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Ks&T Price Risk Management Ks&T Price Risk Management Presentation Transcript

  • Price Risk Management ICE 1st Trading, Risk and Hedging Forum Geneva, 22 April 2009
  • Outline 1. Outlook for Prices 2. Counterparty Credit Risk amidst the Credit Crunch 3. Hedging Policies & Instruments in a hyper-volatile era 4. Current Situation 5. KOCH Industries
  • 1. Outlook for Prices
  • Prices, a bird’s eye view in 4 phases 5 years, continuous 1st nearby ICE Brent Credit c c oli ab r pa r unch ing Go The new “asset” class Healing Mode
  • An Asset Class was born • Accommodative availability of credit • Tolerance for high leverage • Light touch regulatory environment • Digitalization of trading + • Above-trend growth of consumption in Asia • Low OPEC spare capacity = overly aggressive allocation of capital in energy financial markets, some even called it a “bubble”.
  • Oil Price elasticity vs. Credit Crunch • Prior to Credit Meltdown, energy prices fulfilled their “signal role” in fostering physical demand destruction. • This physical demand destruction kicked in as soon as 2007 while in parabolic phase. Timing varied from slate to slate due to wide crack product differentials. • Credit Crunch shocked the appetite for oil financial exposure, a mix of risk aversion and major de-leveraging. • The manufacturing sectors across time zones slumped in unison, furthering weakness. Petchems a perfect example.
  • DOT: US Vehicle Miles Traffic
  • DOT: US Vehicle Miles Traffic Drop started Early 2008
  • Port of Los Angeles Traffic (in TEUs) A TEU is a 20-foot-long cargo container
  • Prices, where are we today? 6 months, continuous 1st nearby ICE Brent Bottomed out? $45/bbl
  • A market in need of Healing (1) • Extreme Price ranges lowers participants' pain threshold. Capital de-leveraging cuts VAR allocations in financial institutions hit by balance- sheet constraints. Shock absorbers are cautious. • Such extremes make long term industrial and infrastructure investment planning hazardous.
  • A market in need of Healing (2) • Parabolic Prices triggered a political outcry aiming for a major regulatory overhaul in OTC trading. Prices receded since then, not the political will… • Ratable hedgers step back, stop and amend hedge programs, rethink Risk Management policies. • Oil markets have to mean-revert to Supply & Demand balances. In other words, speculators typically exacerbate trends, rarely contrarians to S&D.
  • Prices: participant’s framework After many years building our presence by either being directly involved in various physical and paper oil businesses or by adding tangible economic value to our customers’ relationships, we believe at Koch Industries that we are in a good position to analyze and anticipate oil market trends: Invista / Flint Hill Resources / Georgia-Pacific / KS&T
  • Slates, Runs and Freight • Excess refining capacity active in international trade – Jamnagar 2 not in full force yet, RFCC ramping up next month – Japan demand low, Kashiwazaki-Kariwa nuclear plant re- commissioned shortly? • Distillates plentiful despite above-average Northern hemisphere HDD season. The coldest season in 24 years in NWE • Gasoline picture much better balanced, yield switching reverse of 2008 • Naphtha weak but supply impaired • Fuel Oil comparatively healthy on tight sour and discriminatory steadiness in maintaining conversion utilization. High-Lows narrow as OPEC cuts heaviest grades. • TCE* rates depressed TCE= Time Chartered Equivalent
  • 2. Counterparty Credit Risk amidst Credit Crunch
  • Documentation and standards Credit support ISDA Margin Calculation Confirmations Settlement procedures 16
  • Documentation – importance of standards • Most derivatives contracts have standardized features regarding pricing conventions and settlement • Protect both parties in the transaction while maintaining uniformity among portfolio of positions • International Swaps and Derivatives Association (ISDA) maintains and refines industry standards Index definition Settlement calculations Credit terms Payment instructions 17
  • Credit considerations • Bilateral transactions involve credit exposure • All dealers and most large institutional users of bilateral derivatives maintain a credit evaluation capability to monitor their counterparties • Credit exposure managed primarily via stated credit thresholds either in confirmations or in ISDA Credit Support Annexes • Cash or securities can be used to guaranty performance on derivative settlement • Other clauses may allow parties to close out of transactions if sufficient evidence exists that a counterparty may default 18
  • Guarantees • Frequently the contracting parties to a bilateral transaction are not publicly-rated entities • They may require more onerous credit terms, such as tighter thresholds • Alternatively, they may seek guarantees from rated parent companies 19
  • Enforceability and regulation • Over-the-counter derivatives are acknowledged in most jurisdictions • They are typically not as highly regulated as listed futures markets Self-monitoring by industry groups tends to be the norm • Unlike listed futures markets, OTC derivatives may not be enforceable in all countries • There is an added level of exposure to counterparties in these countries who may decide not to perform on a derivative that is out-of-the-money 20
  • Rebalancing of Exchanges and OTC • IPE/ICE now offering clearing of OTC contracts • Fulfills necessary role of credit intermediation • Credit risk borne by clearing members • Enables price risk managers to hedge risks customized to their needs while not taking on counterparty credit risk • Cost is upfront margin and subsequent margining, which may not be necessary in bilateral OTC contracts
  • 3. Hedging Policies & Instruments in hyper-volatile era
  • Classification of hedging programs Ratable Opportunistic No Yes Discretionary Yes Constrained Non-discretionary 23
  • Discretionary vs. nondiscretionary • A small number of hedgers take a discretionary approach Market timing, based on knowledge gained from other participants and dealers Role of research, consulting agreements • The vast majority of hedgers are less discretionary Reflects their admission of not having superior market knowledge Price takers Trend followers 24
  • Discretionary programs • Discretionary hedging programs may be extremely flexible • Buying and selling hedges based upon market point of view gathered internally or with input from outsiders • But difficult to explain to shareholders • Also may not dampen volatility of physical exposure as traders may choose not to be hedged or even to increase exposure 25
  • Nondiscretionary: two main types • Constant-volume, or ratable-volume Involves defined-volume, defined-frequency accumulation of hedges regardless of price Can involve any particular structure (swaps, collars, caps) • Structured opportunistic Accumulates hedges according to price levels May also dictate structures employed at any given price level 26
  • Constant-volume programs • Example: buying 1-year forward once per quarter in volumes corresponding to 10% of total consumption – After four quarters, hedge volume equal to 40% of that period’s consumption; 30% of 2nd quarter’s consumption; 20% of 3rd quarter’s consumption; and 10% of 4th quarter’s consumption – Total volume of hedge position equal to full quarter’s consumption – Price appreciation/depreciation should affect hedge book and physical exposure similarly, though not perfectly given “beta” effect – Given the dollar-weight averaging of entry prices, the value of the hedge will have somewhat dampened volatility vs. entry levels 27 ISDA® ISDA®
  • Structured Opportunistic programs • May be as rigidly applied as constant-volume programs (i.e. without discretion) • But rigid in a very different way – via statistical analysis of historical prices • Hedges are entered according to how forward prices relate to historical averages • Hedge volumes grow as prices drop, and vice-versa • Choice of instruments may also be a function of price levels
  • Structured Opportunistic pros/cons • Benefit from lower volatility of hedge value vs. ratable programs All other things equal, the size of a S.O. hedge position is equal to or lesser than the size of a ratable hedge position • Effective as long as market behaves according to historical price distribution • Downside: leave consumer un-hedged in persistently strong market • Alternatively, can saddle hedge book length in persistently weak market • Tends not to benefit from term structure as ratable programs do • Indeed, structured opportunistic programs generally hurt by term structure (buying in contango market; exposed in backward market)
  • Price Dive and Consumer Hedging • Regardless of the robustness of your Monte-Carlo risk engine, it is unlikely that the $147 through $35 move constituted a reasonable or even likely price scenario. • Consumers hedgers got scattered in all quadrants: From – Reactive and cutting losses relatively early. All the way to – Did not do anything at all. in • But all are revising their hedge program parameters, particular how recursive the decision-making process should become.
  • Choice of instruments • Typical: Buy swaps at relatively low prices 1.5+ standard deviations below long-term averages Probability of hedge losing value is relatively low Potential mark-to-market costs (margin) lowest • Enter collars or ceilings at median prices Provides more flexibility on MTM should market decline from average levels • Buy caps or do nothing at higher prices Potential for hedge losses proportionately greater
  • Rules of thumb on allocation of instruments • One simple rule of thumb is to hedge one-third of exposure via swaps; another third via collars; and leave the balance unhedged • Justified by its risk profile as halfway between hedged and unhedged • In practice, this is just a point on the continuum; there may be solid reasons to choose alternative points • For structured opportunistic, the decision regarding mix of hedges may be a function of forward prices
  • Views on structures • New structures marketed as offering greater value than existing products There is no free lunch, please do not fall for smoke & mirrors! Any structure can be offered more cheaply if the buyer is willing to maintain or increase exposure Always calculate your leverage ex-ante! TARS horror stories… • A derivatives dealer can develop risk-management tools for any specific exposures via existing or novel structures Need to establish client objectives Relative importance of net cash cost Predictability vs. buying low
  • Example #4: storage hedge collar • Strip of European-style zero-cost collars (floor vs. cap) on crude oil term structure to protect against severe backwardation and/or benefit from contango shape. • Inventory hedges are typically rolling short futures positions • The storage hedge collar provides protection against backwardation, not necessarily spike in outright price • Another example of a spread option 34
  • 4. Current Situation
  • We don’t do Price forecasts • But it appears that once excess physical inventory is eventually mopped up, all necessary conditions are in place for the resumption of a bullish bias: – Vastly expansionary monetary stance in key Central Banks impacts the differed part of the forward curves. – E&P, Refining and Downstream investment in slowdown mode. – The return of speculators to Oil, the “macro trade” is alive and well. Inflation hedge, diversification from the $, lack of alternatives have led to higher open interest and volumes on ICE.
  • A wall of cash…
  • Slowdown in Investments?
  • US & Canada Rig Count
  • Oil Supply adjusting to crisis • With lower price environment, some Projects schedules delayed, some scrapped. – In non-OPEC, IEA estimates 1 mm bpd for 2009/10 • Steeper decline rates from mature fields as maintenance spending is trimmed. • Those factors impact with a lag even in case the market rebounds, some are non-reversible. [sticky factor]
  • What matters today? (1) • Do we still have too much oil supplied and what is OPEC doing about it? – Inventories plentiful, have been rising for 7 months. – Still building but not as fast. – Contango shape allows storage balancing mechanism. • OPEC in catch-up mode for cuts while demand revisions pace quicken – OPEC tightening compliance and will persist – Refiners adjusting to low-run world as refining in excess capacity.
  • What matters today? (2) • The macro-trade is alive and kicking. Risk/reward is alluring. How much downside left?... • Speculative positions (OI & Volumes) on the oil exchanges have increased again since a low in October 2008 • A recent survey of 1,000 hedge funds by Deutsche Bank indicates that a quarter of $294 billion held in cash should find its way into highly favored “global macro strategy” within 6 months.
  • What matters today? (3) • Asia seems to be leading the way on bottoming out process. Ethylene crackers now in full runs again in Korea, Taiwan, etc… • How sustainable is China as the new world growth leader? How reliable is domestic demand for the medium-term? Besides infrastructure spending…
  • Recent regulatory developments • Pension and hedge funds in the crosshair last July • Now very much a CDS story as oil receded. • Last February, anti-speculation measures specific to commodities markets passed House but vetoed • On the agenda of the new administration but unclear which House Committee is taking the lead between Financial Services Committee and Energy and Commerce Committee. • Unregulated OTC trading defended by financial institutions. • OTC Clearing trend versus speculative position limits • London loophole, what London loophole?
  • Prices: a word about Natural Gas • Natural Gas world in Europe still has a split personality: NBP in the UK and GO/FO formulas on the continent due to long-term supply contracts pricing mechanism. • NBP is still the dominant hub in NWE Europe as competition restriction prevent the other continental hubs from taking their rightful place - still influenced by oil prices in the forward season but will break below European Benchmark Prices and surrender to UK Supply / Demand in short-term. • Our NBP Point of View: rather bearish for summer given supply situation, initially we think winter prices will be supported by utility hedging and lack of storage. • European Benchmark Price (a rough estimate of the oil index formula prices - e.g. German average import price)
  • 5. Koch Industries
  • Koch Industries - Overview • Koch Industries is among the world's largest private companies. Founded in 1940, it is owned and managed by Charles and David Koch. • Koch has interests spanning involvement in commodities (metals, petroleum, minerals etc.) and securities trading through to owning and operating refining and manufacturing facilities. • As evidence of its financial strength Koch Resources, LLC maintains a long-term S&P A+ and Moody’s Aa3 credit rating. • Trading operations located in London, Geneva, Singapore, Houston, New York, Wichita, Kansas (Corporate Headquarters), Rotterdam and Mumbai. • Information: www.kochind.com www.ksandt.com www.kochmetals.com http:/derivatives.kochind.com www.kochsteel.com www.kochbullion.com
  • Koch Business Groups Koch Industries owns a diverse group of companies that exercise capabilities in trading, operations excellence and investments on a global scale in core industries that include: trading; petroleum; asphalt; natural gas; gas liquids; chemicals ;metals, plastics and fibers; chemical technology equipment; minerals; fertilizers; ranching; pipelines; pulp; securities and finance, as well as a range of other ventures and investments. Some of the principal companies include: Koch Financial Corporation Koch Supply & Trading, LP Koch Materials Company Koch Supply & Trading, Sàrl Koch Chemical Technology Group Koch Metals Trading Limited KoSa Flint Hills Resources INVISTA Koch Mineral Services, LLC Georgia-Pacific Koch Capital Markets Koch Ventures
  • Koch Supply & Trading - Overview • Koch Supply & Trading, LP (KS&T) is a global supply, marketing, trading and risk management group conducting business in crude oil, refined petroleum products, petrochemical feedstock, freight, base metals, steel and other commodities. • Today KS&T is among the world’s top five crude oil traders and actively trades about 50 types of crude oil around the world. • KS&T trades in physical commodity markets and is also an active market-maker of innovative risk management solutions for a wide range of customers, including several large oil producers • KS&T emphasizes a disciplined, strategic approach, with a focus on customer needs, market analysis and risk-management capabilities. • Information: www.ksandt.com http:/derivatives.kochind.com
  • Koch Supply & Trading: Activities • Worldwide trading and risk management activities in crude oil, refined petroleum products, metals and other commodities: – Global Crude Oil (trading some 50 different types of crude) – Light Products and Chemicals – Natural gas and gas liquids – Heavy Products (e.g. industrial and bunker fuels) – Base Metals (Al, Cu, Zn, Pb, Ni, Sn and brass) incl. online trading – Steel (hot and cold rolled coils) • For additional information see: www.kochmetals.com
  • Koch Supply & Trading – Contacts Structured Products New York Ilia Bouchouev (212) 759-8146 ilia.bouchouev@kochind.com Nicholas Dazzo (212) 319-4895 nicholas.dazzo@kochind.com Patrick Melia (212) 759-8123 patrick.melia@kochind.com Adam Glassman (212) 355-3417 adam.glassman@kochind.com Joseph Master (212) 644-0286 joe.master@kochind.com Ashutosh Tayshete (212) 319-5163 ashutosh.tayshete@kochind.com Wichita Arian Fouquet (316) 828-3888 arian.fouquet@kochind.com Brett Johnson (316) 828-8884 brett.johnson@kochind.com Wes Osbourn (316) 828-5882 wes.osbourn@kochind.com Brett Unrein (316) 828-7178 brett.unrein@kochind.com Geneva Olivier Raevel 41-22-737-4229 olivier.raevel@kochind.com George Christie 41-22-737-4225 george.christie@kochind.com Christian Jestin 41-22-737-4221 christian.jestin@kochind.com Brian Carpani 41-22-737-4244 brian.carpani@kochind.com Singapore Dennis Ho 65-6831-6560 dennis.ho@kochind.com Mumbai S. Ramani 91-22-2403-8437 ramanis@kochind.com
  • Disclaimer Note: These forecasts/data/analysis are based upon a number of estimates and assumptions. Actual results may vary significantly. No assurance or guarantee is made that these forecasts will be achieved. Please be advised that the analysis, examples and prices provided above are for illustrative purposes only. Although the information has been compiled by Koch from sources believed to be reliable, these financial forecasts are based upon a number of estimates and assumptions that are subject to significant business, economic, regulatory and competitive uncertainties. Forecasts are inherently subjective and speculative, and actual results and subsequent forecasts may vary significantly from these forecasts. Koch makes no representation, warranty or guarantee as to, and shall not be responsible for the accuracy or completeness of, this information and has no obligation to update any information provided to you. Koch shall not be liable to recipient or any third party for its use of or reliance on the information contained herein. Koch is not acting as your agent or advisor and you are encouraged to seek independent advice, as necessary, prior to entering into any transaction. This information may not be reproduced, distributed or published by any recipient for any purpose.