COLUMN-New year, same old warehouse problems for London Metal Exchange: Andy Home

(Andy Home is a Reuters columnist. The opinions expressed are

his own)

By Andy Home

LONDON, Jan 7 (Reuters) - A new year it may be but the

London Metal Exchange (LME) will spend a large part of it

grappling with the same old problems afflicting its global

warehousing system.

Waiting times to remove metal from log-jammed locations will

have flexed out again over the course of December, given last

month's large cancellations of aluminium at the Dutch port of

Vlissingen and of zinc at the US port of New Orleans.

By just how much will be clearer when the LME releases its

next monthly report on Monday.

Load-out queues, however, are only the most obvious

manifestation of a storage system that remains obstinately

dysfunctional.

The core underlying problem remains the yawning gulf between

the cost of storing metal in exchange warehouses and storing it

anywhere else. It is the reason why so much metal is still

waiting to leave the LME system.

And that problem, like the queues, is set to get worse,

judging by the increases in rent and load-out charges that will

kick in from the start of April.

It's worth remembering that these are the maximum allowable

rents. Much of the metal lying in LME warehouses will be paying

less rent under private bilateral deals arranged between the

owners of the metal and the warehouse operators.

That said, most of the metal queuing to leave the system,

and that's a very large amount indeed in the case of aluminium,

2.33 million tonnes, will be paying the maximum.

RENTS UP...

Average maximum rents will rise by 3.5 percent in the next

financial year, a similar level to the rate of increase this

year, according to the LME.

The figure has been adjusted to reflect the amount of stocks

held by each warehouse operator.

It's a statistical twist that is legitimate enough but which

serves to mask a more aggressive collective stance by the LME's

warehousers.

Things looks a bit different if the median rental charge for

next year is measured against this year, as shown in this table.

(Only aluminium has been adjusted to exclude the two Japanese

good-delivery locations, which were last used in 2009.)

2015-2016 Aluminium Copper Lead Nickel Tin Zinc

Median Rent 50 46 45 54 51 47

Cts (Taiwan OTC: 3672.TWO - news) /tonne/day

Pct Change 6.38 6.98 2.27 3.85 6.25 6.82

The reason the LME's calculation is lower is because

Pacorini, the warehousing arm of Glencore (Xetra: A1JAGV - news) , is

increasing its rents by a modest 1-2 cents per tonne per day

next financial year. And Pacorini, as of the end of November,

was storing more than half of all the metal in the LME system.

Steinweg, holding the third largest amount of metal, is

lifting maximum storage costs by a similar amount.

Others are being less restrained.

Metro (Xetra: 725750 - news) , which has just been sold by Goldman Sachs (NYSE: GS-PB - news) to the

Reuben brothers, will lift rents by 3 cents

across all metals and all locations, matching its increase this

year. It held the second largest amount of metal at the end of

November.

Henry Bath, the other member of the "Big Four", is going for

an even steeper rise of 4 cents per tonne per day for aluminium,

copper, tin and zinc.

That's particularly significant since Henry Bath, now owned

by Mercuria, was one of the warehouse operators that heeded the

LME's call for restraint in the current year by leaving its

rents unchanged.

So too did CWT (SES: E1:C14.SI - news) , which will lift maximum storage charges by

2-4 cents in the coming year in compensation.

Worldwide Warehouse Solutions (WWS), owned by Noble Group,

actually reduced rents in the current year but has evidently

decided to play catch-up with the most aggressive rate hikes of

all, up to 8 cents for aluminium, nickel and zinc.

It may well have taken the view that restraint got it

nowhere, since its share of LME metals storage had dwindled to

just 0.25 percent at the end of November.

...LOAD-OUT CHARGES UP

Even more significant a shift in stance is evident from the

lift in load-out charges, or, as they are referred to on the

LME, the free-on-truck (FOT) charges.

The average increase for the current financial year running

to the end of March 2015 was just below 1 percent. Only two

operators, Steinweg and Pacorini, lifted FOT charges by any

significant amount. Some, such as WWS, cut their charges.

In the coming financial year only Metro among the major

players together with a handful of smaller operators are holding

their FOT charges unchanged with just about everyone else going

for some sort of increase.

As a result the average load-out rate, again excluding the

Japanese aluminium warehouses, will rise by 3.4 percent over the

current year.

Whichever way you churn the statistics, it's clear that the

total cost of LME warehousing, rent plus load-out charge, is set

to resume its seemingly inexorable upwards trend.

A PREDICTABLE REACTION

And in many ways this is an all-too predictable riposte by

the warehouse operators to the LME's raft of proposed changes to

its warehousing system announced last November.

Indeed, the timing of its latest consultation exercise was

viewed by many operators as a breach of an unwritten rule that

the exchange wouldn't cause operational uncertainty ahead of the

December deadline for warehousers to submit their proposed rent

rates for the following financial year.

As such, several may well have gone for overtly aggressive

hikes to preempt the potential but still unknown costs of

complying with new rules such as conducting their own audits,

meeting per-metal load-out requirements and, for those choosing

to participate, adhering to the even tighter rules governing

storage of premium warrants for the exchange's proposed new

aluminium premium contracts.

More fundamentally, though, these increases in storage fees

reflect how LME warehousers themselves think their business will

evolve.

The LME's multiple rule changes will alter the exchange

warehousing landscape. Specifically, the exchange wants to get

rid of existing load-out queues and, over the longer term, limit

the potential for new queues, particularly those artificially

created by warehousers.

The logical inference is that metal will flow faster through

the LME system. The logical commercial reaction by warehouse

operators is to offset the loss of potential earnings from

queues, in which metal tends to pay the maximum allowable

rental, by increasing the maximum allowable rent threshold and

the cost of loading-out metal.

VICIOUS CIRCLE

The vicious circle, in other words, continues.

The more the LME endeavours to ensure efficient delivery

times from its warehousing network, the more warehouse operators

increase the costs of LME storage.

In doing so, they widen the disconnect with off-exchange

storage, in effect incentivising the movement of metal off

market, endangering both their own and the LME's franchise.

Capping rents and load-out charges would be the most obvious

way of breaking the circle, but the LME is still keeping under

wraps the legal advice it has taken on this subject, even though

the previous impediment, the long-running legal saga with

Russian aluminium producer Rusal (HKSE: 0486-OL.HK - news) , has now run its course.

It remains uncertain, therefore, whether capping rents would

be legal or not. And even if it were, how would warehouse

operators react? Would they simply walk away? Several are

already likely baulking at the extra regulatory burdens flowing

from the current barrage of rule changes.

The relationship between the LME and "its" warehousers has

been dysfunctional for many, many years. And there's still no

prospect of it becoming less dysfunctional this year either.

(Editing by)