London, 13 August 2011: Reuters

The Dutch port of Vlissingen has just notched up something of an LME record, registering the largest single-day warranting of metal in the exchange's history. A massive 195,850 tonnes of primary aluminium were warranted at LME warehouses in the city on Tuesday.

It's not the first time this year that Vlissingen has seen such high-volume stocks flow. It received 100,000 tonnes on both Jan. 7 and July 27. A port that was historically defined by its herring industry is fast becoming a city of aluminium. LME warehouses in Vlissingen now hold 599,675 tonnes of the stuff, the second largest concentration after Detroit, which holds 1,130,075 tonnes.

THE DUTCH DETROIT?

There are some obvious comparisons between the two LME good-delivery locations. Aluminium stocks at Detroit surged during the dark days of late 2008 and early 2009, when the near-collapse of the U.S. automotive sector caused a deluge of unsold metal to flood onto the market of last resort.

LME locations in the U.S. received a total 1.25 million tonnes between October 2008 and June 2009 with the lion's share of over 500,000 tonnes entering Detroit warehouses. What is currently moving onto warrant at Vlissingen may well have its origins in the same period of manufacturing contraction.

It wasn't just North American producers who were left with huge surplus tonnage in the wake of the Lehman moment in September 2008. UC Rusal , the world's largest aluminium producer, offloaded large tonnages to minority shareholder Glencore over the course of 2009. Estimates at the time ranged from somewhere in the region of 1.0 million to 1.8 million tonnes. The metal effectively disappeared from sight, which may well have been part of the motivation at a time of bombed-out prices and mass mothballing of producer capacity.

That legacy stock may finally be surfacing as it moves from the statistically invisible to the visible sphere. The sheer magnitude of the inflows at Vlissingen defies any other interpretation than a wholesale relocation of existing stock.

Nor is there much doubt as to Glencore's involvement. Its warehousing subsidiary, Pacorini, is the sole LME approved operator in Vlissingen. Since Pacorini was bought by Glencore in September of last year, it has invested in new storage capacity in the port.

Warranted stocks in Vlissingen have mushroomed from just 62,250 tonnes to close to 600,000 tonnes over the same period. More is widely expected to follow and we may finally get to see just how much unsold tonnage Rusal tendered back in 2009.

LOCK (DOWN) AND LOAD (OUT)

That concentration of logistics ownership in Vlissingen mirrors the dominance of Metro, the Goldman Sachs subsidiary, in the Detroit warehouse business. That has fuelled market concern that the Dutch port may see the formation of the sort of load-out queue that has become the defining feature of Detroit and which has caused such headaches for the LME executive.

Such fears seem misplaced right now. Not one tonne of metal in Vlissingen has been cancelled. Indeed, not one tonne of metal has even been sighted by other aluminium traders, suggesting that this stock is in a financing deep freezer.

In this regard Vlissingen is quite different from Detroit, which has become the primary outflow channel for LME warehouse stocks. Between them, though, these two locations define the problem of accessibility to LME-registered stocks. The queue at Detroit would not exist were it not for the fact that so much metal elsewhere is locked-up in financing deals and therefore not available to would-be buyers through the LME clearing system.

To quote Europe Economics, the independent consultancy hired by the LME to investigate the Detroit queue, "finance deals affect the distribution of cancellations among warehouses, resulting in a concentration of cancellations in those Warehouses that do not engage in finance deals." It is the combination of financing deals and the resulting concentration of "free-float" metal on just a handful of locations that has undermined the LME's status as market of last resort for those seeking physical aluminium.

Vlissingen is fast becoming the prime example within the LME system of locked-down metal, just as Detroit has come to define the constraints of load-out times.

IT COULD BE A LONG WAIT

Nor is there much reason for thinking that what is on LME warrant in Vlissingen is going to be going anywhere any time soon. Profitably financing metal is predicated on three interacting dynamics: market contango, a competitive warehouse deal and "cheap" money. Contango results from surplus metal. Quite evidently, there is no shortage of aluminium to the point that the market is only now collectively seeing the full build up of stock that followed the Great Contraction of 2008-2009.

A competitive warehousing deal becomes much easier when the financier owns the warehouse operator. The sort of discounted rent deal previously available for metal held off-warrant can now in all likelihood be matched by one for metal held on warrant at a "tied" warehouse.

And as for "cheap" money, the U.S. Fed has just told everyone it will be holding rates at close to zero for the next two years. Moreover, the underlying assumption that normalised interest rates would lead to the unravelling of finance deals is untested.

Specifically, it doesn't factor in the by-product of large-scale metals financing, namely the resulting high physical market premiums. European premiums for duty-paid aluminium are currently quoted at all-time highs of over $200 per tonne over LME cash. The presence of so much metal in Vlissingen is meaningless to the physical market as long as it is not available.

What this means, though, is that an entity that is involved in all facets of the metals business from LME trading through warehousing to physical merchanting can take a holistic view of a finance trade rather than seeing it as a simple sum of the parts.

This is also reason to question whether surging premiums in themselves would cause the unwinding of financing deals. There are two other ways that metal such as that at Vlissingen could be forced out.

Firstly, a sharp contraction in the spreads to the point of backwardation would alter the risk-return dynamics of the trade. This has happened at regular intervals in the LME aluminium market over the last couple of years. But since the protagonists have tended to be other tier-one players with their own warehouses, these periodic squeezes have resulted in little more than a shuffling of the stocks pack.

Secondly, metal locked up in financing could be used to back a physical exchange-traded fund (ETF), a potential product with which both Glencore and UC Rusal have been associated. The much-hyped aluminium ETF has proved remarkably elusive, however, and even if it were launched, the metal would be just as effectively locked down. Only the ownership would change.

All of which suggests that there is going to be a lot of aluminium in Vlissingen for a long time. European consumers paying those high physical premiums can only watch and wait.

Ends --

By Andy Home, Reuters market analyst – for Commodities Now.

The views expressed here are his own.