The world’s largest mining group has called for urgent reform of the nickel market on the London Metal Exchange, arguing that last year’s chaos shows that the key pricing mechanism has become increasingly removed from the way the metal is traded.
BHP on Tuesday became the latest industry player to openly criticise the LME’s nickel contract, which has been dogged by low liquidity since last March when prices more than trebled to record highs in three days. The rise came as fears over Russian supply upended a huge bet by Tsingshan, the world’s largest nickel producer and consumer, on falling prices and led to the exchange controversially cancelling trades.
“The global price discovery mechanism for this critical building block of the energy transition is not functioning well,” BHP said on Tuesday in its annual economic outlook. “Reform of the LME’s metal delivery rules is long overdue. The LME short squeeze episode [last March] highlighted vulnerabilities that had been building for years.”
The broadside from the Australian group echoed frustrations widely held by mining groups, traders and consumers that rely on the LME’s contract to hedge against changing prices of nickel, which is used in stainless steel and electric car batteries.
The LME’s benchmark refers specifically to so-called Class 1 nickel, and the exchange accepts only this high-purity metal for delivery to its warehouses. Acceptance of their product by a trading venue is typically a condition for producers and traders to secure financing from banks.
The contract has long been used as the reference for lower-grade forms of nickel, but that has become increasingly problematic as Class 1 nickel has become a smaller portion of the overall market.
In 2010, 57 per cent of global nickel production could be delivered to LME warehouses, but that figure has fallen below 30 per cent and will fall further, according to BHP. The shift reflects rapid growth in the supply of intermediary products such as nickel pig iron or matte that were developed in response to the needs of a fast-expanding battery supply chain.
Compounding the issues for the nickel market is the sheer concentration of production and the consumption of battery-grade material in Indonesia and China respectively.
“The basic tension is that the exchange where the benchmark price is set has become more removed from what is happening in the physical clearing market — China,” BHP said.
LME nickel prices are trading at about $27,200 per tonne but analysts and traders say the price should be somewhere closer to $20,000. Nickel prices shot higher in December in a return to volatile trading patterns.
The gap between the price of lower-grade nickel and LME prices has become too wide for the benchmark to be reliably used in contracts and trades in some cases.
The market dysfunction makes managing price risk harder for miners, traders and consumers and could even threaten future supply by making it difficult to assess the economics of new projects and secure financing for them.
The LME has been trying to restore trading volumes to the contract but its efforts to reopen nickel trading during Asian hours have stalled because the UK Financial Conduct Authority has not permitted a reopening.
The LME said it recognised “the ongoing structural shift in the nickel market, driven by the dramatic growth in Class 2 output”.
“We are committed to working with the industry to ensure that the LME’s offering meets the industry’s evolving pricing and risk management needs,” it added.
Despite the turmoil, rival exchanges such as CME Group have been slow to launch an alternative to the LME nickel contract. However, former LME chief executive Martin Abbott, who now runs Global Commodities Holdings, a trading and logistics services company, plans to launch a spot trading platform for Class 1 nickel at the end of March that could potentially be tied to a rival futures contract on another exchange.
“We are going into a market that does have a pricing mechanism, albeit one that they [traders] currently describe as flawed,” Abbott said in an interview. “Now we will find out how flawed they think it is.”