of the MW US A380 alloy price.
Building liquidity in a new contract is always difficult but CME has a potential customer pool of companies that are already pricing contracts using the Platts index.
And while its too early to predict if this new CME alloy contract will be a success, it's safe to say it only exists because Nasaac was collateral damage in the warehousing wars.
(Editing by Mark Shaw)