Price Rise and Inventory Management

When two elephants fight, it is the grass that gets trampled

-African Proverb

The next time you find that a can of your favourite beverage to be expensive then don’t blame it to government’s mismanagement. The battle of price has gone beyond the realms of monetary and fiscal policies. It is now being fought between a financial giant Goldman Sachs and a beverage giant Coca Cola. The centre of the issue is a warehousing company Metro International Trade Services.

The price of aluminum (a key input needed for the canning) has gone up by 13% since January this year. The current price of $2500 is way above the price of $1700 in June 2009. The increase is occurring despite rising inventory. Global aluminum stockpiles on the London Metal Exchange have grown from below a million tonne in 2007 to currently more than 4.5 million tonne. Metro’s stockpile totals 25% of the aluminum on LME or about 12% of the world’s warehoused aluminum. In February 2010, Metro’s acquisition for a reported $550 million by Goldman was one of the deals where financial institutions entered the littleknown world of warehousing operations. If the current stockpile remained even over a year, Goldman Sachs would earn revenue of $230 million from Metro's warehouses.

However, space rental is hardly the reason for owning a warehouse. Direct connection to the physical markets for metals can give metal traders an enormous edge in understanding the demand and supply realities and help make profitable buy-andsell decisions. This stockpiling model of commodities is becoming more and more accepted as the newest method to influence prices and secure trading advantages. It has been seen in silver with physically-backed ETFs.

During the recession in late 2008 and 2009, Metro began stockpiling aluminum. With reduced demand, producers needed a place to put their aluminum output to maintain production. They could do this by housing the metal in warehouses and selling the warrants of the metal on the LME. Metro charges a storage fee of 42 cents a tonne each day to the LME warrant holder on aluminum sitting in its warehouses. It uses an incentive system to bring in far more aluminum than it allows leaving its warehouses, causing long delays in the delivery of the metal and, in turn, inflating prices. Once the metal is in the warehouse, the producers who are paying rent sell ownership of the metal on the LME. But the created bottleneck of delivery leaves new owners waiting for months for their product to be released.

According to LME rules, only 1,500 tonne of aluminum is required to leave the warehouses each day, but an unlimited amount can enter. 

The LME created the rules in a different era when stockpiles were much smaller. The issues weren't as glaring as they are today, and it's unfair for the LME not to change dynamically with the system. Coca-Cola alleged it takes more than seven months to access its purchases from the Metro warehouses. During this time, they pay a storage fee. This means less aluminum in the physical market when the need for aluminum is rising.

Coke is accusing Goldman of limiting the supply that is leaving its warehouses, trying instead to increase stockpiles and artificially boosting the prices that producers can charge. Taking money from small consumers through financial market manipulation of commodities is very well known. But now this time, the financial giant is messing with one of the premiere global companies.

Published in The Economic Times