Aluminium price indexing: choosing a reference and writing the clause

Why aluminium needs a price clause

Aluminium is a traded commodity. The price of the metal can move for reasons that have nothing to do with the part, the drawing or the supplier's productivity. A fixed piece price for a twelve month programme transfers that risk to one side. A price clause shares it on a defined basis.

The clause is not only a finance instrument. It changes supplier behaviour. A supplier that is protected against a metal rise can quote a lower conversion price and hold less risk in the price. A buyer that understands the index can compare quotes on the same metal basis instead of comparing two different bets on the market.

The starting point is to separate the part into three layers: the metal, the regional premium and the conversion. The metal is the exchange price. The premium reflects the cost of delivering metal to a region or a warehouse. The conversion covers extrusion, casting, rolling, machining, finishing, packing and margin. Each layer can have a different pricing method.

Choosing the index

The London Metal Exchange is the reference for much of the global aluminium trade. Its primary aluminium contract publishes official cash and three month prices, and its premium contracts cover regional delivery premiums such as the European duty paid premium and the US Midwest premium. The Shanghai Futures Exchange is the reference for much of the Chinese market.

The right index depends on where the metal is bought and how the part is made. A European extruder buying primary billet may price against the LME plus a regional premium and a billet conversion. An Indian fabricator buying ingot may use the LME plus a local premium, or a domestic producer price. A part made from secondary alloy may follow a scrap or alloy-specific reference.

Do not mix a primary metal index with a secondary alloy part without saying so. The correlation is not perfect. The clause should name the exact index, the publication, the price definition, the unit and the currency. 'LME aluminium' is not a complete reference. It could mean cash, three month, official, closing or monthly average.

The quotation formula

A workable formula is: metal price plus regional premium, divided by the metal yield, plus the conversion charge, plus the alloy surcharge, plus freight and packing. The yield is the ratio of finished weight to metal input. It matters because scrap and process loss are real costs, and a clause that ignores them understates the metal content of the part.

For illustration only, assume an aluminium busbar with a finished weight of 2,000 kg, a metal yield of 85 per cent, an index price of 2,500 US dollars per tonne, a regional premium of 250 dollars per tonne and a conversion charge of 1,800 dollars per tonne of finished part. The metal input is 2,000 divided by 0.85, or about 2,353 kg. At 2,750 dollars per tonne, the metal cost is about 6,470 dollars. The conversion is 3,600 dollars. The total is about 10,070 dollars, or 5.04 dollars per kg before freight and tax.

Averaging period and quotational period

The quotational period is the window used to set the metal price for a shipment. It may be the month of shipment, the month before shipment, the month of arrival or a fixed future month. The averaging method may be the monthly average of the official cash settlement, the average of daily prices, or the price on a single quotation date.

The choice shifts risk. If the supplier buys metal before production and the price is set on the shipment month, a rising market helps the supplier and a falling market hurts. If the buyer wants certainty, a period before production can be agreed. The important point is that both sides use the same period and the same published data.

A common dispute is a shipment that straddles two months. The invoice may use one month while the buyer expected another. Define the rule for a shipment that loads on the last day of the month, a partial shipment and a rescheduled shipment. Define what happens if the publication is late or missing. A fallback to the next published day is better than a debate.

Fixed, floating and shared risk

A fully fixed price gives budget certainty but carries a risk premium. A fully floating price follows the index but leaves the buyer exposed to spikes. A shared clause divides the movement within a band: the supplier absorbs the first few per cent, the buyer and supplier share the next band, and the buyer pays the rest. The bands can be set to match the margin in the part.

A cap and floor is another option. The buyer pays within a range and the supplier hedges outside it. The cap protects the budget, but it has a cost. The supplier may price the cap into the conversion charge, or buy an option and pass the premium through. Ask which one is happening.

For a long programme, a periodic reset is often simpler than a daily formula. Reset the metal base each quarter using the prior quarter average, and keep the conversion fixed for the year. That reduces administration and still shares the main risk. The reset date, the index and the evidence should be in the contract.

The clause checklist

Name the index, the publisher and the exact price series. State the unit, the currency and the conversion method. State the quotational period and the averaging method. State the yield, the scrap credit and the alloy surcharge. State whether freight is inside or outside the metal base. State the evidence the supplier must provide with the invoice.

Add a fallback for a missing or discontinued publication. Add a dispute route and a time limit for raising a query. Add a currency clause if the index is in US dollars and the invoice is in another currency. Add a review date for the conversion charge, because labour, energy and finishing costs change even when the metal does not.

Keep the calculation auditable. A one page schedule with the index print, the period, the yield and the arithmetic is enough. If the buyer cannot reproduce the invoice from the published data, the clause is not working.

• Exact index, publisher and price definition
• Currency, unit and conversion basis
• Quotational period and averaging method
• Yield, scrap credit and alloy surcharge
• Freight, packing and coating treatment
• Fallback, dispute route and review date

Mistakes to avoid

The first mistake is indexing the whole piece price. That passes labour, energy and margin through the metal index and removes the supplier's incentive to control conversion cost. The second is using a metal index without a premium, which understates the delivered metal cost. The third is ignoring yield and scrap, which makes the formula look precise but leaves a gap.

The fourth is a vague averaging period. The fifth is a currency mismatch. The sixth is a clause with no fallback, so a missed publication becomes a commercial argument. The seventh is a clause that is never reviewed, even when the alloy, the route or the volume changes.

A price clause is a living part of the contract. Review it at the same time as the should-cost model and the supplier scorecard. If the metal is a small share of the part, a simple annual reset may be enough. If the metal is most of the cost, the clause deserves the same attention as the drawing.