Column: Shanghai’s nickel twist risks further market disruptions

LONDON, Sept 12 (Reuters) – The London Metal Exchange’s (LME) controversial suspension of its nickel contract in March didn’t just impact trading in London.

Immediately following the LME intervention, the Shanghai Futures Exchange (ShFE) was forced to suspend its nickel contract for two days and arguably suffered even greater damage.

Unsurprisingly, LME nickel volumes have plummeted since March, with August activity down 47% yoy. But ShFE nickel volumes have fallen more sharply, falling 74% yoy in August and down 70% through the first eight months of 2022.

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Nickel activity in Shanghai is now back to levels last seen in 2015 when the contract was first signed.

ShFE’s response is to expand the range of physical nickel that can be supplied under their contract to include briquettes.

The move would help address the Shanghai contract’s ongoing problem with extremely low inventories and align it more closely with the LME product.

However, there is also a risk of stimulating competition for LME stocks, which are mostly in briquette form and are already low.

The root problem is that both exchanges compete for physical liquidity in a shrinking part of the global nickel supply chain.

Nickel price, volume and open interest on the Shanghai Futures Exchange

CHANGING FORM

The ShFE first brought up the idea of ​​including briquettes in their contract in 2020. It’s a form of nickel that’s become more widely traded in China in recent years, largely because it’s a popular choice for electric vehicle battery manufacturers.

This year’s market slump seems to have given the proposal new impetus.

It’s easy to forget that the short squeeze that caused chaos in London March was pre-empted by the rolling tights in Shanghai in the second half of last year.

Indeed, the resulting pro-import arbitrage fueled a rush for LME stocks and set the stage for the price explosion that rocked the market in early March.

The ongoing tightness in the Shanghai market is a result of chronically low stock levels. It fell below the 10,000 ton mark in April last year and hasn’t recovered since and currently sits at a meager 3,523 tons.

The physical liquidity of the Shanghai contract is constrained by the fact that it only allows the supply of solid plate nickel cathodes with a limited number of registered brands.

Apart from China’s domestic manufacturers, only Russian brands Norilsk Nickel (GMKN.MM) and Glencore’s (GLEN.L) Norwegian Nikkelverk brands are accepted.

Expanding the delivery criteria to include briquettes seems like an easy win-win to make the contract more useful to domestic battery nickel companies and attract more physical units to ShFE warehouses.

The only problem is where that extra metal might be coming from.

China’s Monthly Imports of Refined Class I Nickel

OUT OF FORM

China does not produce much high purity Class I nickel, most of the country’s production is in the form of nickel pig iron for the stainless steel sector.

Briquettes must be imported from Australia, Madagascar and Canada or from the LME storage system where briquettes account for 87% of recorded nickel stocks.

The history warns of what could happen if the ShFE changes its delivery criteria.

The Shanghai nickel market has been plagued by low inventory liquidity since its inception in April 2015. Faced with the prospect of immediate pressure on its new contract, ShFE Norilsk Nickel included solid sheet as a delivery option from June this year.

This triggered a tectonic movement of Norilsk brand nickel from the LME warehouses to China.

At the beginning of June 2015, LME warehouses held over 267,000 tonnes of full nickel, representing 57% of the total registered stock. By the end of 2017, this stock had dwindled to 71,340 tonnes, which is just 19% of recorded nickel stocks.

China’s refined nickel imports hit an all-time high of 371,000 tons in 2016, including 228,000 tons of Russian-origin metal

ShFE nickel inventories increased from 10,000 tonnes in mid-2015 to also still an all-time high of 112,000 tonnes in September 2016. Since then the mountain has shrunk to a minimum.

SHRINKING PART

A similar shift in briquette inventory cannot be ruled out, although there simply is not enough metal to generate the quantities seen in the 2016 solid plate cathode migration.

LME nickel stocks fell by 147,000 tons last year and have halved again so far this year to 53,532 tons.

Although bolstered by the flow of refined metals into China in the final months of 2021, underlying demand for LME shares came from the battery sector.

The world is building more and more gigafactories and most of them require refined nickel to feed into the metallurgical mix.

The availability of refined nickel is in question and that of briquettes even more so.

Remaining physical stocks risk being split between two trading venues, disrupting rather than enhancing pricing.

The core problem facing both exchanges is that refined Class I nickel accounts for only about half of global production and the ratio is steadily declining as Indonesia builds more nickel matte capacity.

The Tsingshan Group, which was at the center of the March storm, is a massive nickel producer, but none of its production is in refined form to ship to the London or Shanghai markets. With no way to physically deliver against his short position, his massive exposure could only be resolved at exorbitant financial cost.

Restrictions on what type of nickel can be traded on the London market played a key role in the market explosion of 1988, when the LME also briefly halted trading.

The problem was well understood even then, but no one could agree on what would constitute a benchmark specification for a product as chemically variable as ferronickel.

It remains to be seen whether the LME or the ShFE can find a pricing solution for an increasingly diverse range of products, which now includes a fast-growing stream of nickel sulphate.

Competing for a shrinking chunk of the physical market may not be the answer.

The opinions expressed here are those of the author, a columnist for Reuters.

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Edited by Emelia Sithole-Matarise

Our standards: The Thomson Reuters Trust Principles.

The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and freedom from bias under the Trust Principles.

Andi at home

Thomson Reuters

Senior Metals Columnist, previously covering industrial metals markets for Metals Week and EMEA Commodities Editor at Knight-Ridder (later Bridge). He founded Metals Insider in 2003 and sold it to Thomson Reuters in 2008. He is the author of Siberian Dreams (2006) about the Russian Arctic.

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