Wall Street can cry if it wants, but its warehousing business is about to change, says a Morgan Stanley note out this morning.
They’re talking about the business that has been making headlines for the past few weeks. The New York Times accused Goldman Sachs of costing Americans $US5 billion a year by making their aluminium warehouse clients endure long wait times to receive deliveries of the metal.
The bank owns the Detroit-based Metro Metro International Trade Services, a warehouse company which is a part of the London Metals Exchange (LME) system. Goldman, for its part, defended the business in a Factsheet released last month. It’s been a boon to the bank in a world of low interest rates and low demand for commodities.
The problem, says Morgan Stanley, aside from the discomfort of many clients, is that this has started to impact the price of aluminium:
A large concentration of metal in a limited number of warehouses created a situation in which buyers of metal were forced to wait for unusually long periods for access. As a result, anyone wanting immediate delivery of material needed to pay a premium based on location availability. These premiums have been elevated to extreme levels, in the case of aluminium, since the beginning of 2012, as competition for immediate delivery of metal became increasingly severe... However, the implicit subsidies of the location premiums have shielded producers from the prevailing price signal to cut output. Consequently, our prediction of lower premiums would pressure marginal producers in those metals most affected by this phenomenon, namely, aluminium but also zinc.
So regulators are stepping in, and according to Morgan Stanley, they may actually win this one. On July 1st, the LME made its first “serious attempt” at fixing this problem by “by linking load-out rates directly with load-in rates in those warehouse locations with queues of greater than 100 days, so called Affected Warehouses.”
In short, if you bring something into the warehouse, you have to push something out ASAP. This policy would officially be implemented in April of 2014, but the LME is taking measures to prep Affected Warehouses immediately by instituting a “calculation period.” Think of it as a load in, load out practice run.
According to Morgan Stanley, this whole debacle may not all be said and done for another two years. In the meantime, there will be a few short-term kinks while new regulations set in — warehouses may increase their prices, and the price of aluminium could increase as well.
Ultimately, though, the bank thinks this could set things right in terms of the dislocation of aluminium prices as wait times will no longer shield producers from real market demand. Banks that own these warehouses (like Goldman, of course) will see their location premiums fall, making the business less profitable.
So there’s that.