By Declan Conway
OSLO, May 26 (Reuters) - Aluminium scrap dealers on Monday raised doubts over using London Metal Exchange (LME) furtures as a hedging tool, despite assurances from a major LME trader that it could offer their market more transparency and less volatility.
The LME has two aluminium alloy futures contracts: one Standard Alloy contract, and the North American Secondary Aluminium Alloy Contract (NASAAC).
"The connection between the LME and aluminium scrap prices, at least as far as low grades of scrap are concerned, requires, like good fiction, a suspension of disbelief -- it really depends how much you are inclined to do so," said Michael Lion, a consultant with Australia's Sims Group, one of the largest scrap processors in the world.
In his address to delgates at the BIR spring convention in Oslo, Lion listed a number of concerns as potentially deterring scrap dealers when it came to the using LME futures as a hedging tool.
"The greatest determinant to any consistency in scrap pricing to the LME is the burgeoning development of China in the market," he said.
"This market truly is an 'X' factor in scrap pricing influences...the dynamics of this market have become increasingly opaque."
He said strong scrap demand in China had been reduced to a bidding war, de-stabilising the market and leaving no logical place for hedging when discounts can vary almost more than the risk factor against other market fluctuations, such as the LME or COMEX.
He said scrap dealers were also worried about being exposed to strong backwardations (when the cash price is higher than the forward price) on the LME, as well as "expensive" and complex option fees.
Fees at three-months options run in the range of four to five percent of the contract value are simply too costly for scrap dealers.
"Given the wholly capricious nature of backwardations there are still considerable risks, while for the most part scrap hedgers should be viewing the use of the market as a means of reducing risk exposure," Lion said.
"....the complexities both of the performance and diligence and expertise to moniter the positions is very demanding unless you have a fantastically supportive broker."
However, he said there was a valid place for high-grade aluminium -- and copper -- scrap hedging on the prime futures market.
The LME futures contracts, however, could still widely benefit scrap dealers, a major LME floor trader told delegates in Oslo.
Malcolm Culley, senior accounts executive at Amalgamated Metals, said there were three main areas where scrap dealers could benefit: price discovery, hedging, and delivery.
He said the LME could provide scrap dealers with a transparent international reference price, a hedging tool to protect against uncertainty caused by price volatility, and a delivery system as a last resort for users against disrupted supply, or buyers in times of over-supply.
"It is worth realising that the primary aluminium industry, once deeply opposed to LME pricing, now uses the LME as the basis of its prices worldwide," Culley said.
"It is also worth realising that the LME is not rally a gambler's market. If you are serious about your metal business we would suggest that not hedging your price risk is outright speculation. Hedging is the sensible thing to do."