In this blog of Hedging with Jorge, we step into the real-world journey of acquiring aluminium and the often-overlooked costs that come with taking delivery. From LME warrants to consolidation charges, Jorge breaks down the concept of the equivalent premium, a cost that begins accruing the moment you decide to bring the metal home.

Suppose you’ve made the purchase. You paid for 100 tonnes of aluminium, and now you hold four LME warrants representing that volume. So, where is your metal?

Well, here’s the catch: The London Metal Exchange (LME) doesn’t own any warehouses. It merely controls a network of them through approved standards. The warehouses themselves are privately owned. Your metal could be scattered, one lot in Rotterdam, two in Japan and one in Spain. The warrants reflect this disjointed allocation.

Since retrieving aluminium from four different parts of the world isn’t practical, what do you do? You ask your broker to consolidate the warrants, to gather all the lots into a single location. In our example, let’s say everything is consolidated in Barcelona. This service comes at a cost, usually a broker’s fee or a premium based on location. That’s your first extra payment beyond the purchase price.

And that’s where the concept of the equivalent premium is born.

It’s the real cost of accessing the physical commodity, beyond its base market value. The first layer is the consolidation premium. But there’s more.

As Jorge explains, the second layer involves interest. You’ve already paid for the aluminium, which means you’ve tied up capital. That money has a cost, an opportunity cost or financing cost and the longer the metal sits before you physically receive it or resell it, the more interest accumulates.

So, the equivalent premium includes:

Consolidation costs – paid to the broker to gather your warrants in one location.

Interest charges – for the capital used to fund the purchase.

Any additional logistics or storage costs, depending on how long the metal stays in the warehouse.

This series of steps and charges paints a clearer picture: just buying metal isn’t the end, it’s the beginning of costs that make up the total premium of accessing and moving aluminium in the real world.

Understanding these components is crucial in commodity hedging, especially when dealing with physical delivery. It helps producers, traders and even end users anticipate and calculate true landed costs.

Stay tuned for more insights in the next blog of Hedging with Jorge.