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STATE OF SMALL BUSINESS

Banks' Control of Commodities Stings Entrepreneurs

The stranglehold big investment banks have on aluminum markets are driving up prices for small business owners.

Buying aluminum from smelters used to be a pretty straightforward affair for Duane Bryant, president and chief executive officer of Crane Materials International, a 120-person business in Atlanta with about $50 million in revenues annually.

The company's subsidiary, GatorDock, which has 24 employees, depends on a steady supply of aluminum for all of its products, which include nautical walkways, docks, and highway barriers. It used to buy what it needed on the spot market, carefully calculating costs using software that helped it forecast prices.

But the aluminum commodities market is in something of a tangle since investment banks have begun buying and controlling critical delivery infrastructure, creating bottlenecks in supply that often favor their own business enterprises.

While it's widely known this situation is bad for big businesses that depend on plentiful supply of the metal, including the automobile, beverage, and construction industries, the situation has now percolated down into small businesses that also depend on aluminum to create their products. Problems include increased wait times for shipments, a more opaque market, and higher aluminum prices.

"This puts more pressure on profits" Bryant says, adding that he'll often have to renegotiate pricing with customers because of lengthening waits for delivery, during which time prices for aluminum can often increase.

The Backstory

Aluminum is one of the most common minerals on the planet, and there is no shortage either of supply or capacity, experts say. It is extracted from bauxite, a process which typically requires natural gas, also in plentiful supply. Calculating prices by looking at supply and demand, while not a perfect science, was pretty routine in the past, particularly because aluminum is not generally plagued by wild price swings.

Two years ago, the majority of CMI's aluminum purchases were done on the spot market, where the commodity is sold for cash and delivered immediately, Bryant says. Not any more. Within the past year, CMI has been forced to buy more aluminum from the U.S.-based warehouses of the London Metals Exchange, many of which are owned by banks such as Goldman Sachs and JP Morgan Chase.

The warehouses add a storage fee for holding orders, and investment banks make a profit from those fees, which become a component of pricing. Hence, they have an incentive to hold orders longer.

In addition to expense, warehouses lack market transparency, Bryant says, making it nearly impossible to know what's held in inventory and what has been purchased already. That, in turn, makes it close to impossible to calculate supply and demand for pricing purposes.

"This has become part of the program, it is not wanting people to anticipate [prices] as well as they could a few year ago," Bryant says.

Normally, CMI keeps between $1 million and $2 million of inventory on hand, and it places orders of between 400,000 and 800,000 pounds.

Now, CMI holds more aluminum on its premises, and ties up more capital waiting for deliveries, times for which have doubled in some cases to two months. And instead of devoting about 25 percent of one employee's time to calculating commodities costs, Bryant must deploy three people who now regularly track the market.

How It Happened

The issue of the banks' control of commodities infrastructure was first brought to wide attention by a July article in the New York Times, which highlighted the activities of big investment banks in the commodities markets.

While the Bank Holding Company Act of 1956 prevented banks from directly owning commodities, the Gramm-Leach-Bliley Act of 1999 loosened those restrictions, allowing them to engage in broader activities like securities dealings, as long a they were financial in nature. That description has been broadly interpreted by the Federal Reserve to favor investment banks that want more involvement in commodities. And in recent years banks including Goldman Sachs and JPMorgan Chase, have rushed in to buy infrastructure for aluminum, primarily consisting of warehouses.

So while the banks do not control the amount of aluminum supply, they can create a bottleneck for the commodity, which in turn can affect prices and delivery times, experts say.

The Great Recession turned the aluminum market upside down, says E. Lee Bray, a mineral commodity expert for the U.S. Geological Survey. Prior to 2008, smelters such as Alcoa held the majority of aluminum inventory, which was sold on the spot market.

Of 1.8 million tons in inventory held at the end of 2007, U.S. smelters held 1.4 million tons, while LME warehouses in the U.S. held 463,000 tons, Bray says. By 2009, those figures had reversed: Smelters held 937,000 tons, and LME warehouses held 2.2 million tons. That situation continues on today, Bray says.

"During the financial collapse, the aluminum smelters needed to have cash to meet their normal business needs, but they could not go out and borrow money because of the financial crisis," Bray says.

While the banks rowed away from the foundering mortgage Titanic, they turned their attention to commodities. Goldman, for example, bought Metro International Trade Services, a metals warehouse company, in 2010. Similarly, JPMorgan Chase bought Henry Bath, also a metals warehouse company, in 2011. Both are LME warehouses.

Smelters had a choice then of either selling their product to LME warehouses, owned by investment banks that paid quickly, or to businesses that might be on the verge of bankruptcy and never pay. So more product wound up in warehouses.

Paying for the Bottleneck

Big businesses have been disproportionately affected by the bottleneck. In July, MillerCoors, among other market experts, testified before the Senate Committee on Banking Financial Institutions and Consumer Protections about how bank ownership of aluminum storage has cost it and its customer billions of dollars.

MillerCoors, which uses the equivalent of 4,000 747 jumbo jets worth of aluminum annually, says aluminum is its single biggest price risk. In the past couple of years, it has experienced exactly the same problems as CMI, of having to buy from warehouses.

"My company and other manufacturers can no longer plan to buy the aluminum we need directly from aluminum producers,"Tim Weiner, global risk manager of commodities and metals for MillerCoors, said in his testimony.

That's cost MillerCoors "tens of millions of dollars in excess premiums over the last several years with no end in sight," he said. In 2012 alone, LME warehouse bottlenecks added $3 billion in additional expenses to all companies that purchase aluminum in the U.S., Weiner added.

And for entrepreneurs like Bryant, perhaps more so than for big businesses that have more financial cushion and market sway, the resource problems penetrate deeply into his operations.

"It forces me to dedicate more people and time to monitoring what is happening to spot buys and inventory build on the LME instead of growing the company," Bryant says.

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IMAGE: Getty
Last updated: Aug 26, 2013

JEREMY QUITTNER | Staff Writer | Staff Writer, Inc. and Inc.com

Jeremy Quittner is a staff writer for Inc. magazine and Inc.com. He previously covered technology for American Banker and entrepreneurship for BusinessWeek.




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