OREANDA-NEWS. A sharp decline in the premiums that aluminium buyers pay in addition to the London Metal Exchange (LME) price is cutting a final means of support that had insulated primary aluminium producers from difficult market headwinds.

US midwest premiums that have helped mitigate the effect of falling LME prices on primary aluminium producers have fallen by nearly $400/t this year, eroding US producers' margins as they struggle with high energy costs and a strong US dollar that inhibits their global competitiveness.

Alcoa this month reported a third quarter loss of $59mn in its primary metals division, down from a profit of $245mn in the year-earlier period. Century Aluminum will announce its results next week, but analysts are already expecting a sharp drop as a result of falling premiums.

The midwest premium that buyers pay for delivery of the metal out of warehouses fell to $143/t on 10 September, its lowest level since April 2011. The premium has since recovered slightly, plateauing to around $165/t today. But that figure is still a far cry from the historic high of $536/t in January.

The rise in premiums was driven by an increase in queues to remove metal from LME warehouses, which aluminium buyers claim stemmed from collusion between the warehouses, investment banks and metal traders seeking to maximize profit through a series of transactions that slowed the flow of metal. Frustrated by what they saw as unfair practices increasing their costs, buyers pushed for LME warehouse reforms.

Once the LME reformed its warehousing rules to improve transparency and discourage new financing deals that tie up metal and drive up queues, premiums moved lower. This is in part because of the movement of metal out of LME warehouses into the market, but also because metal holders were encouraged to move inventory into private warehouses, where data on queues and inventories is not so publicly available. In addition, backwardation of the LME price curve has reduced liquidity in financial trading of aluminium.

Although the premiums are meant to price metal from LME warehouses, they also set a benchmark for negotiating physical deals directly between producers and consumers. Thus premiums essentially became a part of producers' revenues, protecting them from falling LME prices.

Without the high premiums, sellers are exposed to LME prices that have failed to follow wider metal markets higher. The three-month official LME aluminium price settled at $1,536/t on 20 October, barely above its six-year low of $1,510/t on 24 August, according to Argus Metal Prices.

Aluminium producers and industry groups blame Chinese oversupply for flooding the global market and sinking prices and premiums. They say Chinese traders are exporting semi-fabricated aluminium and then remelting it into primary aluminium at another destination to take advantage of a rebate on processed aluminium exports and avoid a tax on primary aluminium exports.

Century Aluminum this year forecast that the falling premiums and prices in the US and on the LME would at least discourage the export of Chinese aluminium into the global market. But a strong US dollar and falling aluminium prices on the Shanghai Futures Exchange are helping Chinese traders hold on to the arbitrage.

On the Shanghai Futures Exchange, the spot-month aluminium price on 20 October fell to $1,763/t, its lowest since June 2009.

The only saving grace for producers is the possibility of capacity cuts in China. If that does not happen, producers in the US and Europe, where energy costs are highest, may have to take more production off line. Century has already said it plans to idle part of its Hawesville smelter in Kentucky this month in response to low prices and Chinese oversupply.

Support for prices will come in the form of closures, but "not as quickly as expected," AZ China consultant Paul Adkins says.

"Unfortunately two other things have happened — new capacity is being brought on line, and the export arbitrage window is reopening," Adkins said. "Both of these are not helpful for restoring China's metal balance."