Energy & Resources, Talking Point

Speculative failure

How China’s biggest nickel producer got caught out in the futures market


Tsingshan: the low-key Chinese resources firm made paper losses of $8 billion on nickel trades

Chinese investors sometimes refer to ‘demon stocks’. These are characterised by logic-defying lurches in their share prices and are frequently associated with improper market disclosure and insider trading.

There’s a metal that’s also earned itself the ‘demon’ monicker: nickel. Since its trading debut on the Shanghai Futures Exchange (SHFE) in March 2015, “demon nickel”, has been known for extremely volatile price shifts.

Much of the trading in the metal has been dominated by a few heavyweights, including Tsingshan Holding Group, which is based in Wenzhou, a coastal city in eastern China with a reputation for producing some of the country’s savviest speculators.

Tsingshan is not only China’s biggest nickel producer but also an active player in the futures market. Last week it stumbled into a major crisis, however, when its massive short position was dangerously exposed by an unprecedented spike in nickel prices at the London Metal Exchange (LME).

Tsingshan is now fighting for its financial survival at a time when other commodity prices are also surging in response to the Russian invasion of Ukraine. That has led some onlookers in China to describe the situation in more political terms as “an epic encirclement battle” in which “financial warfare” is being waged by unspecified forces against a strategically-important Chinese firm. But what has really happened?

Step forward Tsingshan

Unlisted Tsingshan is little-known by most of the world’s stock market investors, although it has a wider reputation in the commodities trading market.

It was founded by Xiang Guangda in 1988, when he left a state-owned factory to start a company supplying window frames and parts for cars. With the encouragement of state-owned carmakers such as FAW, Xiang then moved into the stainless steel industry, Economic Observer reports.

Nickel’s role as an industrial metal had for decades focused on the steel production process, where it was valued for its anti-corrosive properties – with higher-grades extracted from nickel sulphate. The metal was never considered a particularly scarce resource, mind you. There’s abundant supply in Indonesia and the Philippines though that largely comes in the form of nickel oxide, which can be more challenging to convert to a high-quality end product at a consistent profit.

The nickel price briefly surpassed $50,000 per tonne in 2007 thanks to China’s need to feed a rapidly growing economy. As with many other commodities at the time, China had a huge demand for nickel but little say in setting its price.

That’s when Tsingshan stepped in as an industry disruptor. Xiang’s company ploughed ahead on the thinnest of profit margins and then focused mainly on the production of nickel pig iron, a semi-refined product that is a cheaper alternative in the stainless steel manufacturing process, especially as compared with purer nickel compounds extracted from nickel sulphate. 

This approach also helped Xiang to forge closer relationships in Indonesia, where Tsingshan invested in industrial parks to house production chains running from the mining of coal and nickel oxide through to electricity generation and the extraction of nickel pig iron. As of 2021 Tsingshan was producing 600,000 tonnes of nickel a year (about a fifth of global output) and had emerged as one of the world’s top 500 firms in terms of revenues, with more than Rmb300 billion ($47 billion) in sales.

Xiang’s rise to the role of ‘the nickel king’ upended the global supply chain of nickel. The metal’s price dipped below to about $8,000 a tonne in 2015. However, it has rebounded more strongly in recent years as automakers discovered that adding more nickel to electric car batteries improves their energy density, which translates into more driving range per pound of battery. As demand for electric vehicles (EVs) began to accelerate, especially in China, so too did the price of nickel. The expectation is that the revolution underway in electric vehicles is going to put more upward pressure on prices as well. Such are the concerns that Tesla boss Elon Musk demanded in 2020 that miners produce more nickel and avoid bottlenecks.

Once again Tsingshan has stepped forward as a disruptor, announcing in early 2021 that it had achieved another breakthrough in converting nickel pig iron into nickel matte, an intermediate product that can be further processed into battery-grade nickel. It shipped its first batch from its Indonesia plant last year, with three production lines now under operation with monthly capacity of 3,000 tonnes, researcher Mysteel reported in January.

The hopes are that the new process could open up a new source of battery-grade nickel from cheaper ore in Indonesia. “Tsingshan has not only led the technological advance of the nickel and stainless steel industry, it is also the sector’s trailblazer when it comes to expanding overseas. It has singlehandedly remodelled the industry and it has made great contribution to the growth of the EV sector…” wrote WeChat-based blogger Fengbao Zhiwang (which means ‘King of Storm’ in Chinese), a veteran commodity trader (many of his articles have gone viral in China since Tsingshan’s short squeeze at the LME this month).  

Tsingshan speculates on nickel prices as much as it produces the metal?

“Tsingshan has a ferocious side in the futures market… it’s a ‘crocodile’ that all the traders want to avoid,” Fengbao Zhiwang also warns.

When Rusal, a major aluminium producer, was sanctioned in 2018 by the United States government (as part of a response to allegations that the Russians had meddled in the US presidential election), nickel prices at the LME surged on expectations that nickel sales from Russia would be curtailed. Chinese traders such as Tsingshan made a killing on the uncertainty, Fengbao Zhiwang recalled, as they took positions in the metal at the LME while also trading it in Shanghai.

A year later after suggestions that the Indonesian government might introduce an export ban on some nickel products, the metal surged again to about $20,000 per tonne from $12,000.

The speculation was that on this occasion Tsingshan had played a major role in squeezing short-sellers out of their positions. Inventories of nickel at the LME plunged by 100,000 tonnes to about 30,000 in less than two months. “It’s an open secret that the metal is being taken up by China’s Tsingshan Group, the great disruptor of the stainless steel industry and possibly now of the nickel market,” Reuters reported in November 2019, adding that the stockpiling had triggered an investigation from the metals exchange.

While it’s perfectly normal for a nickel producer to hedge its risk by shorting futures of the metal it produces, a position to the tune of more than 100,000 tonnes looks excessive. However, the Chinese heavyweight might have grown overly confident in its own influence, as Fengbao Zhiwang put it, as counterparties are now dealing with a “big brother with a lot of money, [nickel] stocks, government backing and insider information”.

This time round Tsingshan was on the wrong end of the trade?

Tsingshan was reported to be profiting from another swing in futures trading last year after announcing that it expected to sell much more of its cheaper nickel matte into the market.

The company was talking about plans to produce as much as 850,000 tonnes of nickel in 2022, an increase of 40% on the previous year. And while there was scepticism in the wider market that Tsingshan could reach that level of production, Xiang seemed to be betting that more nickel would soon become available and trigger a fall in the metal’s price.

To make a financial profit from the expected price decline, Tsingshan went back into hedge fund mode and initially built up a short position of at least 150,000 tonnes of nickel at the LME. By January the position was said to have extended further to about 200,000 tonnes. At the same time, speculation also grew that an unidentified investor seemed to be betting against Tsingshan and had cornered more than 50% of nickel stocks at LME.

What happened next, of course, was that Russia invaded Ukraine. The Russians are the third-largest nickel producer (they produce about 16% of the highest-grade supply) so nickel prices responded quickly as companies in the sector reduced their exposure to Russian counterparties. The risk in Tsingshan’s short position immediately shot up.

Tsingshan’s short trade started to unravel spectacularly on March 7, when the LME’s benchmark three-month nickel future surged 66% to over $48,000. The following day there was an 18 minute blur of unprecedented trading in which the futures price went vertical, surging nearly 250% to beyond $100,000 a tonne.

Putting that into perspective: nickel has spent most of the last decade priced between $10,000 and $20,000 a tonne. 

The LME then took the decision to suspend trading in nickel for a week – the first time this action has occurred since the collapse of a tin cartel in 1985, the Wall Street Journal reported. In another jaw-dropping announcement, the exchange announced that all the trades executed in London that day would also be cancelled.

Stunned by the surge in price, Tsingshan was sitting on paper losses of as much as $8 billion, according to the Wall Street Journal. Xiang was in a dark mood, telling Chinese media outlets that “there have been some moves by foreigners”. But the 64 year-old also reassured the market that his firm was in “active negotiations with relevant parties” and that “relevant government departments and leaders are all very supportive of Tsingshan”.

Who might be betting against Tsingshan and who could come to its rescue?

The sudden surge in nickel prices on the LME was soon being widely discussed on Chinese social media, with allegations that the “mysterious cartel” that had purchased more than half the LME stockpile of nickel was Glencore, an Anglo-Swiss commodity trader. Some alleged that Glencore actually wants to take control of the Chinese giant’s Indonesian operations on the cheap with Tsingshan forced to sell down its assets to avoid going bust.

National Business Daily reported, however, that Glencore had denied that it was leading the group betting against Tsingshan but reports in the international media have suggested that the two trading giants have been squaring up to one another for months.

Meanwhile, the short-squeeze has been terrifying for a wider group of banks and brokers, many of which have needed to make hefty margin calls of their own to cover their short positions on the exchange. The bulk of Tsingshan’s short position was also said to have been accumulated through bilateral deals with banks, not on the exchange itself.

“There’s a very big short and a very big long who’ve been sparring. And because of their sparring, it’s brutalised so many other shorts,” Malcolm Freeman of Kingdom Futures told Reuters.

The same concerns prompted the LME to freeze trading on the exchange last week, although companies that had taken the other side of the trade were furious that the LME had voided contracts from last Tuesday’s trading session, with hints at a geopolitical dimension to the cancellations (the LME is now a unit of Hong Kong’s stock market operator HKEx). Cliff Asness, the founder of the hedge fund AQR Capital Management, was incredulous in his comments to Bloomberg, accusing the metals exchange of “stealing money from market participants trading in good faith and giving it to Chinese nickel producers and their banks”.

Instead of biting the bullet and squaring up its short position, some commentators suggested Tsingshan could actually drum up enough physical nickel to fulfill the contracts as they expire. The problem is that it largely produces lower-grade nickel, while the metal delivered into LME warehouses must be at least 99.8% pure.

Another option is that Tsingshan turns for help to state-owned producers such as Jinchuan from Gansu province, which might share some of its nickel output. Or maybe it could approach a few of its friendlier clients, including EV battery giant CATL.

An effort like that would require coordination from the Chinese government, of course.

Is Tsingshan a victim of ‘financial warfare’ against China?

A populist school of Chinese social media bloggers have suggested as much and demanded the Chinese government step in and offer help.

Previously China had little say in nickel’s global supply chain. Tsingshan’s rise has changed all that. That’s why a few years ago Chinese media outlets described Tsingshan as “the Huawei of the nickel market”. The big difference, however, is that Huawei has never engaged in overly risky financial operations in the manner that Tsingshan has routinely executed. 

That’s why not all onlookers are buying into the notion that the Chinese government should come to Tsingshan’s rescue.

Indeed this is not the first time that a major Chinese firm has  made disastrous bets in the commodities or derivatives markets in the name of defending China’s energy and natural resources security. Citic Pacific, for example, was the first to make a major investment in Australia’s iron ore mines but the state-backed firm suffered a $2 billion loss after making a bad  bet on currency hedge in 2008. The Singapore-listed China Aviation Oil also collapsed in 2004 after its derivative trading in jet fuel went terribly wrong. Less than a year later, a rogue Chinese trader infamously built up a short position of more than 200,000 tonnes of copper.

All these costly precedents were a result of excessively speculative  trading, National Business Daily concluded. The newspaper predicted that Tsingshan and its major trading counterparties might reach an agreement on how to square their positions. The key factor, of course, will be at what prices.

Tough negotiations were still ongoing this week. Meanwhile, the nickel price fell to around $45,590 per tonne when trading in the metal was resumed at the LME on Wednesday.

The Financial Times reported that the reopening was not without glitches, after newly installed curbs designed to prevent prices declining by more than a 5% limit that had been set were breached and forced the LME to halt electronic trading just after 8am to “investigate” the problem. The market reopened for a second time at 2pm. “The chaotic resumption of business is a further embarrassment for the LME,” the FT noted disparagingly, adding “Wednesday’s bungled restart follows one of the most dramatic episodes in the 145-year history of the LME.”

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