LONDON (Business News) - Global copper market heavyweights are drafting proposals to stop metal from getting stuck in queues leaving storage facilities, as such delays would threaten the credibility of the London Metal Exchange's (LME) flagship product, industry sources said.
The issue has arisen at a delicate moment, as the LME lines up a potential $ 2 billion sale to another exchange.
Exchange regulations allow companies operating warehouses in the global network registered by the LME to release only a fraction of their inventories each day - much less than is regularly taken in for storage.
Clients of the exchange - the world's biggest marketplace for industrial metals - wait in queues to collect the metal, all the while paying rent to warehouses. The warehouse operators blame logistical bottlenecks for delays but critics say it is a tactic to increase rental income.
This distorts markets, giving artificially tight availability in the midst of plentiful supply.
Industry sources say the LME has tolerated similar strategies for aluminum, although this metal is also u sed heavily by banks and trading houses as collateral for financing deals.
The aluminum market is in chronic oversupply and there are concerns that queues to get it are blocking other metals, including copper.
Signs that delaying tactics had spread to scarcer copper galvanized the LME's copper committee to push the exchange's board into action. It decided in April to delist the Dutch port of Vlissingen as a registered delivery point for copper due to long queues at already congested warehouses.
Now the committee wants the LME to go further, and is asking industry for proposals on ways to fix the problem, sources familiar with the matter told Business News, saying the credibility of the LME's flagship copper contract is at risk.
The futures exchange, on Leadenhall Street in London's City financial district, retains some open outc ry trading and a small proportion of its cash contracts are settled through physical delivery of metal.
"It (the queues) is creating serious problems with the contract. It's not a cash contract if you have to wait months to get it," a senior industry source said.
"We will ask for proposals on what to do next," he said.
The decision, made at a committee meeting earlier this month, reflects mounting frustration among users of the LME's warehouse network which critics say is broken and undermining the LME's main role as a market of last resort - the place to go to buy or sell copper, at a price, if all else fails.
The proposals, to be collected and discussed at the next copper committee meeting in October, could include delisting other locations, building more warehouse space and mandating a daily outflow rate specifically for c opper, as the LME has already done for nickel and tin, sources said.
They could also include specifying a minimum daily delivery-out rate as a proportion of total stockpiles per warehouser per location, sources said.
"Clearly it is a difficult issue, there is no one simple solution to help cut some of these queues that have developed but, where we're able to take action, we will," Chris Evans, head of business development at the LME, said.
The LME's warehousing operations have been dogged by controversy since big banks and trading houses including Goldman Sachs (GS.N) and JP Morgan Chase (JPM.N) bought warehousing companies in 2010.
NUCLEAR OPTION
"There are some locations today where queues will limit or even prohibit the outf low of copper. You have certain locations, and Johor is one of them, that could be a problem going forwards," said another senior industry source familiar with the discussions.
Johor in Malaysia is an Asian metals warehousing hub, second only to Singapore. It is dominated by Pacorini Metals, owned by Swiss commodity trading giant Glencore (GLEN.L) which runs more than a third of 33 LME-registered warehouses there.
Traders have recently complained about months-long queues to take delivery of tin from the notorious hotspot.
Part of the reason industry is being tapped for proposals, a third source said, was because the web of warehousing and logistics issues were so complex.
"Johor is problematic because it and Nola (New Orleans) are important delivery points for copper, therefore the nuclear option of delisting, while open, is more difficult," he said.
WAREHOUSING KEY
This is a pivotal period in view of the exchange's potential sale.
Bids from InterContinental Exchange (ICE.N) and Hong Kong Exchanges and Clearing Ltd. (0388.HK) (HKEx) stand at around 1.3 billion pounds ($ 2 billion) according to industry sources. An LME board decision on which bid to recommend to its shareholders could come this week.
The high price tag for a business that logged just 7.7 million pounds in net profit in 2011 has turned off other suitors and put the spotlight squarely on value from the exchange's unique selling points, which include its global delivery network.
The LME raised its minimum daily delivery out requirements for all metals from April this year, in a bid to address the problem.
But it has long held the issue is not in its warehousing structure, but in stimulus pumped out by the U.S. Federal Reserve, which, tied with low interest rates, caused banks to pounce on financing aluminum as a low-risk income stream.
"When we announced the changes to the delivery out rate, we said that we would keep constant track on how it (queues) was affecting the market, and whether any further action needs to be taken - and that's what we're doing," Evans added.
"If we need to take further steps to ensure the smooth functioning of the market, then we will," he said.
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