MJP swap trades pick up pace amid US probe, China stocks

Chicago Mercantile Exchange Japanese aluminum premium contract or MJP swap trades started to pick up pace in the second half of 2017, with open interest surging 69% to 9,052 lots on December 29 from 5,362 lots on July 3.

The increase mirrored the rise in spot trades in the physical market as Japanese buyers, notably consumers, cut volumes under long term contracts and became more active in the spot market.

S&P Global Platts captured a total 66,250 mt of spot CIF Japan physical trades in 2017, 41,750 mt or 63% of which were in the second half of the year.

In the fourth quarter, MJP swap contracts traded in long "strips" for January-December 2018, rather than for shorter periods. This was another sign of the paper market's affinity with the physical market.

Negotiations for 2018 annual contracts, where the premium was to be fixed for the year, started last November. The swaps were used to hedge the 2018 settlements.

One trader involved in paper swap as well as physical aluminum trades said there were probably around 10 active players in the MJP paper market at present, and the volume cleared in the over-the-counter market was one or two times the size of the exchange-cleared volume.

There are around 30 active players in the spot CIF Japan physical market, and the swap market still has room to grow, the trader said.

"Bid/ask spreads in the nearby paper contracts are around $5-$7/mt, but are expected to narrow in the future. The frequency and volume are picking up, so I am optimistic about growth in the contracts," the trader added.

ALL EYES ON US PROBE OUTCOME

In the US spot physical market, renewed interest in the US government's Section 232 investigation into whether aluminum imports were impairing US national security pushed up premiums in 2017, notably in Q4.

The government may impose a new import duty depending on the outcome of the investigation, which is expected by end March.

As major exporters to Japan were global smelters with operations in Australia and North America, US premium trends are closely linked with those in Japan. In sales negotiations with Japanese buyers, indications from smelters would be based on US market trends. This makes sense to Japanese buyers because the US market is the world's most liquid and closely tracked.

However, this Japan-US physical premium linkage was less apparent in H2 2017 due to winds blowing in the opposite direction from China.

While there was a clear uptrend in the US Midwest, Japan was almost flat in H2, with a bearish outlook triggered by growing stockpiles in China.

Shanghai Futures Exchange stocks have been increasing even though Chinese aluminum smelters and alumina refiners were supposed to cut production by as much as 30%, according to exchange data.

Shanghai Futures Exchange aluminum prices weakened as a result, hovering around $2,000-$2,100/mt in December -- the same level as the LME price.

Low Chinese domestic prices were fueling exports of semi-processed aluminum products, sources said. China levies an export tax on aluminum ingot, while some semis are tax-free.

Some producer and international traders expect the downward pressure from China to be limited as a shortage in the US market was currently absorbing the excess supply in Asia, and the impact of China's export drive was not as visible as it was in 2015, the last time the LME was higher than the SHFE.

"In order for China to export constantly, LME needs to be $200-$300/mt higher than SHFE. The SHFE downside will be limited as the cost of production is high in China," said one international trader.

CME futures also started to take on another role aside from hedging physical trades in 2017, as market participants started to study the swap forward curve for clues on the longer term market direction.

The answer was not straightforward.

CME swaps showed that the general trend was up, but there was a lot of ups and down at short intervals.

The January 2018 CME contract, for example, traded 17 times over September to December -- including at $103/mt September 13, $98/mt September 28 and $100/mt October 6 -- before peaking at $103.50/mt and falling to $102/mt on October 27.