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(Andy Home is a Reuters columnist. The opinions expressed arehis own)
By Andy Home
LONDON, July 18 (Reuters) - In the beginning there wasDetroit.
Looking back now on the genesis of the London MetalExchange's (LME) warehousing woes, the original aluminiumload-out queue in Motown wasn't rocket science.
Global financial crisis. Manufacturing collapse. A deluge ofunsold metal into the "market of last resort." Super-contango inthe LME forward aluminium curve. Cheap money. Stocks financing.
Metro, the dominant LME warehouser in Detroit, found itselfwith most of the free-float aluminium in the LME deliverysystem. The ensuing surge to get hold of that metal, led bystocks financiers, got jammed in the exit door because of theexchange's then minimum load-out rate of 1,500 tonnes per day.
Revenues from the queue allowed Metro to out-bid everyoneelse for fresh metal supply, creating a circular money-makingmachine.
Cue Goldman Sachs, which bought Metro and fine-tunedthe strategy. There are now 983,925 tonnes of aluminium in thequeue at Detroit, with a notional rental value of over $220million.
Modern-day alchemy, turning base metal into gold!
But it seemed to be a localised problem. One metal. Onelocation. One company.
Five years on, though, the queues have spread to other LMEgood-delivery locations and to other metals such as copper,where surplus is still a highly marginal phenomenon.
The LME has tweaked its load-out rules, to no obviouseffect. Now the entire global user-base is mulling over theexchange's latest proposed fix.
But the simple fact is that this mestastasising problem, tocoin a phrase used by my colleague John Kemp, isas much about the changing landscape of the LME warehousingbusiness as anything else.
This is a still unfolding story of the rise of themerchant-warehouser, a new breed of operator that has evolvedthe Motown queue metric to a new level.
THE DECLINE OF THE INDEPENDENT WAREHOUSER
When Goldman bought Metro back in 2010, it triggered awholesale consolidation of the LME warehousing business.
Prior to then only one warehousing company, Henry Bath, hadbeen owned by a bank, JP Morgan. It was a historicalanomaly dating back to the purchase of Henry Bath, which issuedthe first ever LME warrant in 1883, by LME brokerMetallgesellschaft in the early 1990s.
No one really cared that much since there were plenty ofother LME warehousers to use.
Once Goldman got into the business, though, others rushedinto the same space. Glencore, as it was then, boughtPacorini, Trafigura bought NEMS, Noble Group boughtwhat is now called Worldwide Warehouse Solutions (WWS) and LouisDreyfus bought GKE.
CWT, a logistics company, reverse-engineered theprocess by buying up trading houses MRI and, more recently, LNMetals.
Barclays Capital, together with steel traderMetalloyd, set up its own LME warehousing company, Erus Metals.
The number of independent LME warehousing companies hasaccordingly steadily declined to around 35 percent of the total. ***********************************************************Graphic on current LME warehouse ownership: http://link.reuters.com/zyf79t***********************************************************
And most of them are small and location-specific such as BLG(Bremen), Zuidnatie (Antwerp), Keystore (Hull) and Vollers(Antwerp and Rotterdam).
The only truly global independent LME warehouser isSteinweg, the grand-daddy of the LME storage business.
Maybe that should read "independent", given its linkedownership with trade house Raffemet. Or as Steinweg successfullypersuaded the Minor Metals Trade Association, which prohibitstrade ownership of its warehousing facilities, "servicesprovider" Raffemet.
The consolidation process has now pretty much run itscourse, largely because there are so few independent warehousersleft to buy.
The only recent development has been the purchase of ScaleDistribution in Liverpool by Macquarie Bank and fund manager RedKite, a deal everyone concerned describes as a bespoke business.
SHIFTING LANDSCAPE
Similarly, the build-out of LME storage capacity has, fornow at least, also run its course.
The number of LME-registered units increased from 584 inMarch 2010 to 689 in August 2012.
Over the last year, however, the total has marginallycontracted to 678 units, based on the LME's warehouse list datedJuly 11, 2013.
That levelling-out of total storage capacity masks some verysharp shifts in market share, though.
The graphic below shows the net changes in warehouse unitownership by major operators since August last year. *********************************************************** Graphic on ownership since August 2012: http://link.reuters.com/xyf79t***********************************************************
There is always going to be a certain amount of noise inthis data-series. Warehouse operators, most of whom rent storagespace, are always fine-tuning their capacity as leases expireand metal flow dynamics change.
But there are still three very clear trends at work.
The first is the shrinkage of the smaller, mostlyindependent warehousing sector, a net loss of 17 units.
The second is the shrinkage of the bank-owned warehousingcompanies.
Henry Bath's foot-print, for example, has declined by a net26 units in what looks like a major portfolio tidy-up.
So too has that of Goldman's Metro to the tune of a net 11units, including a complete withdrawal from Johor in Malaysia,where it has closed all six registered units.
While the banks retreat, the merchant-warehousers advance.
Glencore Xstrata's Pacorini has added a net 24 units overthe last year. Trafigura's NEMS has added a net 9 units.
The rise of these merchant-warehousers becomes even moreevident in a comparison with March 2010, before the carve-up ofthe LME warehousing business had really got going.
The two stand-outs are again Pacorini, up a net 92 units,and NEMS, up a net 20 units, as shown in the next graphic. *********************************************************** Graphic on ownership since March 2010: http://link.reuters.com/wyf79t***********************************************************
LOCATION, LOCATION, LOCATION
Even more telling is where these merchant-warehousers haveexpanded their storage capacity.
Trafigura's NEMS has consolidated its operating focus onAntwerp, where it has opened 16 new units over the last year,while trimming the number of those elsewhere.
It now operates 26 of a total 57 LME-registered sheds in theBelgian port. The next largest operators are Steinweg and MetalTerminals, each with seven units.
Glencore Xstrata's Pacorini has expanded into Vlissingen inthe Netherlands, New Orleans and Johor.
Pacorini effectively "owns" LME storage in Vlissingen,operating 53 out of a total 55 units and turning what was once aport famous for its herring industry into a city of aluminium.
In New Orleans it operates 32 out of a total 55 units. Thenext largest operator is Metro with 18 but the battle forcontrol is swinging in favour of Pacorini. It's opened five newunits over the last year, while Metro has closed two.
Pacorini is equally dominant in Johor with 11 out of 20units. Following the exit of Metro, the next largest operator isHenry Bath with four units.
Now, it's surely no coincidence that the five locations withload-out queues in excess of 100 calendar days, the LME'sproposed threshold for faster load-out, are Detroit, Antwerp,Johor, New Orleans and Vlissingen.
Dominating a good-delivery location is a pre-requisite forcontrolling both inflow and, crucially for those queues,outflow, as Metro showed all those years ago.
Metro, incidentally, is still the largest warehouse operatorin Detroit with 27 units, although both Noble's WWS and Pacoriniare muscling in with five and two units respectively.
THE RESISTIBLE RISE?
The LME, as it has repeatedly pointed out, has no legaljurisdiction over who owns the warehouse companies that servicethe world's foremost metals exchange.
It does control the approval of new storage units. Thetechnical pre-requisites are multiple and onerous, as anywarehouser will attest. Indeed, warehousers ascribe the highcost of LME storage to their own costs of complying withexchange rules.
However, beyond the technical tick-boxes, the LME seems tohave never had a broader set of criteria about the build-out ofstorage capacity at any one location.
Or if it has, it has been a case of worrying about toolittle rather than too much storage. Back in 2008-2009, forexample, Detroit was something of a back-water in the LMEdelivery system and Metro itself was gradually shrinking itspresence. It had to scramble to open units ahead of the flood ofaluminium deliveries from North American producers.
That, though, was a unique moment in time.
There is no comparison with what Pacorini, for example, hasdone in Vlissingen. In early 2010 it had just nine units in theport. It now has 53.
This may be good business for it and its owner but does thealuminium market, either the LME or the physical market,actually need such huge capacity in a location surrounded byother good-delivery points like Antwerp and Rotterdam?
The LME has always espoused free-market principles, which inthe case of warehousing has translated into a refusal tocontemplate capping storage capacity by location and/oroperator.
Yet a relatively simple solution to its warehouse woes wasalways to link capacity to load-out requirement, emulating thelargely successful way it handles dominant futures positions.Put simply, if a warehouse operator wants to dominate agood-delivery location, it comes with a quid-pro-quo in terms ofhow much it must deliver out.
It's a shame that such an option didn't make it into thecurrent consultation document.
WHO NEXT?
Because this LME warehousing landscape is going to keepchanging and, based on current trends, it's going to keepshifting in favour of the merchant-warehousers.
Both JP Morgan and Goldman have to sell their warehousingbusinesses by 2020 under U.S. banking rules on commodityinvestments.
In reality neither is going to wait that long. Indeed thefor-sale signs are already up.
Who, though, is going to buy?
Other banks are unlikely to, given the accumulatingregulatory pressure on proprietary trading and physicalcommodity assets.
There will be few logistics companies with the financialmuscle to afford what are likely to be high-priced assets.
The most obvious contenders are another generation ofphysical merchants, who often now come disguised in the garb ofhedge funds.
The risk is that they evolve further that original Motownqueue metric. (Editing by James Jukwey)
