Must-know: Aluminum pricing and how it’s distorted by companies

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Oct. 29 2019, Updated 8:23 p.m. ET

The dynamics of aluminum prices

As discussed earlier, aluminum demand is less exposed to economic cycles compared to steel. The overall demand indicators for aluminum have been positive. The production cuts in China and in aluminum companies elsewhere have provided support to aluminum prices. The aluminum industry has been in oversupply for nine years in a row. Oversupply simply means that the production by aluminum companies has been greater than the actual consumption of aluminum.

 

Key determinants of aluminum prices

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The chart above shows the movement in aluminum prices. As you can see, the prices have been very volatile. The prices fell to a four-year low this year, before rebounding to top $1,900 per ton. Aluminum’s financial demand and end-user demand impact aluminum prices. We saw in the last part of the series how the inventories at London Metal Exchange are surging.

Understanding the premium in aluminum prices

An important point to note here is the price paid by aluminum consumers isn’t the prevailing price on the London Metal Exchange. The buyers have to pay a higher price for the aluminum that they purchase—the premium. The premium is a surcharge that aluminum consumers must pay on top of the prevailing prices to take the delivery of metal from the warehouses. This premium helps the aluminum producing companies, as their final selling price equals the price on the London Metal Exchange plus the prevailing premiums.

These premiums have been acting as a cushion for aluminum companies, shielding them from the falling aluminum prices. These premiums are volatile and currently hover in the range of $400 per ton. This is roughly 20% of prevailing aluminum prices.

A large part of these premiums are due to the rent that warehouses charge for storing aluminum. Large financial companies like Morgan Stanley (MS), Goldman Sachs (GS), and JPMorgan (JPM) own these warehouses. There have been complaints in the past of possible premium rigging by these companies. We’ll discuss more about this in the next part of this series.

Aluminum price is a key driver for companies like Alcoa (AA) and Century Aluminum (CENX) and ETFs like SPDR S&P Metals and Mining ETF (XME).

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