Commodities Beckon Banks

This article is really interesting when you read it, I encourage you to ask the question: Can a Fox mind the chickens? Just another way that the commodity market is manipulated!

Aivars Lode

BUSINESS JULY 5, 2011.
Commodities Beckon Banks
Resource Storage Gives Lenders Profits in Tough Times, but Some Clients Complain of Bottlenecks.

Text By CAROLYN CUI And TATYANA SHUMSKY
About 600 miles from Wall Street, Goldman Sachs Group Inc. employees are busy doing deals. WSJ's Brian Baskin reports on one of the newest profit centers for big banks...warehousing metals and commodities. But instead of a sleek office tower, they work in a rundown warehouse deep in an industrial section of Detroit. And rather than trading in stocks or bonds, they move metal—lots of metal.

Goldman's warehouse on the banks of the Detroit River is one of more than 100 storage facilities controlled by the giant securities firm around the world. The warehouses are part of Wall Street's effort to forge a new frontier in the commodities markets: warehousing metal.

In the past 18 months, Goldman, J.P. Morgan Chase & Co. and trading firms Glencore International PLC and Trafigura Beheer BV have snapped up warehouse operators, all of them accredited to house metal traded through the London Metal Exchange, or LME. The buying binge means the four firms now are landlords to about two-thirds of the LME's entire metal stocks, from aluminum to copper to zinc.

LME metal stocks represent a small portion of the global supply. For example, LME's total aluminum stocks are about 4.5 million tons, or about 10% of the world's annual supply.

For Wall Street, warehouses are a way to earn extra income, especially as core businesses like trading are suffering. The facilities represent a relatively small but profitable way to bet on commodities markets without actually trading, the firms said.

But the growing muscle of securities firms in the metal-storage business is riling users and traders, who say the firms have both a bird's-eye view of supply and demand and the ability to control what goes in and out of their warehouses. These traders worry the firms could exploit their knowledge. The new owners say they keep their trading arms and warehouse operations separate, and there is no evidence to suggest they share information.

Traders and metal users have complained to the U.K.'s competition watchdog and the LME about companies acting as both trader and warehouse keeper. On Thursday, the Office of Fair Trade said the complaints lacked substance, and the agency won't investigate. The LME says it has no evidence to support claims the warehouses are used to gain an unfair advantage.

Goldman's operations in Detroit are at the center of the controversy, because aluminum prices are higher in that area than the trading price in London, and Goldman controls most of the warehouses in Detroit. Warehouses like the one along the Detroit River hold about one million tons of aluminum, or almost 25% of the LME's stocks.

Metal users such as beverage giant Coca-Cola Co. and can maker Novelis Inc. have expressed concern to the LME that the Detroit warehouses send out too little of the commodities they need. The LME has responded by instructing warehouse to release more commodities.

"This is inappropriate," says Nick Madden, chief procurement officer at Novelis, referring to the release limits and the wait to receive aluminum. Warehouses in Detroit owned by Goldman are only required to release 1,500 metric tons of metals a day. The warehouse only rarely surpasses this limit, according to LME data.

Novelis, a beverage-can maker, is the largest user of aluminum in the U.S. "We see it as very unhealthy for the market," he says. "The ultimate bill goes to the consumers."

Procurement officers at Coke and Novelis have said the limited releases are driving metal costs higher. A Goldman spokesman says its warehouse unit "is fulfilling the LME's requirements."

With record levels of commodities piling up, companies that own the warehouses are raking in nearly $1 billion in rental revenue each year, according to LME data.

Here is how it works: If a producer or merchant needs to store some aluminum, for example, it sends the metal to a warehouse, paying rent every day. In Detroit, Goldman charges 41 cents per metric ton of aluminum per day, or about $150 a year, according to LME data.

The rent is offset by big cash incentives warehouses pay to attract metal. But with millions of tons in storage, even a difference of a few dollars of income per ton can quickly add up.

The business was a backwater in the commodities markets for decades, dominated by small, independent operators. Then the financial crisis put the industry on the radar screens of Wall Street firms looking for new ways to make money. The firms correctly predicted a slump in metal demand during the recession, increasing the need for storage.

In 2010, J.P. Morgan acquired Henry Bath & Son as part of the New York bank's purchase of RBS Sempra Commodities. Goldman bought Metro International Trade Services LLC, a Romulus, Mich., warehousing company, for an undisclosed sum. Trafigura, the world's second-largest metal trader after Glencore, purchased U.K.-based NEMS Ltd. Glencore paid $209 million for Pacorini Metals, the metal-storage business of Pacorini Group, an Italian, family-run firm.

"The warehouses give the banks exposure to commodities without them having to be involved in price volatility," said Clare Eilbeck, a metals researcher at Brook Hunt, a subsidiary of commodities consulting firm Wood Mackenzie.

Simon Collins, a director at Trafigura, says the Amsterdam-based firm sees its warehouses as a "recession hedge" when other businesses slow. So far, the frenzy of warehouse buying is paying off. Glencore's Pacorini earned profits of $31 million in 2010 on revenue of $220 million, according to its recent initial-public-offering prospectus. Henry Bath was one of the biggest contributors to J.P. Morgan's base-metal business in the first five months of this year, according to people familiar with the matter. A J.P. Morgan spokeswoman declined to comment. A Glencore spokesman also declined to comment.

In Detroit, Goldman often offers a discount to attract customers to its warehouses but sometimes forces buyers to wait seven months or longer to get their inventory back, according to some users and LME data.

As a result of recent complaints, the LME will require most warehouses to release more metal on a daily basis starting next April. But analysts say the exchange's move isn't enough to alleviate the delays.

In New Orleans, warehouses owned by Goldman, J.P. Morgan, Glencore and Trafigura have accumulated 60% of all the LME's zinc stock. Right now, traders say, the delay in getting metal out of storage is about five days, but traders are worried that might increase—like in the aluminum market—as stocks rise but output remains constant. Greater stocks inside warehouses mean more clients potentially requesting the release of stored commodities.

"Clients are clearly not pleased with metals being tied up for many months," said Mike Frawley, global head of metals at Newedge USA LLC. Clients have little choice but to wait or find another source, such as buying directly from a producer or merchant.

But getting metal quickly from other sources for faster delivery costs extra. For aluminum, buyers are charged a premium of about $187 a ton, according to Karen McBeth, global director of Platts Metals Group, a commodities-information provider. Aluminum currently trades at $2,486 a metric ton at LME. Zinc users are being charged about $165 a ton more than the LME trading price.

There will be yet another problem if the economy picks up and buyers increasingly need metal they are storing in warehouses. "I am very worried," said Steven Spencer, chief executive of Traderight Ltd. "We have never seen stocks this high. It's going to be very hard to move so much metal around."

Write to Carolyn Cui at carolyn.cui@wsj.com and Tatyana Shumsky at tatyana.shumsky@dowjones.com