Steel swaps explained

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Introduction to

Steel Swaps

http://bit.ly/steel-reports 1

1. Overview of the Steel Market

2. What is a Steel Swap?

3. How are Steel Swaps Used?

4. Worked Examples / Solutions

5. Available Contracts

6. Summary & Next Steps

Agenda


Overview of the Steel market

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Global Steel Production VS Chinese Steel production (1,000 Metric Tons)

World China

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Global Steel Trade (1,000,000 Metric Tons)


Top Steel Importers & Exporters

TOP 10 WORLD TOP STEEL EXPORTERS Million Tons

Position (2009) 2008 2009 % Change

1 Japan 37.1 33 -11%

2 EU27 33.8 30.1 -11%

3 Russia 28.2 27.4 -3%

4 Ukraine 28.4 23.8 -16%

5 China 56.2 21.7 -61%

6 S Korea 19.7 19.6 -1%

7 Turkey 18.3 17.2 -6%

8 Taiwan 9.8 9.8 0%

9 USA 12.6 8.8 -30%

10 Brazil 9.1 8.5 -7%

WORLD TOP STEEL IMPORTERS Million Tons

Position (2009) 2008 2009 % Change

1 China 15.4 22 43%

2 EU27 40.1 20.8 -48%

3 S Korea 28.1 19.9 -29%

4 USA 28.4 14.3 -50%

5 Turkey 13.1 10.1 -23%

6 Vietnam 7.9 9.4 19%

7 Thailand 11.5 8.9 -23%

8 Iran 7.8 8.6 10%

9 India 6.8 7.7 13%

10 Taiwan 9.1 6.4 -30%



Spot [08/11] 511 [ -4 ] MTD [NOV] 513.00

QTD [Q4] 531.50 YTD [2010] 527.16

Hot Roll Coil - Northern Europe [ EUR / MT ]

TSI ( 05/2006 - 11/2010 )

Spot [08/11] 652 [ 1 ] MTD [NOV] 641.78

QTD [Q4] 641.45 YTD [2010] 619.63

Hot Roll Coil - China [ USD / MT ]

Cleatrade ( 01/2009 - 11/2010 )

Volatility in the Steel Markets

• Steel prices are extremely volatile making it very difficult to predict future cash-flows.

• A reliable ‘risk management’ tool to control exposure to volatility is clearly needed.

• Such a mechanism allows for flexible forecasting of [ costs / revenues ] into the future.

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2. What is a Steel Swap?





Agenda


What is a Steel Swap?

A Steel Swap is a ‘Risk Management’ tool that takes the form of…

…a ‘Cash-Settled’ agreement…

…brokered between ‘Two Counterparties’…

…to Settle the Difference in Price between…

• a Price Agreed Today for

– a particular steel product (e.g. HRC)

– produced or delivered in a given area (i.e. Ex-Works North Europe)

– at/over a specified period in the future (e.g. Q4 next year)

• and the Actual Steel Price for the above as Measured by an Index

– e.g. The Steel Index



For Example 1. It is April and the average price of N. Europe Ex-Works HRC (according to ‘The

Steel Index’) is €520 per metric ton.

2. I think the price of HRC is going up and will average higher than €525 in May.

3. My counterparty disagrees and thinks the price will be lower than €525 in May.

4. Since we are both confident in our views we agree that we will review the

actual index average again at the end of May.

5. We agree a swap contract with a strike price of €525.

• So, for every EUR that the index average for May is higher than €525 my counterparty agrees

to pay me €1. Conversely, for every €1 it is less than €525 I agree to pay my counterparty €1.

6. On June 1st we average the weekly values of ‘The Steel Index’ and find that the

actual average for the month of May was €526.

7. I collect €526 - €525 = €1 from my counterparty .



In Reality

• Counterparties are organisations (steel mills, service centres, end users,

investment banks, hedge funds etc…) of various sizes.

• Individual trades usually consist of many concurrent swaps novated

simultaneously (i.e. 50,000 lots >> €1 change in price = €50,000 exchanged)

• Trades are anonymous and novated through brokers (like FIS)

• A clearing house and its members stand between the financial transactions

of the two counterparties and act as insurance against counterparty default.

• I.e. even if one counterparty goes bankrupt the second may still confidently retrieve its

earnings from its clearing member or the clearing house.


The Mechanics of Steel Swaps Trading


Swap Buyer (Front Office)

Swap Buyer (Back Office)

Swap Seller (Back Office)

Swap Seller (Front Office)

Clearing Member (Back Office)

Broker (FIS)

Clearing Member (Back Office)

Clearing House (LCH.Clearnet)

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2. What are Steel Swaps?





Agenda



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Physical Position Swap Position

Price per MT

Taking a swaps position with the opposite [ profit / loss ] to your natural position in the physical market results in the [ profits / losses ] from each position cancelling each other out.

The position can be held to maturity (for cash settlement) or flexibly reversed (closed out) by taking a second swap position that is equal and opposite to your first swap position.

The size of the position and overall effect on your net market exposure is highly flexible.

So whether steel prices increase or decrease, the net [cost / revenue] you [pay / receive] is thus fixed relative to the spot market

Combining Natural Exposure with Swaps

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Who Uses Steel Swaps?

• Mills

• Service Centres

• Automobile Manufacturers

• Construction Companies

• White Goods Manufacturers

• Pipe Manufacturers

• Shipyards

• Rail Infrastructure

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Guarantees forward income for future steel

production at today’s rates

Guarantees forward steel prices allowing

for fixing of future procurement costs

Commercial control of physical operations

unaffected –> no loss of market presence

The ‘forward curve’ provides insight into short and long term market conditions

Can increase short term market share without building/purchasing steel

Swaps are instantly (within seconds) tradable and thus offer rapid flexibility

Swaps are financially settled and not attached to the physical commodity

Why Use Steel Swaps?


Steel Mills may also be interested to know that

you can also trade cash-settled Iron Ore Swaps. By

combining steel and iron ore swaps it’s possible to

flexibly guarantee both their costs and revenues

up to 23 months into the future. For more

information visit http://bit.ly/iron-ore-swaps

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http://bit.ly/iron-ore-swaps











Agenda


Worked Example // The Problem

• It’s Q1 and a steel mill in North Europe has an exposure of

15,000mt (5,000 mt per month) of unsold HRC for Q4.

• They are worried that prices are in decline and want to fix their

revenues at today’s prices to protect their bottom-line.

• The following strategies are available to manage this exposure:

1. Try to find and fix a steel price with a buyer today (but risk physical default)

2. Run the position spot (but risk losing money if the market softens)

3. Agree a contract (floating price) (but risk losing money if the market softens)

4. Use steel swaps to quickly hedge their net exposed position


Confused? No Problem! Call us on +44 20 7090 1126 or email us at [email protected] and we’ll walk you through it

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• The Mill decides to use swaps to offset its exposure

• The Mill contacts FIS and places a ‘sell’ order for 750 lots of LCH.Clearnet cleared swaps

(20mt per lot x 750 lots = 15,000 mt) on the Q4 period.

• A broker at FIS negotiates a firm strike price with a ‘buyer’ in the market at €580 per

metric ton for settlement against TSI’s Northern European HRC index.

• The trade is agreed and FIS and the Mill inform the clearing house of the trade.

• The Mill has successfully hedged its net revenue for the exposed volume of unsold HRC

at €580 per metric ton regardless of the actual price of the spot market in Q4.

Worked Example // The Solution



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Physical Position 5,000 tons x €560 x 3 months = €8,400,000

Swap Position ( €580 - €560 ) x 5,000 x 3 = €300,000

Net Revenue €8,400,000 + €300,000 = €8,700,000

8,700,000 / 15,000 = €580 per metric ton

Worked Example // Best Case Result



At the end of Q4 the settlement price on Northern Europe TSI HRC is calculated at €560 per metric ton

Pro

fit

& L

oss

€560

€580

+ €20 Swap P&L

Average €/MT NEUR TSI HRC Q4

• The profit from the Mill’s swaps position is sufficient to

offset the fall in North European HRC prices since the date of

novation.

• 9 months in advance of delivery, the Mill has successfully

sold its exposure to the spot market and hedged against

falling steel prices.

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Physical Position 5,000 tons x €585 x 3 months = €8,775,000

Swap Position ( €580 - €585 ) x 5,000 x 3 = - €75,000

Net Revenue €8,850,000 - €75,000 = €8,700,000

8,700,000 / 15,000 = €580 per metric ton

Worked Example // Worst Case Result



At the end of Q4 the settlement price on Northern Europe TSI HRC is calculated at €585 per metric ton

€580

- €5

Swap P&L

Average €/MT NEUR TSI HRC Q4

• 9 months in advance of delivery, the Mill has successfully

sold its exposure to the spot market

• Had the market softened, the Mill would have continued to

enjoy net revenues of €580 per metric ton on the 15,000

tons of exposed steel.

• In this case, however, by fixing its net revenue at €580 the

Steel Mill has lost out on €5 per mt of potential revenue (i.e.

it has taken a €5 per mt opportunity cost)

• IMPORTANT! At any point during the trade the Mill can re-

expose itself to the spot market by optionally buying back its

swaps at the going market price before settlement.

• This example illustrates both the benefits and the potential

risks of swaps trading.

€585

Pro

fit

& L

oss

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Agenda



China Rebar / Cleartrade Steel / LCH.Clearnet product index clearing house

clearing house LCH.Clearnet

lot size 20 metric tons

price quotation USD

trading months Up to 24 Months Ahead ( Mths, Qrtrs & Yrs )

settlement Cash settled

product China – Rebar

index Cleartrade Steel Index ( Provided by Umetal )

grade In the category of Q235

quantity Standard spot-market order size of 100 mt and above

diameter 16 – 25mm

material surcharges (e.g. scrap surcharge) Excluded

extras (e.g. non-standard dimensions) Excluded

price point Prices sourced from 25 major cities across China

swap specifications

index specifications

Interested in this swap? Require more information? Get our free reports at http://bit.ly/steel-reports or call us on +44 20 7090 1126

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China HRC / Cleartrade Steel / LCH.Clearnet product index clearing house


lot size 20 Metric Tons

price quotation USD / metric ton (converted from CNY index)



product China – Hot Rolled Coil

index Cleartrade Steel Index ( Provided by Umetal )

grade In the category of Q235

quantity Standard spot-market order size of 100 mt and above

gauge / width 4.75 mm / 1500 mm x C

material surcharges (e.g. scrap surcharge) excluded

extras (e.g. non-standard dimensions) excluded

price point prices sourced from 25 major cities across china

swap specifications



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Turkey Scrap / The Steel Index / LCH.Clearnet product index clearing house


lot size 20 metric tons

price quotation USD / metric ton



product Turkey – Heavy Metal Scrap

index The Steel Index

grade Heavy metal scrap 1 & 2 blended in an 80:20 mix

delivery Within 30 days

payment Cash / LOC

price point CFR Turkish Port

swap specifications



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N Europe HRC / The Steel Index / LCH.Clearnet product index clearing house



price quotation EUR / metric ton



product North Europe – Hot Rolled Coil


grade Prime mild carbon steel EN10111 DD11 (or equivalent)

gauge / width 2.0 mm + / 1250 – 1600 mm

coil weight 10 – 25 metric tonnes

material surcharges (e.g. scrap surcharge) Included


price point Net effective base price, ex-mill / N Eur Base Point

swap specifications



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S Europe HRC / The Steel Index / LCH.Clearnet product index clearing house



price quotation EUR / metric ton



product South Europe – Hot Rolled Coil


grade Prime mild carbon steel EN10111 DD11 (or equivalent)

gauge / width 2.0 – 4.0 mm / 1250 – 1600 mm

coil weight 14 – 25 metric tonnes



price point Net effective base price, ex-mill / S Eur Base Point

swap specifications



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USA HRC / CRU / CME Clearport product index clearing house

clearing house CME Clearport

lot size 20 short tons

price quotation USD

trading months 24 consecutive months


product US Midwest – Hot Rolled Coil

index CRU

grade For commercial quality

gauge / width Extras excluded

coil weight > 40,000lbs



price point Net effective base price, ex-mill

swap specifications



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Agenda


In Summary


Indices – Third party price assessments that provide industry transparency

Swaps – A risk management tool that provides a flexible, cost-effective and

reliable alternative to physical risk management

Clearing – A safety net to protect against counterparty default

Freight Investor Services – The world leading broker of steel and iron ore

swaps and pioneer of cash settled swaps contracts

FIS Reports – A quick and free way to keep up with current (index) and

forward (swaps) pricing for a wide range of steel products

• Get them free at http://bit.ly/steel-reports

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Next Steps


Get our free steel market reports + forward price curves

by email | [email protected]

online | http://bit.ly/steel-reports

Contact London for a telephone or personal consultation in person | 80 Cannon Street, London, EC4N 6HL

by telephone | +44 (0) 207 090 1126

online | http://bit.ly/steel-swaps

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Thank you for your time. We look forward to hearing from you soon.

FIS – Brokers of Steel Swaps Leading the way in commodity derivatives.

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Steel swaps explained

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Transcript of Steel swaps explained