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Phillip Killicoat, Credit Suisse: Finance in the global iron ore industry

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Phillip Killicoat, FID Commodities – Metals & Mining, CREDIT SUISSE delivered this presentation at the 2013 Americas Iron Ore conference. Americas Iron Ore is one of the most respected annual …

Phillip Killicoat, FID Commodities – Metals & Mining, CREDIT SUISSE delivered this presentation at the 2013 Americas Iron Ore conference. Americas Iron Ore is one of the most respected annual gatherings for North and South American iron ore markets. The agenda features iron ore industry and market developments; new project developments and expansions in North and South America; overview of steel demand; iron ore spot market price; infrastructure and transport challenges and investment opportunities.
After five successful editions, the Americas Iron Ore Conference consolidates as the largest meeting place for executives and professionals of the steel and iron ore industry in the region. For more information, please visit the conference website: https://www.immevents.com/mining-conference/americas-iron-ore-conference

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  • 1. Finance in the Global Iron Ore Industry November 2013 Phillip Killicoat +44 207 888 0893 1
  • 2. Finance in the Global Iron Ore Industry Capital markets Mitigating risks Financing for iron ore producers Then and now Hedging in mine financing Iron ore market developments 2
  • 3. Trade-offs in raising capital for mining projects Cost of capital Equity Mezz Bonds Bank loan What motivates each type of mining investor? Flexibility 3
  • 4. Equity investors and mining Then Growth focus Bubble charts Blue sky optionality „Leverage to the cycle‟ Now „Cash is king‟, capex discipline Investor demands for yield Pressure for project curtailments, concerns of excess supply Credit ratings matter 4
  • 5. Fixed income investors and mining Then Small equity buffers Demand for higher yielding instruments High prices masked production/construction underperformance Active bank loan market Now 50% equity buffers Basel III reg cap restrictions Volatile prices expose 5
  • 6. Mining is a risky business Source: AP 6
  • 7. The rise of China has increased real price levels and volatility Historic iron ore prices (Real terms 2010 USD) 180 160 140 120 100 80 60 40 20 0 Source: IMF, Credit Suisse 7
  • 8. Why hedge? A modest hedge protects profit margins for the volume hedged Improves loan-carrying capacity by withstanding market shocks Provides a cash flow buffer to achieve target run rate production plans in all market conditions Protecting [25]% of 2 year cash flows meaningfully reduces equity dilution risk if prices were to fall again If prices never fall, equity investors still have full upside exposure on [75]% of production over the hedged period If prices fall at any point you have the option to unwind the swaps and monetise the hedge mark-to-market as cash 8
  • 9. Iron ore hedging process Set up Execution Settlement Scenarios Security Select strategy Monthly Low case ISDA Volume Cash settled Mid case Unmargined Price High case Tenor 9
  • 10. Hedge settlement – separate physical and financial flows Settlement Diagram Financial swap If realised price <$125* CS pays Miner $125 minus realised price Physical Miner or If realised price >$125 Miner pays CS the realised price minus $125 Physical IO delivered to off-taker Off-taker pays market price (net of freight, quality and agency adjustments) Customer * Swap level determined at time of execution 10
  • 11. Payoff scenarios – the hedge pays the miner needs it most High realised price = $150/t Par realised price = $125/t Low realised price = $90/t Operating profit US$mm Operating profit US$mm Operating profit US$mm 250 250 250 200 200 200 150 150 150 100 100 100 50 50 50 0 0 Physical Financial Net 0 Physical Financial Net Physical Financial Net 11
  • 12. Iron ore swaps and options volume averaged >360Mt since April Iron ore swaps volume (Mt annualised) Annualised Mt 450 OTC SGX 400 LCH CME SMX Oct 2013: * 30 Mt * 1.4 Mt/day * 361 Mtpa 350 300 250 200 150 100 50 0 abr/09 out/09 abr/10 out/10 Source: SGX; LCH; CME, SMX, Credit Suisse abr/11 out/11 abr/12 out/12 abr/13 out/13 12
  • 13. Iron ore swaps and options volume averaged >360Mt since April Iron ore swaps volume (Mt annualised) 1200 Annualised Mt OTC SGX LCH CME Oct 2013: * 30 Mt * 1.4 Mt/day * 361 Mtpa 1000 800 SMX Dalian Adding Dalian * 67Mt * 6.7 Mt/day * 808Mtpa 600 400 200 0 abr/09 out/09 abr/10 out/10 Source: SGX; LCH; CME, SMX, Credit Suisse abr/11 out/11 abr/12 out/12 abr/13 out/13 13
  • 14. Sources of liquidity across the ferrous market Share of swaps activity by industry segment (% total volume) Miners, 30% Investors, 25% Consumer, 10% Mills, 5% Merchants, 30%
  • 15. More frequent price adjustment is passed down the value chain Raw materials Steel mills  Iron ore  From: Arbitrary adjustments in steel list price  Coking coal  Alloys Now indexed Monthly or Quarterly Steel consumers  Autos / machinery  Appliances  Construction  To: raw material formula steel sales contracts Steel pricing basis: Fixed conversion margin with floating IO+CC formula
  • 16. Disclaimer THE INFORMATION CONTAINED HEREIN IS PROVIDED FOR INFORMATIONAL AND DISCUSSION PURPOSES ONLY AND IS NOT, AND MAY NOT BE RELIED ON IN ANY MANNER AS, LEGAL, TAX OR INVESTMENT ADVICE OR AS AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY AN INTEREST IN ANY FUND (A “FUND”) MANAGED OR SPONSORED BY CREDIT SUISSE ALTERNATIVE INVESTMENTS (“CSAI”). A PRIVATE OFFERING OF INTERESTS IN A FUND WILL ONLY BE MADE PURSUANT TO A CONFIDENTIAL PRIVATE PLACEMENT MEMORANDUM (AN “OFFERING MEMORANDUM”) AND SUCH FUND‟S SUBSCRIPTION DOCUMENTS, WHICH WILL BE FURNISHED TO QUALIFIED INVESTORS ON A CONFIDENTIAL BASIS AT THEIR REQUEST FOR THEIR CONSIDERATION IN CONNECTION WITH SUCH OFFERING. THE INFORMATION CONTAINED HEREIN WILL BE QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH OFFERING MEMORANDUM, WHICH WILL CONTAIN ADDITIONAL INFORMATION ABOUT THE INVESTMENT OBJECTIVE, TERMS AND CONDITIONS OF AN INVESTMENT IN A FUND AND WILL ALSO CONTAIN TAX INFORMATION AND RISK DISCLOSURES THAT ARE IMPORTANT TO ANY INVESTMENT DECISION REGARDING A FUND. NO PERSON HAS BEEN AUTHORIZED TO MAKE ANY STATEMENT CONCERNING ANY FUND OTHER THAN AS SET FORTH IN THE RELEVANT OFFERING MEMORANDUM AND ANY SUCH STATEMENTS, IF MADE, MAY NOT BE RELIED UPON. THE INFORMATION CONTAINED HEREIN MUST BE KEPT STRICTLY CONFIDENTIAL AND MAY NOT BE REPRODUCED OR REDISTRIBUTED IN ANY FORMAT WITHOUT THE APPROVAL OF CSAI. WHEN ISSUED IN AUSTRALIA, THE OFFER OF THESE INVESTMENTS MAY ONLY BE MADE BY WAY OF AN OFFERING MEMORANDUM ONLY TO WHOLESALE CLIENTS, AS DEFINED IN CHAPTER 7 OF THE CORPORATIONS ACT. NOTHING IN THIS DOCUMENT PURPORTS TO BE AN OFFER OF ANY INTERESTS OR INVESTMENTS. IN ADDITION, NONE OF THE INTERESTS ARE A REGISTERED SCHEME, AS DEFINED IN THE CORPORATIONS ACT, AND NO OFFERING MEMORANDUM WILL NOT BE LODGED WITH THE AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION (ASIC). WHEN ISSUED IN THE UNITED KINGDOM, THIS DOCUMENT IS ISSUED BY CREDIT SUISSE ASSET MANAGEDMENT (LIMITED) WHICH IS AUTHORIZED AND REGULATED BY THE FINANCIAL SERVICES AUTHORITY. THIS DOCUMENT IS DIRECTED AT PROFESSIONAL CLIENTS ONLY. IT SHOULD NOT BE DISTRIBUTED TO OR RELIED UPON BY RETAIL CLIENTS. WHEN ISSUED IN SWITZERLAND, THESE INVESTMENTS QUALIFY AS UNITS OF A FOREIGN COLLECTIVE INVESTMENT SCHEME IN THE SENSE OF ART. 119 OF THE SWISS COLLECTIVE INVESTMENT SCHEMES ACT (CISA). NO ACTION HAS BEEN TAKEN OR APPLICATION HAS BEEN MADE TO THE SWISS FEDERAL BANKING COMMISSION (SFBC) FOR AUTHORIZATION OF PUBLIC DISTRIBUTION OF THESE UNITS IN OR FROM SWITZERLAND. ACCORDINGLY, THESE UNITS ARE NOT REGISTERED WITH THE SFBC UNDER THE CISA. AS A RESULT, AN INVESTOR DOES NOT BENEFIT FROM THE SPECIFIC INVESTOR PROTECTION AND/OR SUPERVISION BY THE SFBC AFFORDED UNDER THE CISA AND ITS IMPLEMENTING ORDINANCES. ANY OFFER OR SALE MUST THEREFORE BE IN STRICT COMPLIANCE WITH SWISS LAW AND IN PARTICULAR WITH THE RULES OF THE CISA, ITS IMPLEMENTING ORDNANCES AND THE CIRCULAR 03/1 OF THE SFBC ON PUBLIC SOLICITATION. ACCORDINGLY, THE UNITS MAY NOT BE OFFERED, PROMOTED, SOLD OR DISTRIBUTED TO THE PUBLIC IN OR FROM SWITZERLAND, BUT ONLY TO QUALIFIED INVESTORS IN ACCORDANCEWITH THE CISA AND ITS IMPLEMENTING ORDINANCES. IN CONNECTION WITH THIS INVESTMENT, CREDIT SUISSE MAY PAY TO THIRD PARTIES, OR RECEIVE FROM THIRD PARTIES AS PART OF THEIR COMPENSATION OR OTHERWISE, ONE-TIME OR RECURRING REMUNERATIONS (E.G. PLACEMENT OR HOLDING FEES). IN RECEIVING PAYMENTS BY THIRD PARTIES CREDIT SUISSE‟S INTERESTS MAY BE ADVERSE TO THOSE OF THE HOLDERS OF THIS INVESTMENT PRODUCT AND SUCH PAYMENTS CAN AFFECT THE INVESTORS RETURN. FURTHER INFORMATION MAY BE REQUESTED FROM YOUR RELATIONSHIP MANAGER. THIS DOCUMENT CONSTITUTES MARKETING MATERIAL AND IS NOT THE RESULT OF A FINANCIAL ANALYSIS AND, THEREFORE, NOT SUBJECT TO THE DIRECTIVES ON THE INDEPENCE OF FINANCIAL RESEARCH (SWISS BANKERS ASSOCIATION). WHEN ISSUED IN HONG KONG, THE INFORMATION CONTAINED IN THIS PRESENATION HAS NOT BEEN APPROVED BY THE SECURITIES AND FUTURES COMMISSION IN HONG KONG. ACCORDINGLY (A) INTERESTS IN A FUND MAY NOT BE OFFERED OR SOLD AND HAVE NOT BEEN OFFERED OR SOLD IN HONG KONG, BY MEANS OF ANY DOCUMENT OTHE THAN TO (I) “PROFESSIONAL INVESTORS” AS DEFINED IN THE SECURITIES AND FUTURES ORDINANCE (CAP.571) OF HONG KONG AND ANY RULES MADE UNDER THAT ORDINANCE; OR (II) IN OTHER CIRMCUMSTANCES WHICH DO NOT RESULT IN THE DOCUMENT BEING A “PROSPECTUS” AS DEFINED IN THE COMPANIES ORDINANCE (CAP. 32) OF HONG KONG OR WHICH DO NOT CONSTITUTE AN OFFER TO THE PUBLIC WITHIN THE MEANING OF THAT ORDINANCE; AND (B) NO PERSON HAS ISSUED OR HAD IN ITS POSSESSION FOR THE PURPOSES OF ISSUE, AND WILL NOT ISSUE OR HAVE IN ITS POSSESSION FOR THE PURPOSES ISSUE, WHETHER IN HONG KONG OR ELSEWHERE, ANY ADVERTISEMENT, INVITATION OR DOCUMENT RELATING TO ANY INTEREST IN A FUND, WHICH IS DIRECTED AT, OR THE CONTENTS OF WHICH ARE OR ARE LIKELY TO BE ACCESSED OR READ BY , THE PUBLIC IN HONG KONG (EXCEPT IF PERMITTED TO DO SO UNDER SECURITIES LAWS OF HONG KONG) OTHER THAN WITH RESPECT TO INTERESTS IN A FUND THAT ARE OR ARE INTENDED TO BE DISPOSED OF ONLY TO PERSONS OUTSIDE HONG KONG OR ONLY TO “PROFESSIONAL INVESTORS” WITHIN THE MEANING OF THE SECURITIES AND FUTURES ORDINANCE (CAP. 571) OF HONG KONG AND ANY RULES MADE UNDER THAT ORDINANCE. 16