But, wait -- how does the scam actually work? Even some close readers were left befuddled. To make matters more confusing, Goldman Sachs responded to the Times' story in a Politico newsletter Monday morning, saying that the buildup in warehouse inventories was simply a matter of economics. "As with other global commodity markets, prices are ultimately driven by supply and demand, and there's been significant overcapacity in the global aluminum market for years now," a Goldman spokesman said. "Thus, the need for storage and the role the warehouses have increasingly played. In many ways the Times is confusing a symptom for the cause.”
It's true: Global demand has languished, while new supply from the Middle East and India has boomed. But because of how aluminum market rules work, it's still possible to conduct some serious arbitrage.
The United States, explains Harbor Aluminum Intelligence analyst Jorge Vazquez, produces 1 million tons of aluminum less than what it consumes. So it has to get the rest from elsewhere -- usually through futures contracts on the London Metal Exchange, which used to be owned by its members, including Goldman and other banks. Those prices have declined since their mid-2000s highs:
But the market price is only part of what a MillerCoors or a Coca-Cola has to pay for the aluminum in its cans. They also have to pay the "premium," or the logistical cost of getting the metal to their plants. The London Metal Exchange has to approve the warehouses where aluminum goes before it's shipped out and set the maximum amount that the warehouses can ship out per day and maximum rent that the warehouses can charge the owners of the metal (the Exchange takes one percent of the rent as a fee).
Here's the trick: Three years ago, Goldman bought a bunch of warehouses around Detroit and started paying traders extra to bring their metal there rather than anywhere else. The longer it stays, the more rent Goldman can charge, which is then passed on to the buyer in the form of a premium.
"The bigger you get, the bigger the incentive you can afford to bring it into the warehouse," says Vazquez. "It's like a snowball. So what this means is the warehousing system is effectively establishing the premium in the market." Even if manufacturers do try to bypass the warehouses, the Times reports, the market price is still artificially high. And a company called Glencore is doing the same thing in its warehouse in Vlissingen, the Netherlands, which amplifies the global effect.
The bottom line: Banks have lots of money and have leveraged that buying power to control enough of the aluminum market to generate extra revenue, which--the Times calculates--has cost consumers $5 billion over three years.* So even if prices are lower than they were during economic boom times, they're still higher than they would be under fairer market conditions. (The game is, of course, much more complicated than that. For an explanation that includes the words contango and backwardation, refer to FT Alphaville.)
All this could come to an end, however, if the Federal Reserve decides not to renew the exemption that allows banks to own infrastructure where commodities are stored. On Tuesday, the Senate Banking Committee will hold a hearing on whether they ought to.
* This language has been clarified since originally published to accurately reflect the Times' reporting.