AMU Explainer: Metal storage and why contango matters to traders

Physical traders exist to provide liquidity to markets during periods of surplus or shortage. Here, we focus on their role in managing surplus market conditions, where contango plays a crucial function.

In times of surplus—such as the collapse of the former Soviet Union in 1991, the Global Financial Crisis of 2008-2009, and the sharp reduction of Canadian exports to the US in 2025—traders purchased metal when end users were unwilling to do so.

This meant traders were willing to assume the financial risk of storing, financing and eventually selling that metal when market conditions became more favorable.

Storage options: Producer pre-bills

Traders have historically been creative in arranging storage.

In some cases, they simply prepaid for metal and left it at the primary producer’s smelter. This was known as “pre-bill metal,” where the producer tendered a holding certificate to the trader, certifying that it held X number of tons on its plant site. The trader would pay against the holding certificate. The producer would hold the metal at its smelter until the trader elected to ship the metal out.

More often than not, the producer did not charge the trader storage fees unless it was compelled to create extraordinary storage yards, in which case it might require a nominal monthly storage fee. Storage at the smelter was the best option because the trader did not incur freight costs to move the metal.

This approach worked well for smelters with liberal revenue-recognition rules. Some did not.

Conservative smelters may not recognize the revenue on these pre-bill sales unless the metal physical moves—meaning the trader had to remove the metal from the smelter site.

Often, this meant moving it a few miles away to off-site storage. Or the trader elected to move it to a consuming location. This is where “consignment inventories” came into play.

Storage options: Consumer consignment

Anyone old enough to remember Enron’s meltdown will recall how, in the late 1990s and early 2000s, Enron and many other companies relied on off-balance-sheet inventory financing.

Companies sold inventories to affiliates or third parties and agreed to buy them back later through a series of financial swaps.

The system worked for legitimate companies that understood their deferred liabilities. But for some, like Enron, those liabilities became overwhelming and led to bankruptcy. The Sarbanes-Oxley Act of 2002 shut down the practice, and companies lost the ability to manage inventories in this way.

In aluminum, physical traders developed consignment inventory as a replacement for off-balance-sheet financing.

Aluminum traders adopted vendor-managed inventory (VMI), an idea pioneered by companies such as Fastenal in supplying hardware to manufacturing plants.

Aluminum consignment is straightforward.

The trader ships metal to the consumer’s location and the consumer agrees to provide free or very low-cost storage. Title to the metal remains with the trader until the consumer declares a need for metal for production. The consumer notifies the trader that it wants X tons. The trader bills the consumer for that amount, and the consumer draws from the consigned inventory.

The beauty of the arrangement is that:

• The trader receives free or low-cost storage.
• The trader effectively controls a portion of the consumer’s eventual demand.
• The consumer eliminates inventory altogether.

Consignment works best with consumers that are considered good or excellent credit risks. Why?

Because behind every trader is a banker assessing the collateral pledged to finance the metal.

An highly rated consumer holding consigned metal is considered low risk by the bank, which is comfortable the collateral exists. That said, the cardinal rule of consignment is “trust but verify.”

All traders and banks employ third-party warehousing agents to audit inventories and ensure they align with what the consumer reports as on hand. This is the same practice used for smelter-held inventories and public third-party warehouses.

Storage options: Third party warehouses

Traders who don’t store at smelters or consign metal with consumers will also use third-party warehouses.

A good example is Owensboro Riverport Authority (ORA) in Owensboro, Ky. ORA has handled millions of tons of primary aluminum over the years for many traders. It is situated on the Ohio River to accept inbound barges carrying imported metal, as well as rail shipments from Canada.

Owensboro is also located near some of the largest consumers of primary aluminum in the US, including Commonwealth, Hydro, Novelis, Southwire and Tri-Arrows Aluminum.

ORA offers strong storage options for traders whose bank covenants require them to store metal in public warehouse where collateral can be easily verified.

Contango and its role in financing

Traders accept physical premium risk as part of their role in the supply chain.

The old adage is “well bought is half sold.” However, even a well-priced premium purchase can sour if the metal cannot be financed. This is where the London Metal Exchange (LME) plays a critical role.

A contango market is one in which the forward price is progressively higher than the cash price. In principle, the month-to-month increase in prices should reflect the cost of financing inventory plus storage costs.

Financing costs vary depending on the trader’s credit rating and the security of the collateral.

In this example, we use the secured overnight financing rate (SOFR) in the US plus a premium of 200 basis points to estimate cost of capital.

The current SOFR rate is 3.64%. This puts financing at 5.64% (364 basis point financing rate + 200 basis-point premium).

Financing

LME cash at this time is $3,072 per metric ton. At a minimum, the cost of financing LME cash metal would be $173.26 per year ($3,702 x 5.64%), or about $14.44 per ton per month ($173.26 / 12 months).

Storage

LME storage fees are capped at 57¢ per metric ton per day, or $17.10 per month (57¢ x 30 days). In this example, we do not assume LME storage because traders are not carrying metal in LME warehouses. Instead, we assume a blend of smelter-held storage, consignment and third-party warehouses at $3.00 per ton per month.

Taken together, financing cost plus storage costs amount to $17.44 per ton per month.

Now let’s compare that with prevailing LME month-to-month contangos.

LME contangos and cost are not aligned

As of Feb. 9, the month-to-month contangos are not attractive for financing metal.

February to March is $6 per ton. March to April $6. April to May is even worse at $4. May to June is a mere $2.

This creates a serious problem for physical traders carrying inventories. They cannot hedge inventories on the LME and earn enough contango when rolling short hedges forward. In effect, they face a negative yield curve.

In simple terms, for March to April, with a contango yield of $6 per ton and costs of $17.44, the trader loses about $11.44 per month—about half a cent per pound.

This is an untenable position for the trader. So how do traders cope?

They either create an “artificial contango” in forward physical premium quotes, or they recover financing costs through appreciation in the physical premium.

Since Dec. 31, appreciation in the Midwest premium has more than compensated for the lack of LME contango. On Dec. 31, the premium was 91.05¢ over LME. Currently, it stands at $1.0395.

That appreciation is more than sufficient to cover financing costs over the past two months, which have been slightly above 1¢ per pound.

Cynics might argue this explains why the Midwest premium has continued to move higher, as back-and-forth transactions among traders have pushed reported premiums upward.

The reality is the Midwest premium is covering financing costs now. Were it not, traders would simply mark up future delivery premiums by the net cost of financing—roughly half a cent per pound per month.

Why this matters

The market is trying to determine when physical premiums will top out.

A key factor will be whether more import supply enters the pipeline. Traders and producers are the linchpins to increasing imports. However, both must recover the costs of financing that pipeline. The LME is not doing that today.

As a result, traders need premiums to continue appreciating. For seaborne imports, this is essential. Otherwise, they must markup future premium quotes.

For Canadian producers, the issue is less problematic because they ship against orders that are invoiced immediately. For them, financing is limited to receivables, which they absorb as a cost of doing business while remaining satisfied with current spot premiums.

On balance, the lack of contango means the market has a vested interest in seeing premiums continue to rise until LME contango widens. That may not occur given the low level of physical stock in LME warehouses.

As a result, the market may be caught in a pincer movement, with higher premiums required to stimulate import supply.