* Contango wider, benign environment for bank ali deals
* Real economic strength might prompt cancellations
* Interest rate rises could be offset by steeper contango
By Pratima Desai
LONDON, April 18 (Reuters) - Fears of an end to lucrative deals that have locked up large swathes of aluminium stocks are premature because it is likely to take many months for interest rates to reach levels that make them unprofitable.
Financing deals are estimated to have tied up a hefty 70 percent of record high aluminium stocks at around 4.6 million tonnes in London Metal Exchange warehouses.
"There is a risk to these deals, but my feeling is interest rates would have to be significantly higher before we start to see deals being unwound," said Alex Heath, head of base metals at RBC Capital Markets.
"I don't think that even a 1 percent rise could be enough to make a material difference ... Given the state of the U.S. economy, it's unlikely interest rates there will rise quickly."
The European Central Bank earlier this month raised benchmark interest rates for the euro zone to 1.25 from 1.0 percent and because of that traders are starting to worry the deals could be unwound or not renewed.
Either could lead to a surge in availability of aluminium, used widely in transport, construction and packaging.
"The ECB rise is not an isolated incident, there will be other rises. As borrowing costs go up, inevitably a mountain of aluminium will be released," a trader said, adding financing deals have mostly been done in dollars and euros.
Fastmarkets analyst Will Adams has said he expects prices to move lower in the next month on concerns that financing deals will unwind. "It might start to unnerve the market," he said.
But in the United States, forecasts are for the Federal Reserve to leave benchmark interest rates at near zero for the rest of this year, despite predictions of rising inflation.
"Central bankers are not being aggressive on interest rates, they are being extremely cautious. It looks like a fairly benign environment for aluminium financing deals," said Dan Brebner, analyst at Deutsche Bank.
SIGNIFICANT CONTANGO
Aluminium has been a top performer this year partly because of these deals, which kept material away from the market. Benchmark aluminium on the London Metal Exchange touched $2,720 a tonne on April 11, its highest since August 2008.
"For banks, these deals are the best option among a pool of poor options as far as investing money goes," said Justin Lennon, analyst at Mitsui Bussan commodities. "We will only see them cancelled when we see real economic strength and higher margins for employing the money elsewhere."
A typical deal consists of buying nearby aluminium from a producer, selling it forward at a profit and striking a deal to store it cheaply for an extended time period. The difference between the nearby and forward price is known as the contango.
"There's a pretty significant contango for aluminium, an important aspect that will enable these structures to remain in place," Deutsche's Brebner said.
To illustrate, the contango or discount for the LME's three-month contract against the December 2012 contract is now more than $100 a tonne compared with $80 a tonne at the end of January. The discount for the cash contract against the December 2012 contract is $121 from $87.
It has widened in recent weeks because of surging prices of power, which on average account for about 35 percent of aluminium smelting costs.
"Interest rates are a risk, but it depends on whether they can be offset by the contango increasing by the same amount," said Gayle Berry, analyst at Barclays Capital.
"It would depend on a deal-by-deal basis, but on the whole you could probably stomach a bit of an increase in interest rates without seeing financing deals coming under pressure."
If the European Central Bank and the Federal Reserve were to embark on an aggressive tightening cycle then nearby prices could tumble, widen the contango and potentially reinforce the profitability of bank aluminium deals.
"Expectations for growth would plummet, expectations for metals demand growth and prices would follow. The contango would probably widen," Brebner said.
(Editing by Jane Baird and Alison Birrane)