(Kitco News) – Last Friday at midnight, the London Metal Exchange (LME) and the Chicago Mercantile Exchange (CME) enacted the most comprehensive limitation on Russian exports to date: a ban on all Russian metal produced after April 12. The move was made to bring the LME into compliance with the latest U.S. and U.K. sanctions imposed following Russia's invasion of Ukraine.
The goal is to prevent Russia from being able to profit from the export of metal produced by companies such as Rusal (aluminum) and Nornickel (nickel) which help the country fund its ongoing military operations in Ukraine.
“Russian metal warrants issued on or after 13 April 2024 for metal produced before 13 April 2024 are still subject to restrictions that prevent U.K. LME Members and clients from canceling or withdrawing the corresponding metal unless they are doing so for the account of a non-UK Client,” the LME wrote in a statement.
For their part, the CME told Reuters that they “are reviewing and will communicate any impact to our markets. We do not disclose the origin or brands of the eligible or registered metal we have in store and that is consistent across all of our physically delivered markets.”
The new sanctions have already resulted in the exploitation of new loopholes and trades within the LME system based on the technical nature of the contracts and corporate relationships.
For starters, the new regulations do not ban bilateral contracts between two companies, but only those made through the LME. Russian metals traded this way are expected to be available at a discount, and the ruling out of the LME and CME as destinations means there will be plenty of supply for these kinds of deals.
But during the first trading day under the new rules, another scheme emerged. According to a Bloomberg report, traders are making deals with the LME-approved warehouses to profit off the massive stocks of Russian metal that will not be sold, making it “the latest episode in a rich history of traders seeking to exploit loopholes to profit from giant stocks of aluminum on the LME, which can generate hundreds of millions of dollars a year in storage and handling fees.”
Type 1 Russian metals are those that were already in the system on or before April 12. These can still be traded through the LME. Type 2 are any metals sourced from Russia which were produced after that date.
“Crucially: once Type 1 metal leaves the system, it loses its special status,” they said. “If it’s re-registered, it becomes categorized as Type 2, and faces the same restrictions.
The report lays out the scheme. “First, traders are rushing to withdraw the large volumes of (Type 1) Russian metal already stored on the LME,” they write. “Then, after selling it (now, as Type 2) back on to the LME, they can cut a deal with the warehouse to share the rent from future owners.”
The traders and warehouses are “ultimately betting that the metal could sit there for months on end if UK nationals can’t withdraw it,” and the longer it remains there, the more money they both make.
On Tuesday of this week, nearly $200 million worth of aluminum was ordered for withdrawal from LME warehouses, signaling that the trade is now well underway, the Bloomberg report noted.
The LME responded to the new trade in a statement, saying that the exchange “continues to monitor the market closely and remains ready to take further action should that be required, including in relation to adverse market behaviours as a result of the introduction of the recent sanctions.”
According to a recent report from ING, the end result of the new sanctions will be an even greater share of Russian metal flowing to sanction-neutral countries, at ever-lower prices.
“The LME is a market of last resort for the physical metals industry,” the ING report noted. “Although most metals traded globally are never delivered to an LME warehouse, some contracts stipulate that the metal should be LME deliverable. This means that Russian companies will be forced to accept lower prices. Russia-origin metals will trade at even wider discounts and continue to flow to sanction-neutral countries, like China, the world’s biggest aluminium consumer.”
The bank said that China “is likely to continue to buy discounted Russian material to use domestically” while exporting their own domestically-produced and unsanctioned aluminum to Europe and the U.S. to fill the supply gap, effectively buying low and selling high.