It didn't take very long for someone to work out a way of making money from the London Metal Exchange's (LME) new rules around Russian metals.
The U.S. and UK governments announced on Friday April 12 a new sanctions package, which prohibited either the LME or CME exchanges from accepting deliveries of Russian metal produced after that date. The LME duly updated its rule-book on April 13, suspending deliveries of new Russian metal.
When trading resumed on the Monday, someone cancelled 79,875 metric tons of aluminium, equivalent to around a sixth of LME registered inventory.
By the end of the week a total 172,500 tons had moved to the cancelled category, draining warranted stocks to 152,000 tons, the lowest level in almost two years.
Given that Russian brands accounted for more than 90% of all LME-registered aluminium at the end of March, this is clearly Russian metal on the move.
The LME had warned about the potential for large amounts of Russian metal to enter exchange warehouses not to exit it.
But the exchange's warehouse system comes with its own kinks, particularly when it comes to storing aluminium.
Russian Splits
The latest sanctions package is intended to hit Russia's export revenue from sectors that account for 5.5% of global aluminium supply, 4.0% of copper supply and 6.0% of nickel.
Any metal produced after April 12 should in theory trade at a discount to the LME price since it is now non-deliverable.
But as well as splitting Russian metal between old and new production, the sanctions split older production into two categories of LME warrant.
Russian aluminium already on warrant on April 12 was subject to delivery restrictions but those have now been lifted. What the LME calls Type I Russian warrants can circulate freely through the LME system and be loaded out for physical delivery.
Russian metal produced before April 13 can still be warranted but such Type 2 warrants will come with restrictions on UK and U.S. entities and citizens being able to cancel, re-warrant, shift locations or take delivery for their own account.
It's worth noting that there were 737,000 tons of aluminium sitting in LME off-warrant storage at the end of February. Some, possibly most, of this shadow stock will be Russian metal.
What was cancelled last week were Type 1 warrants. The metal could return to the LME and be re-warranted subject to the exchange's audit trail requirements.
More likely it will return and be re-warranted as Type 2 material. Or it will be replaced with shadow stock, which will also become a Type 2 warrant if delivered onto exchange.
Either way, Type 2 warrants are more likely to stick in the LME system given the restrictions around taking physical delivery.
Storage Split
That would be very good news for whoever is warehousing the stuff, since there is nothing a warehouse operator loves more than metal that isn't going anyway any time soon. The longer it stays in the shed, the more revenue the storage provider gets.
And whoever re-warrants what's just been cancelled or replenishes it with off-market metal can earn a share of that revenue.
So-called "ever-green rent arrangements" allow for a split in future storage revenue between the warehouse and the entity delivering the metal.
They are regularly used by warehousers to attract metal to their storage space. They have the advantage of being cash-flow neutral, allowing smaller players to compete with bigger operators, who can pay a cash incentive to drag metal out of the physical supply chain.
But they have also been a bone of contention for many years, generating LME stocks churn as new owners are forced to move metal between warehouses to free themselves from the rental share deal with the party that originally delivered the metal.
The LME decided to continue allowing them, albeit with some tweaks, after a 2019 consultation on warehousing reform.
Recent large movements of lead and zinc stocks through the LME system are almost certainly as much a function of warehousing as metal dynamics.
Aluminium has always been the primary battleground in the LME storage wars. It's a bigger market than any of the other base metals traded on the LME and it's prone to periods of persistently high stocks.
It was aluminium that caused the LME headaches 10 years ago in the form of long load-out queues from Detroit.
It looks like aluminium is now going to cause more trouble as warehousers and traders capitalise on the Russian warrant split.
Turbulence
The sharp reduction in LME live aluminium tonnage has inevitably caused turbulence across the front part of the curve.
The LME cash-to-three-months spread was valued at $46 per ton contango at the close on Friday April 12. It has since swung into the sharpest backwardation since June last year. The cash premium was valued at just over $27 per ton at Monday's close.
A one-day short position roll, known as "tom-next" on the LME, cost over $25 per ton at one stage Monday.
The outright price seems unsure what to do. There was a knee-jerk spike to a 22-month high of $2,728 per ton on the sanctions news but the gains were lost by the end of the day. Last week saw three-month metal rally again but the move reversed at Monday's high of $2,688 and has slid back to $2,590 on Tuesday morning.
The UK and U.S. governments were hoping that by allowing older Russian metal to continue trading, they would avoid a drain on stocks and any resulting price turbulence.
They didn't allow for the fact that after years of gaming the LME's labyrinthine rules around load-out queues, both aluminium traders and warehouse operators are primed to spot any regulatory gap, however narrow.
It's a high-risk game given both governments' interest in seeing the sanctions take effect without market distortion.
But the game is definitely on.
