A book hitting the stores Tuesday by CNBC's Kate Kelly takes a look inside the powerful group that runs the global commodities trade. The following is an excerpt.
During the summer of 2011, officials at the London Metal Exchange got an unexpected complaint from The Coca-Cola Company. The amount of physical aluminum in storage was piling up, said a representative of the soda maker, and, along with it, so was the expense of buying the metal for beverage containers.
The culprit, as Coke saw it, wasn't simple supply and demand—in fact, there was plenty of aluminum sitting in warehouses. It was the shrewd tactics of Goldman Sachs, the bank that owned a network of metal-storage facilities in the Detroit vicinity, where waiting times for extracting aluminum were longer than ever. Every day those metal bars sat idle, Goldman's warehouse company effectively drove up the premium amount that aluminum producers could charge for delivering supplies to beverage-packaging factories, a cost that amplified the expense of the actual metal and, thus, the prices Coke and others paid for soda cans.
"The situation has been organized artificially to drive premiums up," said Dave Smith, Coke's head of strategic procurement, at an industry conference that June. "It takes two weeks to put aluminum in, and six months to get it out."
Coke wasn't alone in its frustration. More than a year earlier, eight players had complained privately to the LME, the obscure London metals bourse that set the benchmark price for aluminum, zinc, copper, and other important nonprecious, or base, metals that were key in manufacturing. The U.S. warehousing system that the exchange oversaw was so inefficient that it was hurting corporate profits, they had argued.
The Midwest premium, the regional U.S. rate for getting metal from a seller to a buyer, was a cost imposed on Coke and other manufacturers in addition to the cash, or spot price of aluminum, which was by then bouncing back from its lowest levels in some time. Aluminum prices had increased 13 percent since the beginning of 2010, when Goldman had paid half a billion dollars to acquire Metro International Trade Services, the metal storage business it now owned in Romulus, Michigan. Bought relatively cheap at a time when commodity prices were low, Goldman took on Metro as a way to broaden its suite of physical commodity holdings, which had become an important complement to its derivatives trading in London and the U.S.
In addition to the revenue Metro offered, it presented Goldman with the possibility of a free look at what was happening on the physical side of commodities through ground-level operations. Tweaking existing contract trades in a commodity based on feedback from colleagues who worked in the physical markets was by then commonplace in banking. "We had pipeline capacity all over the place and we would call up and say, 'How's gas flowing this morning?'" remembers a trading manager who worked for years at one of Goldman's competitors. If flows were weak, he added, "We'd go, 'Oh, we're not going to get the pop we thought, so let's reposition.' " Still, Goldman spokespeople consistently denied that employees familiar with Metro's business operations shared information about it with internal traders.
Goldman wasn't the only one dipping into the physical commodity world, a cornerstone of companies like Glencore International, the Swiss trading firm originally known as Marc Rich & Co., that considered owning hard assets to be a critical aspect of trading commodities. JPMorgan had recently bought a metal-storage firm called Henry Bath & Son, among other physical assets. Broadly speaking, the bet was that metal traders would stock up on physical product while prices were relatively low and hold their stocks until the market improved, generating steady rental incomes for the warehouse owners in the process.
The new metal-warehouse owners quickly proved right—and had huge stacks of metal bars to prove it. The nine hundred thousand tons of aluminum Metro stored in its Detroit facilities when Goldman bought it in 2010 were growing daily. Meanwhile, incentive fees Metro paid to hedge funds, physical commodity traders and other tenants—usually one or two hundred dollars per ton each year—encouraged them to leave the metal there for longer periods.