Column: Shanghai’s nickel twist risks more market fracture

The London Metal Exchange’s (LME) controversial suspension of its nickel contract in March didn’t just impact trading in London.

In the immediate aftermath of the LME intervention, the Shanghai Futures Exchange (ShFE) was forced to suspend its nickel contract for two days and has arguably suffered even greater damage.

LME nickel volumes have unsurprisingly slumped since March with activity in August down 47% on the same month last year. But ShFE nickel volumes have fallen harder, collapsing 74% year-on-year in August and dropping by 70% over the first eight months of 2022.

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

ShFE’s response is to broaden the range of physical nickel that can be delivered against its contract to include briquettes.

The move would help address the Shanghai contract’s persistent problem of super-low inventory and align it more closely with the LME product.

But it also risks stimulating competition for LME stocks, which are overwhelmingly in the form of briquettes and already low.

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

Shanghai Futures Exchange nickel price, volume and open interest

Changing shape

ShFE first mooted the idea of including briquettes against its contract in 2020. It’s a form of nickel that has become more widely traded in China in recent years, largely because it’s a popular choice for electric vehicle battery makers.

This year’s market meltdown appears to have given the proposal fresh impetus.

It’s easy to forget that the short squeeze that caused the London March mayhem was foreshadowed by rolling tightness in Shanghai over the second half of last year.

Indeed, the resulting import-friendly arbitrage accentuated a run on LME stocks, laying the foundations for the price explosion that rocked the market in early March.

Persistent tightness in the Shanghai market is a function of chronically low exchange inventory. It fell below the 10,000-tonne level in April last year and hasn’t recovered since, currently standing at a meagre 3,523 tonnes.

Physical liquidity on the Shanghai contract is constricted by the fact that it only allows for delivery of full-plate nickel cathode with a limited number of registered brands.

Other than China’s domestic producers, only Russia’s Norilsk Nickel and Glencore’s Norwegian Nikkelverk brands are accepted.

Extending the delivery criteria to include briquettes looks like an easy win-win of making the contract more useful for domestic battery-nickel players and attracting more physical units to ShFE warehouses.

The only problem is where that extra metal might come from.

China’s monthly imports of refined Class I nickel

Out of shape

China doesn’t produce much high-purity Class I nickel, most of the country’s production taking the form of nickel pig iron for the stainless steel sector.

Briquettes have to be imported from Australia, Madagascar and Canada or from the LME warehouse system, where briquettes account for 87% of registered nickel stocks.

History provides a warning of what might happen if ShFE changes its delivery criteria.

Low stocks liquidity plagued the Shanghai nickel market from its launch in April 2015. Faced with the prospect of an immediate squeeze on its new contract, ShFE included Norilsk Nickel full-plate metal as a delivery option from June of that year.

In doing so, it generated a tectonic movement of Norilsk-brand nickel from LME warehouses into China.

LME warehouses held over 267,000 tonnes of full-plate nickel, accounting for 57% of total registered inventory, at the start of June 2015. By the end of 2017 that stockpile had dwindled to 71,340 tonnes, representing just 19% of registered nickel stocks.

China’s imports of refined nickel hit what remains an all-time record high of 371,000 tonnes in 2016, including 228,000 tonnes of Russian origin metal.

ShFE nickel stocks rose from 10,000 tonnes in the middle of 2015 to what also is still an all-time high of 112,000 tonnes in September 2016. Since then the mountain has dwindled to next to nothing.

Shrinking share

A similar shift in briquettes inventory can’t be ruled out, although there is simply not enough metal around to generate the volumes seen in the 2016 migration of full-plate cathode.

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

Although accentuated by the flow of refined metal to China in the closing months of 2021, the underlying demand for LME stocks has been coming from the battery sector.

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

Availability of refined nickel is challenged and that of briquette even more so.

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

The core issue facing both exchanges is that Class I refined nickel only accounts for around half of global production and the ratio is falling all the time as Indonesia builds ever more nickel matte capacity.

Tsingshan Group, which found itself at the centre of the March storm, is a massive nickel producer but none of its output is in a refined form that could be delivered against either the London or Shanghai market. With no option of delivering physically against its short position, its massive exposure could only be resolved at eye-watering financial cost.

The limitations on what sort of nickel can be traded on the London market played a key part in the market blow-up of 1988 when the LME also briefly suspended 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 ShFE can find a pricing solution to what is an increasingly diverse product spectrum, which now includes a fast-growing stream of nickel sulphate.

Competing for a declining slice of the physical market may not be the answer.

(Editing by Emelia Sithole-Matarise)