Aluminum buyers at the Big Three automakers have expressed interest in using the newest creation of the London Metal Exchange (LME), a "Midwest-delivered" hedging contract for an aluminum alloy designed to lend greater domestic transparency to often volatile monthly pricing for grade A380. U.S. automakers use this material to make engine blocks, cylinder heads, manifolds, transmission and water-pump casings and other nonstructural parts.

Purchasing of secondary aluminum and die castings made from the scrap-based aluminum alloy is expected to climb sharply this decade, as engineers continue to work on lighter, more fuel-efficient motor vehicles. So, LME launched the risk-management contract on March 4 to meet the needs of North American automakers, already the largest buying group for secondary aluminum.

Kevin Moore, commodity manager for worldwide aluminum purchasing at General Motors Corp., say he is interested in using the LME contract, and so are secondary aluminum buyers at Ford Motor Corp. and the Chrysler arm of DaimlerChrysler. Moore says the world's largest automaker "ideally would like to lock in prices for the secondary product for up to 10 years at a time." The company will need 3.6 billion lb/year of aluminum annually by 2012, compared to 2.1 billion lb in 2002. Moore says 1.5 million lb will be primary aluminum, 1.7 billion lb will be secondary aluminum and 400 million lb will be specialty-grade secondary aluminum alloys low in iron and zinc.

There is widespread disappointment with the aluminum alloy contract that was launched in London in 1992 because trading volumes are small compared with other contracts traded on the LME. Buyers at North American automakers haven't used the global aluminum alloy contracts, mostly because the LME has allowed quality specifications to vary, depending on the supplying smelters, and that has run afoul of U.S. accounting rules. Financial Accounting Standards Board (FASB) regulation 133 allows companies to hedge only the products bought, but not derivatives. "We really need this single-specification contract to succeed for us to comply with these U.S. accounting rules," says Daniel Bealko, global commodity manager for lightweight metals at GM.

The new contract is based on the Aluminum Association's specifications for A380.1 alloy ingot. Physical metal is being stored at LME warehouses in Chicago, St. Louis, Nashville and Baltimore, although warrants for metal in Maryland will be valued at a discount from metal in the Midwest. And it will provide a better way of monitoring sales prices in the U.S. than the current system of polling merchants.

U.S. market prices reflect delivered secondary aluminum ingot in minimum 40,000-lb lots based on a formula factoring in fixed and raw materials costs for the smelters, plus marketing variables. So there is always a spread, a premium, between the LME monthly price and the North American market price to cover tariffs, insurance and freight. However, the lack of liquidity in the market has created a history of volatility in the price variance between secondary aluminum on the LME and in the U.S. end-use marketplace.

LME officials hope to take that price volatility out of the market with the regional contract. Scrap suppliers worry that the contract could fall prey to market distortions if investment fund buying drives up prices (or causes them to plummet) regardless of supply and demand.

Barry Jones, chairman of the LME aluminum committee, suggests there will be enough activity in the new contract to accurately reflect North American market prices. Since the LME is trading metal for actual delivery and future-delivery contracts, "it is an ideal tool for consumers or hedgers to fix forward prices for the aluminum alloy," Jones says, noting the exchange will act as a market of last resort for producers. Bruce Warshauer, chief executive of Wabash Alloys in Indiana, the world's largest secondary alloy producer, says his customers "certainly have a need and desire for forward pricing for aluminum castings that go into their cars."

Traders are worried about liquidity of the new Midwest-based contract since such a narrow focus has raised concerns about its long-term viability. "For this contract to be successful, it must become a liquid market," agrees Moore. Even Warshauer says the contract will be reliable only if it is reflective of actual physical transaction prices and there is sufficient market liquidity.

Heale insists "there are enough big players in the U.S. auto industry who are already interested in this contract," and believes the hedging vehicle will be successful "because buyers and suppliers in the industry came to us to create the contract."