The LME nickel squeeze, 2022

At a glance

What happened

Nickel was already rising in early 2022 when Russia's invasion of Ukraine added a supply shock. On 7 and 8 March the LME price roughly quadrupled, briefly topping $100,000 a tonne, as holders of short positions were forced to buy back into a thin market. The largest short belonged to Tsingshan, a producer hedging its own output. The LME halted trading on the morning of 8 March, cancelled about $3.9bn of trades done that morning, and did not reopen the contract until 16 March.

Why it went wrong

A producer selling forward against its output is the most standard hedge there is, but Tsingshan mainly produced nickel pig iron and matte, which cannot be delivered against the LME contract. The hedge followed a price it could not settle with its own metal. Margin on the futures was due in cash every day, while the higher value of unsold metal brought in no cash at all, so calls forced buying into the squeeze and pushed the price higher still.

What it teaches

Check what a contract actually delivers, not just what it tracks: a hedge in a grade you do not produce is a basis position. Size the cash you will need to fund a hedge daily, not just whether it works at maturity. And remember that exchanges can halt trading and even cancel trades: a market being open is an assumption. The High Court later upheld the cancellation as lawful.

Key terms

Short squeeze

A rise driven by shorts being forced to buy back into a market with too little offer to absorb them.

Deliverable grade

The specification a contract can be settled with physically — and the thing a producer hedge must match.

Basis risk

The exposure left when a hedge references something other than the asset actually held.

Variation margin

The daily cash settlement of a derivative’s mark-to-market, owed whatever the physical position is worth.

Trade cancellation

An exchange’s power to void executed trades, used here for a whole session’s nickel business.

Liquidity risk

The risk of being unable to fund a position that is economically sound, which is what closes most of them.

Where it sits in the course

Case studies like this one are used throughout risk management teaching, including FRM® preparation, as worked examples of basis risk, margin calls and market closure. In OTC Learn the lesson runs in five steps: what happened, the position, why it broke, what it cost and what it teaches, followed by a worked example with the numbers. See the lesson outline.

The instruments behind it

OTC Learn lessons on the products this case turns on:

• Commodity ForwardAgree a price today for delivery later
• Commodity SwapFixed price for floating market price
• Central ClearingA central counterparty steps into every trade