By John Helmer, Moscow
There are at least five million tonnes of aluminium in storage at the moment hidden from count in order to prevent the price of the metal from collapsing. Much , if not most of that aluminium comes from the Russian aluminium monopoly, United Company Rusal. Investigators for the US Commodity Futures Trading Commission (CFTC) in Washington, and members and staff of the Senate Banking Committee, under pressure from constituents who want to lower the aluminium price, are beginning to take an interest in market rigging schemes by Rusal and its principal trader, Glencore Xstrata. First to feel the impact is Rusal’s share price, which slipped this week to HK$2.89, with a market capitalization now of less than $6 billion.
So dependent are Rusal’s revenue and profit lines on keeping its metal out of sight, a recent call by Rusal for greater transparency and accuracy in the disclosure of trader and storage operations was unusual. In remarks to Bloomberg in May, Oleg Mukhamedshin, Rusal’s deputy chief executive, said  “the market is not as transparent as it could be. We are asked by our investors what’s going on, and we are just not able to address those questions.” Rusal insiders, who can address those questions with the missing numbers, say they are “terrified” of company sanctions if they do. “Despite the fact that financial investors have such a significant impact on LME prices, we cannot have a proper analysis in terms of open interest and stocks,” Mukhamedshin added in his Bloomberg interview. “The whole world is trying to get more transparent. There are clear benchmarks. Why shouldn’t LME follow best benchmarks?” He was kidding.
According to Rusal’s website, the company controlled by Oleg Deripaska (image left) for a trust of state officials, is the world’s largest producer of primary aluminium. Production for 2012 was 4.2 million tonnes; that’s a 9% share of the global market. Rusal reports  indicate that Kremlin restrictions on the amount of smelter production it can stop in Russia, and the number of Russians it can throw out of work, mean that in the December quarter of last year output was cut by just 2%. In the March quarter of this year, Rusal says  it cut another 42,000 tonnes (3%) “mostly attributable to the decreased production at certain less efficient smelters located in European part of Russia and Urals.” Moscow banking analysts are being told that Rusal plans to cut more production this year – about 300,000 tonnes, or 7.2% compared to 2012.
How much of the continuing output is actually sold in Russia and in export is far from clear. So is the reliability of Rusal’s sales revenue figure. Glencore’s chief executive Ivan Glasenberg (image right) – a shareholder and board member of Rusal – has been trading by agreement with Deripaska about 40% of the total output on terms which are the subject  of litigation by minority shareholders in the London Court of International Arbitration. In time this tribunal will decide who is paying – Deripaska, Glencore, or Rusal’s minority shareholders – for this concealed trading scheme.
Rusal acknowledges that Glencore is its biggest customer. The Rusal financial report  for 2012 qualifies the revenue figures by saying: “The Group’s customer base is diversified and includes only one major customer – Glencore – with whom transactions have exceeded 10% of the Group’s revenue. In 2012 revenues from sales of primary aluminiums and alloys to this customer amounted to USD3,138 million (2011: USD3,547 million).” — page 37. Actually, that’s 34% of Rusal’s aluminium sales.
Recently, a substantial stock of unsold Rusal metal was discovered  at a warehouse complex at Sillamae, Estonia. What tonnage moves in and out of the Silmet storage, an accountant on the spot said : “Even if I have such information, it is a commercial secret”.
How this metal is accounted for on Rusal’s balance-sheet, and on the corresponding balance-sheets of Glencore and other traders, is uncertain. By stocking this phantom aluminium in warehouses outside Russia, uncounted by the London Metal Exchange (LME) – off-warrant aluminium, in the LME lingo – Deripaska and Glasenberg keep secret how weak demand for the product is, and how much the price must continue to fall in order to sell. If price must fall, while Rusal’s costs remain stable, the result is obvious. Rusal is haemorrhaging cash – negative $123 million in 2012, according to Citibank calculations; negative $364 million this year.
According to a report issued by Citibank analysts in Moscow in April, if aluminium prices slide another 5%, Rusal’s earnings (Ebitda) will dwindle by 50%; a 10% decline in the metal price will turn into a 65% cut in Rusal earnings. Citi is forecasting a 4% cut in the aluminium price this year, 11% next year, and 13% in 2015. Publication of the Citi forecasts is being deterred by lawyers Rusal has sent to demand enforcement of their copyright. Analysis of Rusal’s hidden stocks of metal, concealed payments, and the implications for Rusal’s solvency were deterred last week in New York by a litigation threat issued by Rusal lawyers against media publishers. An international business data agency has been warned by Schillings, a UK law firm engaged by Rusal to threaten libel action, that asking certain questions to and about Rusal is defamatory.
How much can be kept secret by threats like these if the US government starts investigating allegations of market supply manipulation and aluminium price rigging?
A spate of US newspaper reports has now appeared charging that LME warehouse stocks of aluminium are being illegally manipulated to generate profits for the warehouses and the banks, especially Goldman Sachs and JP Morgan, which own the warehouse companies. This week there was finger-pointing in Washington over who is to blame, as the beverage can business ( Coors beer, Coca Cola) attacked the banks in the hearing room of the Senate Banking Committee.
Four witnesses testified on July 23  before Senator Sherrod Brown’s subcommittee on financial institutions and consumer protection. Brown attacked the banks, their warehouse companies and the LME as a “cooperative” of vested interests. Timothy Weiner, testifying for the brewer Miller Coors, explained : “Historically, consumers and suppliers purchased aluminum directly from aluminum producers. The LME was always a market of last resort – where aluminum producers would go to sell their stock in times of oversupply and where aluminum users would go to buy metal in times of extreme shortage. This is a key function of all exchanges. However, Mr. Chairman, over the past few years, the market for aluminum and other base metals has drastically changed. My company and other manufacturers can no longer plan to buy the aluminum we need directly from aluminum producers.”
“Instead, what’s happening is that the aluminum we are purchasing is being held up in warehouses controlled and owned by U.S. bank holding companies, who are members of the LME, and set the rules for their own warehouses. These bank holding companies are slowing the load-out of physical aluminum from these warehouses to ensure that they receive increased rent for an extended period time. Aluminum users like MillerCoors are being forced to wait in some cases over 18 months to take physical delivery due to the LME warehouse practices or pay the high physical premium to get aluminum today. This does not happen with any of the other commodities we purchase. When we buy barley we receive prompt delivery, the same with corn, natural gas and other commodities. It is only with aluminum purchased through the LME that our property is held for an extraordinary period of time.”
According to Weiner, his firm has applied to the UK and US market regulators to stop the aluminium warehouse scam. “There is no clear “regulator” or oversight of the London Metal Exchange warehouses, the LME itself is a self-regulated entity. In addition to direct talks with the LME, both formal and informal, we have urged regulators in the United States, the United Kingdom and the European Union to give thoughtful consideration to the effect of LME business practices on the industries that rely on a supply of aluminum priced by reasonable market conditions. Specifically, we have asked the UK Financial Services Authority (recently reorganized as the Financial Control Authority) and the CFTC to regulate the LME system as it pertains to the commodity metals market. Both agencies have indicated they are uncertain whether they have the regulatory authority necessary.”
Graham Steele is the legislative assistant to Senator Brown responsible for this line of investigation and attack. He is reluctant to acknowledge that as much of the aluminium stockpile being manipulated is off-warrant, in warehouses which are not part of the LME system. He was unable to say whether the focus of the senate subcommittee will in time focus on the relationships between the banks, aluminium producers like Rusal and traders like Glencore.
Goldman Sachs wasn’t invited to testify, so it issued  testimony of its own. This is far more interesting, because the bank claims the principal beneficiary of the warehousing system is the producers of aluminium, and the largest metal traders when they buy the metal from the producers. According to Goldman Sachs, “it is the owners of the metal who direct warehouse operators to dispose of stored metal or transport metal from LME-approved warehouses to warehouses outside the LME system to meet their own needs or objectives…Some additional key facts about global aluminum markets and the LME system: Aluminum stored in Metro warehouses [owned by Goldman Sachs] amounts to approximately 1.5 million tonnes, compared with global aluminum production in 2012 of about 48 million tonnes. Approximately 95 percent of the aluminum that is used in manufacturing is sourced from producers and dealers outside of the LME warehouse system. The LME warehouse companies do not own the metal in their facilities. They merely store it on behalf of the ultimate owners.”
That includes the biggest producer of aluminium in the world, Rusal, and its trading partner Glencore.
According to a Reuters report  on July 23, the US regulator of the aluminium market, the Commodity Futures Trading Commission (CFTC), has begun its investigation. The CFTC has sent a letter to at least two warehousing firms stocking aluminium “ordering them to preserve emails, documents and instant messages from the past three years, two sources who received the letters told Reuters…The CFTC explicitly said that the firms should retain communication related to incentives or premiums given to metal producers in exchange for storing metal; daily loading rates; high load-out requests; delivery policies and procedures and complaints about load out requests. At least two companies involved in warehousing received the letter, but sources said they believe such notices were sent to all the major players.”
Can Reuters be prevented from identifying “major players” like Rusal and Glencore by threats from UK defamation lawyers?
In Washington CFTC’s spokesman Steven Adamske said: “We have not confirmed publicly that we have sent letters to aluminum warehouses in the United States.” He intimated that the letter Reuters got hold of was to warehouse companies. But he warned that the CFTC investigation of the aluminium market may be more extensive. “As a general matter, we investigate claims or evidence of commodity price manipulation in interstate commerce. This would apply to whether they are on or off exchange as long as the commodity is listed under the Commodity Exchange Act.”
This evidently suggests that non-LME warehouse stocks, like those in Estonia, may be a target of investigation. Asked if Glencore is the recipient of a CFTC don’t-destroy order, Adamske said it is “impossible for me to answer.” He means the CFTC will not confirm or deny investigations or their targets. So, can the CFTC say whether producer concealment of the off-warrant aluminium stocks is a subject of interest to the CFTC’s investigation of the reasons for the current aluminium supply premium? “I cannot answer whether this question is ‘a subject of interest’; but as a general matter if we believe something is being done to affect the price of a commodity then that would be of interest.”
According to Citi’s report on Rusal of April 18, the forecast for this year’s LME price for aluminium is $1,964 per tonne, while the premium for delivery earned by Rusal should be $249 per tonne. The current LME price  is between $1,800 and $1,850, depending on term. It was $1,700 a month ago.
The problem facing Rusal is that if its hidden stocks become as visible through the Washington investigations as the supply premium caused by LME warehousing, then both the metal price and the premium will shrink. According to Citi’s projected Rusal balance-sheet for this year, there is just a billion dollars of difference between sales revenues of $10.2 billion and costs of sales of $8.9 billion. If the first dwindles under price and premium pressure, while the second remains flat, Rusal’s earnings may plummet.
So how much aluminium is being hidden from the market? A London market source claims it is believed at the LME at present that the amount of hidden or off-warrant stocks of aluminium is about 5 million tonnes. That is close to, perhaps more than the amount of aluminium on warrant and counted in the LME statistics. The latter number  is currently 5.46 million tonnes. That’s 50,000 more tonnes than the LME reported last week. The comparable size of the off-warrant stockpile, said the source “is an accepted fact in the market”.
How much of this aluminium comes from Rusal? The source responded; “All the producers must be represented in the off-warrant stockpile”. He said there are no reliable estimates of which aluminium producers account for most of the hidden metal. But there is a clue, he claims. Glencore may be operating off-warrant warehouses through Pacorini, a Swiss-bassed company Glencore acquired in 2011. According to the Pacorini website , “services include any or all of the following components • LME and non-LME warehousing • tailor made distribution programmes.” Pacorini’s list of its warehouses can be matched against the LME regulated list . Pacorini doesn’t mention the locations of its non-LME warehouses.
If there are stocks of 5.46 million tonnes in the LME system, and at least 5 million more tonnes in hiding, how much is there in all? The number is even bigger than adding these two together because China, the world’s largest consumer of aluminium, is stocking large aluminium volumes of its own. The larger the China stockpile, the lower the volume of Chinese imports from Rusal. Apparently the Schillings law firm wasn’t alert with its defamation notices on July 8, when Bloomberg published a report ostensibly about how much production Alcoa, the US producer, is cutting. Halfway down the text there appears this stockpile admission from Rusal. “Inventories total about 12 million tons, excluding China, Oleg Mukhamedshin, a director at Russian smelter United Co.[Rusal], said in an interview July 1. That’s equal to about 27 percent of 2012 global consumption, according to data compiled by Bloomberg .”
So it’s semi-official then. Rusal, the world’s largest producer of aluminium, is avoiding having to cut its Russian production by hiding more and more of its metal abroad, in effect unsold to the end-user, although this has yet to be clarified in the audited financial reports prepared by KPMG. Look carefully at how KPMG qualifies the meaning of Rusal’s revenue figure, and you might judge that the off-warrant aluminium is also being hidden from the auditor. “Revenue from the sale of goods,” the auditor’s notes for the 2012 financial report  claim, “is recognised when the significant risks and rewards of ownership have been transferred to the buyer, recovery of the consideration is probable, the associated costs and possible return of goods can be estimated reliably, there is no continuing management involvement with the good and the amount of revenue can be measured reliably. This is generally when title passes.”
Watch for adverbs like “probable”, “possible”, “reliably” and “generally”, for behind them big nouns, big numbers are hiding.