September/October 1995
Warehouses registered with the LME play a key role in the exchange’s trading activities. But just what do these warehouses do and how do they do it? Here’s a basic look at how these metals businesses operate, with a focus on one U.S. warehouse’s experience.
By Si Wakesberg
Si Wakesberg is the New York Bureau Chief for Scrap Processing and Recycling.
In 1991, the London Metal Exchange signed up its fist warehouse in the United States , a facility in Baltimore operated by C. Steinweg Inc.
It seemed a tentative step considering that the exchange already had a network of registered warehouses in Europe and a few in the Far East. Indeed, the LME was testing the waters, making that one U.S. warehouse the only game in town for a while.
But in the four intervening years, the LME has contracted for 23 more warehouses to handle a variety of nonferrous metals on this side of the Atlantic. (For a list of these facilities, their locations, and the commodities they handle, see "The U.S. Contingent" on page 142.) These facilities are now a distinct part of the exchange's worldwide operations, offering U.S. metal producers and traders the opportunity to participate in physical trading transactions on a local basis.
Serving Exchange Members
Like the more than 400 LME-registered warehouses located in other parts of the globe, the U.S. warehouses exist as a service to LME members—as designated facilities where they can send or receive metal according to the terms of any forward or spot contracts they exercise. In fact, "the standard LME contract always calls for receipt or delivery of a reported LME brand on the due date from or into an LME-approved warehouse," according to "Wolff's Guide to the LME," something of an industry bible on the subject.
While many of those contracts may never result in any actual physical transactions thanks to market fluctuations that could drive a trader to offset one contract with another, when contracts are physically executed, the role of the warehouses is key.
As Simon Clow puts it in his book “The International Nickel Trade”: “Consumers and merchants can take delivery of prompt metal from the LME to cover their physical requirements, while suppliers are able to deliver material to the market when they can find no alternative physical demand for it.” This ability to deliver or to take delivery of metal, Clow writes, "enables both producers and consumers to hedge their exposure to fluctuations in price more easily." (Incidentally, there is no force majeure clause in an LME contract, so delivery of metal is always guaranteed.)
Beyond serving LME members, the warehouses—or at least data on inventories at the warehouses—play an important role for the metals industry as a whole, often acting as a gauge of a particular commodity's supply-demand conditions. And this information, in turn, can influence commodity prices, many analysts believe.
There are those who will debate this, of course—the chairman of the LME's warehousing committee, for example, was quoted a few years ago as saying that "stock levels have ceased to be the market indicator they once were." Nevertheless, metals watchers continue to frequently attribute metal price changes to warehouse inventory reports. Just this past July, for instance, a sharp rise in the price of copper was said to be a reaction to news accounts of a 50-percent decline in LME warehouse stocks of copper since the beginning of the year.
What It Takes To Make the Grade
This potential makes it vital that LME warehouse stock statistics be kept up-to-date. And, indeed, the exchange supervises its warehouses carefully to ensure inventory data accuracy, according to Hal Tolin, general manager of Hoogewerff Reserve L.P. (Chicago), an LME-registered warehouse operation formed through a partnership between the principals of Reserve Recycling (Chicago)—which owns the scrap firm Reserve Iron & Metal—and Hoogewerff U.S.A., a subsidiary of the Dutch warehouser, stevedore, and ship charterer known by a similar name.
"We send stock reports twice a week to the London headquarters of the LME, indicating what material is coming in and what's being taken out," Tolin explains. These figures are then compiled worldwide so that the exchange can issue complete inventory data each week. As an extra measure of accuracy, there is also an annual audit by an independent firm. And from time to time, Tolin informs, LME officials drop in at the warehouse for a look-see.
Of course, inventory data maintenance is only the tip of the iceberg in terms of warehouse requirements. In order to become an LME-registered warehouse, companies must meet a variety of conditions, Tolin notes. For one thing, he says, " U.S. warehouses must be located in a foreign trade zone—that is essential." This requirement is vital, he explains, because imports into a foreign trade zone—a U.S. customs designation—are admitted on a duty-deferred basis. Thus, imported metals stored in U.S. LME-registered warehouses are not subject to any duty payments until the material is moved to a specific U.S. destination, and duty is avoided altogether if the metal is exported.
As for other qualifying factors, Tolin points out that certain security measures must be in place and there are some insurance requirements as well.
In addition, while the LME sets no minimum space requirements, warehouses must store LME-designated metals indoors, Tolin notes. He points out that the exchange relaxed this regulation for a brief period—allowing aluminum to be stored outdoors—in reaction to the flood of Russian aluminum on the U.S. market, which caused warehouses to overflow with incoming material. But, he adds, there was some antagonism to this procedure, so as the Russian metal flow into the United States began to ebb, the LME withdrew permission for outdoor storage.
(There has been an obvious decline in shipments of Russian aluminum thus far this year compared with the peaks seen in 1994, Tolin notes. "However," he adds, "it may be erroneous to deduce from this that Russia is exporting less aluminum. It's just that their exports may have been diverted this year to Europe and the Far East , where markets have strengthened.")
There are also some more-subjective standards tied to LME approval of warehouses. For instance, Tolin offers, the warehouse operator must have a reputable history. "The LME is looking for continuity, for long-term players," he says. And the exchange insists that its warehouses have the ability and flexibility to properly service LME members, and therefore looks into the availability of equipment, whether the equipment is owned or leased, condition of the equipment, how the warehouse operates on a day-to-day basis, and so on.
In Hoogewerff Reserve's case, the company was already a stevedore and warehouser of steel prior to applying to become an LME warehouse, which gave it a leg up in its quest to become LME-affiliated. As an approved warehouse, it now handles aluminum, aluminum alloys, lead, zinc, tin, nickel, and most recently, copper.
That last commodity was only added to the list of metals approved for LME warehousing in the United States in April, reportedly because of concerns about Comex's rather strong position in the U.S. copper market. Tolin says he has been particularly pleased with the opportunity to receive and deliver the red metal. "Handling copper has made things a lot more exciting," he declares.
Overall, however, he notes, activity in nonferrous metals by the warehouse appears to have decreased somewhat this year from the record levels recorded in 1994. "The strongest activity in 1995 seems to be in aluminum alloys," he says.
Metal Moving In, Metal Moving Out
Because each LME warehouse is privately owned and operated, there is competition among them, Tolin notes, pointing out that it is up to each warehouse to market itself to traders who might want to take advantage of the facility's location and capabilities. This is especially true for warehouses in those regions where the LME has registered multiple warehouses owned by different companies, such as Chicago, where Hoogewerff Reserve must compete with another LME warehouse about 60 miles away.
The warehouses' marketing efforts are essentially limited, however, as LME rules specify that in any exchange transaction, it is up to the seller to specify the delivery point for the metal. Nevertheless, buyers will often arrange "swaps" between warehouses if they've contracted to take up metal from a different warehouse than they'd prefer.
So how do traders go about receiving—and delivering—LME-warehoused metals? In terms of taking up metal from an LME warehouse, the process begins when a buyer has secured a warrant from a broker with ties to the LME. This warrant—basically a bearer document entitling the holder to take delivery of a particular load of metal—details the type and brand of metal to be sold, the exact weight and number of pieces involved in the transaction, and the warehouse and location. After the prompt date falls due, the warrant holder could then take delivery from the applicable warehouse by contacting the warehouse or its agents to arrange for delivery of the metal.
On the other side of the transaction, sellers must deliver a registered brand of metal to an official LME warehouse (of their choice) before the prompt date of their sales contract.
In either case, whoever owns the metal being stored in an LME-approved warehouse pays rent on that storage in the form of a tariff set by each warehouse. While these rates tend to align among all the warehouses in any one world region, there may be differences in charges set by U.S. warehouses compared to European warehouses or Asian warehouses, depending on the level of activity and costs within those regions. For example, as this article was being written in mid-summer, European warehouse charges appeared to be somewhat lower than U.S. charges. "In general, however," Tolin reports, "our charges are in line with those of other warehouses and the LME sees to that since we publish a tariff rate with the exchange."
The Credibility That Comes With It
The requirements and responsibilities that go with running an LME warehouse can be complex, but the payoff in worldwide exposure and reputation-building can make it worth it, Tolin concludes. "There's no doubt it lends credibility to the company and a certain international recognition," he says. "We are delighted to be part of a wide international network that helps store and deliver physical metal for the exchange."
Warehouses registered with the LME play a key role in the exchange’s trading activities. But just what do these warehouses do and how do they do it? Here’s a basic look at how these metals businesses operate, with a focus on one U.S. warehouse’s experience.