CRU Aluminum: Delisting Russia from the LME, a Tough Call

The other advisory committees representing other metals, including aluminum, were against the idea. The copper recommendation was tabled.

What has changed to compel this action?

Annexation and suspension of gas exports

The Ukraine War continues into its eighth month. What is new is that Russia has held a referendum in the four Russian-occupied eastern provinces. It passed by a wide margin and was condemned in the West as an orchestrated sham. Putin has announced his intention to annex the provinces immediately. This annexation follows a script similar to Putin’s action in Crimea, where the West did little to oppose him.

Things may be different this time because the West is galvanized in its opposition to Putin’s actions.

Suspension of natural gas export gas exports through Nord Stream is the other major change. Exports were suspended in early September for maintenance. Now, a mysterious series of major leaks has been found beneath the Baltic Sea. There are suspicions of sabotage by Russia itself. The logic here being that it gives Moscow “cover” for not supplying gas due to the required repairs.

Western hesitancy to impose heavier sanctions on Russia has been based on not wanting to antagonize Putin to a point where he suspended exports. Well, he has now done that, so that is now additional pain that can be inflicted on Western Europe!

Self-sanctioning has caused Russian metal to find new markets

Novelis has been the most high-profile aluminum buyer to publicly say they would not buy Russian metal in the future. Other companies are working behind the scenes to line up alternate suppliers.

Anyone who doubts that this is happening need only check out reports that Russian metal is flooding into Mexico, South Asia, and Turkey in unusually large volumes and at substantial discounts. The recent buzz at leading industry conferences has been that Russian metal is being sold at a discount of $100-150 per metric ton to non-Russian prices.

Metal also began to flow back into the LME warehouses in South Asia. Russian interest themselves have made a curious statement that they were exploring direct sales to the LME.

This is curious because Russian metal has delivered into the LME for years, ever since the former Soviet Union collapsed in 1991 and Russian metal began flooding into the Western market. Virtually all these deliveries of metal to the LME were made by leading traders such as Transworld Metals, Glencore, Gerald, and others. As our readers know, Glencore has a long-term deal with UC Rusal to take substantial tonnages of LME-deliverable metal each year through 2024, with an option for 2025.

Why then make this statement about LME delivery? The likely answer is that Russian companies, and Glencore, are running out of conventional physical metal markets to sell into. With 3.4 million tons of exports each year, markets such as Mexico, Turkey and South Asia are not large enough to fully absorb their exports.

Conventional wisdom has been that China would come to their rescue. China has its own problems with its economy stumbling and really does not need to import aluminum in 2022 or 2023. The only way China could absorb large tonnages would be if they chose to (1) buy substantial tonnages for their Strategic Reserve Stockpile or (2) buy tonnages at huge discounts to justify closing their own, older and loss-making smelters to maintain a balance in their domestic supply-demand situation.

The decision to buy for the stockpile would not be a hard one. But deciding to import Russian metal and shutter domestic smelters is not well-timed given the state of the economy. It is true that there is a large amount of Chinese capacity losing money. CRU estimates that over 36 million tons of global operating aluminum capacity is losing cash at the LME cash price of $2,223 per ton. China has 34.8 million tons of the total. There are about 8 million tons losing more that $300 per ton. So the losses are big.

The question is whether the Chinese could deal with the optics of buying Russian aluminum and putting Chinese workers on the street in this economic cycle. Right now, Beijing seems to be saying “no.”

The LME becomes the ‘market of last resort’

The Russian dilemma is not unique. During the Global Financial Crisis of 2008-2009, the LME became the market of last resort for producers all over the world. From 2007 to 2009, LME stocks rose 3.7 million tons.

Now, Russian companies want to tap into the LME to keep their smelters running and generating cash. This desire comes at a tough time for the aluminum market, which, like other metals markets, is struggling with the fear of recession depressing prices.

If Russians companies start selling LME forward and delivering against their sales, it is going to depress the absolute price. They could push prices down hard. Comments from other analysts suggest that prices could fall to $1,450-1,700 per ton.

Would this selling and delivery to LME matter to physical market premiums near-term? We think not. The market is already saying, “We don’t want Russian metal.” And physical premiums are still declining, so no one seems to be panicking over replacing Russian metal with other origins.

The wrong and right reasons to delist

Let us be clear, the LME should NOT be delisting Russian brands because of fears that it could depress prices. If that were the rationale, we should have delisted most producers during the Global Financial Crisis. That is burying one’s head in the sand. You cannot shut down a market because it might lead to a bad outcome for part of the market. Producers fear the effects of Russian sales to the LME. Buyers, on the other hand would say, “Bring it on. Keep producing and selling to the LME, we get lower prices!”

The logic behind delisting the Russian brands should follow the same prescription as sanctions on Iran and on South Africa during Apartheid. Geopolitical concerns must trump commercial considerations.

Delisting Russian brands should be based on denying the Putin regime the ability to indirectly monetize its natural resources to wage war in Ukraine. There are arguments being made that UC Rusal is not a state-owned enterprise. Does anyone honestly believe that any major natural resource company operates in Russia without the tacit approval of the state? It is all interconnected.

The decision to delist Russian brands should be driven by delivering a strong rebuke of Putin’s behavior on the geopolitical front.

Repercussions of Delisting

The opponents of delisting argue the following:

• It would collapse global premiums. This assumes that Russian companies would be forced to further discount in the conventional physical markets if denied the ability to deliver to LME at “LME flat.” Hasn’t the market already said it will not buy this metal at any price? We would argue that the market might see premiums RISE for non-Russian supply to compensate for the loss of Russian metal.

• It would lead to big increases in unreported Russian stocks. This would depend on the market’s ability to finance those stocks. That decision may rest with Glencore, which is the major conduit for Russian LME-deliverable metal. If the LME delists Russian metal from delivery, its collateral value to a bank is GONE. No bank will finance Russian metal if it is no longer fungible. Traders would have to put up their own capital. We doubt that would happen. The Russian state would have to put up the capital to keep Rusal going.

• It destroys the integrity of the LME role as a market of last resort. There is marginal validity to this, but the real question is whether the LME should be a depository of metal that is non-fungible. If the physical market does not want to buy Russian metal due to self-sanctioning, the LME is not performing its function of providing a market for fungible metal. Allowing metal to be delivered into the LME when it is no longer fungible does a disservice to the market, as its stocks would become “dead inventory” and give a misleading impression to the market.

If the LME does decide to delist the Russian brands, Russian suppliers faces three difficult choices:

(1) They build stocks financed with their own capital or that of a partner

(2) They get China to step in and take their metal at a steep discount

(3) They decide to curtail production of their most marginal assets and do a combination of the first two options

This debate is just getting started and will incite compelling arguments on both sides. We will follow this closely over the next few months.

By Greg Wittbecker, Advisor, CRU Group, Gregory.Wittbecker@CruGroup.Com