|Shares Out. (in M):||90||P/E||0||0|
|Market Cap (in $M):||1,827||P/FCF||0||0|
|Net Debt (in $M):||83||EBIT||0||0|
|Borrow Cost:||General Collateral|
I am short Century Aluminum. Century is the best pure-play on upstream aluminum production. Other aluminum companies like Alcoa, Kaiser, Constellium, and Norsk Hydro have a bunch of midstream assets (ie processing) or other business lines. Century operates five smelters in the US and one in Europe. Century is the most beta you can find on the price of physical aluminum. I highlighted “physical” for a reason...this is important, Century receives the LME plus the physical premium.
I actually started working on Century as a long. I became curious about aluminum after reading about how automakers and aircraft OEM’s are increasingly substituting aluminum for steel for strength and weight reasons. So I looked at a couple aluminum companies figuring this would be relatively simple to understand. Several conspiracy theories and senate hearings later and I realized the aluminum market was way crazier than I first assumed.
Why bury the lead - let’s discuss the Midwest Premium. What is this anyway? When a smelter like Century sells aluminum to a customer, the contract is based on LME plus the local premium. In the case of the US, almost all smelters are located in the midwest (smelters are old and were built near access to cheap coal power) so the premium for the entire US is the Midwest Premium. Other geographies have their own premia subject to their own local market dynamics.
One would imagine the premium would mostly be the cost to store and transport it. Since those costs probably shouldn’t fluctuate much, one might also imagine that the Midwest Premium probably wouldn’t fluctuate much over time. And guess what, you would be right. For several decades, the Midwest Premium hovered around $100/mt. It did this in bull markets, it did this in bear markets, it did this when the price of aluminum was high, it did this when the price of aluminum was low, interest rates, etc. Sure there were some relatively minor movements based on a variety of factors, but generally the Midwest Premium stayed constant. This fundamentally makes sense...again, the premium shouldn’t be much more than the cost to store and transport aluminum.
Then in 2010, the Midwest Premium started rising. Pretty soon, it started rising very fast. Recently, it went vertical, abruptly spiking to record levels. This charge for essentially shipping and handling had strangely increased 400% from $100/mt historically to over $500/mt. Below is a chart of the Midwest Premium stretching back over 15 years for some perspective on how unusual this move was.
When commodities charts look like that, it’s seldom anything beyond a short-term anomaly. Baltic Dry index, rare earths, whatever…and the idea that there is a new paradigm in storing aluminum seems awfully silly. For some further perspective on how unusual this is, the Midwest Premium had historically only been about 5% of the price of the LME aluminum price, but at $500/mt (note that the chart is in pounds and there are 2,200 pounds per metric ton) it was over 30%. So what happened in 2010? Well, before I tell you, let’s talk about how the premium is determined.
For all intents and purposes there is just one warehouse in the US that controls most of the physical supply of aluminum: Metro International Trade Service (Metro). Metro is a network of warehouses in Detroit that for whatever reason (I’m guessing inertia combined with the likelihood that metal storage is a crummy business) manages to house most of the US aluminum supply. Metro is registered and regulated by the LME, thus allowing delivery under LME contracts and a variety of other LME regulations. The Midwest Premium is basically set based on the comings and goings of aluminum at Metro.
...Back to the Midwest Premium
Okay, so what happened in 2010? Wouldn’t you know it, Goldman Sachs bought Metro. Of all the gin joints, right? There was nothing crazy going on, they simply saw a good trade opportunity. As the owner of Metro, Goldman got paid from storage fees which are typically pretty small, something like $70/mt. With the aluminum market in contango, they saw a nice opportunity to profit, but they also figured out a way to turbocharge the trade.
The first thing Goldman did was start offering inducements for people to store their aluminum at Metro. This was basically a one-time bonus of a $100-200/mt to put your aluminum in their warehouse. Now that might seem a little strange, I mean, how does a company that charges X per year make any money by paying 2-3X upfront? Not exactly a good payback before operating expenses.
The second thing that Goldman started doing was enforcing LME’s load-in/load-out rules. The gist of these rules is that an LME-registered warehouse only has to load and unload a certain amount of aluminum per day. Oddly, the LME rules were such that the load-in rate was much higher than the load-out rate, and the load-out quota was a shockingly low 2,000mt, which is only a pallet or two’s worth. This means an LME warehouse could legally trap aluminum if they were so inclined. Now the inducements start making sense, because you can afford to pay those amounts upfront if you figure out a way to lengthen the storage life. In fact, this is what started happening. So an actual customer/owner of the aluminum at Metro would need their aluminum for something. Say, Coca-Cola to make cans. Let’s see how the conversation between Coke’s procurement guy and the manager of Metro would go:
Coke: “Hey, can we get 20,000 tons of our aluminum? Marketing is all bulled-up on this Kardashian-Edition Coke we’ve got coming out, and we need to do a giant canning run. You don’t even want to know what the secret ingredient is.”
Metro: “Gee, we’d love to except we just hit our daily load-out quota so we’re done for the day. Why don’t you try tomorrow? Love the Kardashian idea, by the way.”
Coke: “What do you mean? It’s 10am. It’s our aluminum and we kinda need it.”
Metro: “No I hear you, but we’re done for the day, all our drivers went to the MGM Grand.”
Coke: “Seriously, if we don’t get our aluminum Kanye West is going to go postal.”
Metro: “Sorry, take it up with LME. It’s Miller time. Thank you, come again.”
The final thing Goldman started doing was getting cute with some of the many financial owners of aluminum, as in the commodity desks of other investment banks. Those 2,000 tons of aluminum that Metro “hit their quota” with? Half the time it was aluminum owned by another investment bank who agreed to move it from one Metro warehouse to another. Boom, quota met, and no one who actually uses aluminum can get their hands on it. There are stories about Metro truck drivers just aimlessly driving around the Metro facilities with a load of aluminum.
How bad did it get? One way this is measured is the days to destock one’s aluminum, or the load-out queue. Before being under Goldman’s control, Metro averaged about 40 days to destock one’s aluminum. Obviously there are some logistical constraints to unloading the entire US’ aluminum supply, so 40 days sounds about right I’d say. How many days did it take until very recently? 700. Yes, it went from taking just over a month to get your aluminum out, to two years.