+44 20 7090 1126
steel@freightinvestor.com
http://bit.ly/steel-reports
Introduction to
Steel Swaps
http://bit.ly/steel-rep...
1. Overview of the Steel Market
2. What is a Steel Swap?
3. How are Steel Swaps Used?
4. Worked Examples / Solutions
5. Av...
Overview of the Steel market
0
200
400
600
800
1,000
1,200
1,400
1,600
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2...
Top Steel Importers & Exporters
TOP 10 WORLD TOP STEEL EXPORTERS
Million Tons
Position (2009) 2008 2009 % Change
1 Japan 3...
http://bit.ly/steel-reports
Spot [08/11] 511 [ -4 ] MTD [NOV] 513.00
QTD [Q4] 531.50 YTD [2010] 527.16
Hot Roll Coil - Nor...
1. Overview of the Steel Market
2. What is a Steel Swap?
3. How are Steel Swaps Used?
4. Worked Examples / Solutions
5. Av...
What is a Steel Swap?
A Steel Swap is a ‘Risk Management’ tool that takes the form of…
…a ‘Cash-Settled’ agreement…
…broke...
What is a Steel Swap?
For Example
1. It is April and the average price of N. Europe Ex-Works HRC (according to ‘The
Steel ...
What is a Steel Swap?
In Reality
• Counterparties are organisations (steel mills, service centres, end users,
investment b...
The Mechanics of Steel Swaps Trading
http://bit.ly/steel-reports
Swap Buyer
(Front Office)
Swap Buyer
(Back Office)
Swap S...
1. Overview of the Steel Market
2. What are Steel Swaps?
3. How are Steel Swaps Used?
4. Worked Examples / Solutions
5. Av...
http://bit.ly/steel-reports
-400
-200
0
200
400
600
800
430 450 470 490 510 530
[Profit|Loss]
Physical Position Swap Posit...
http://bit.ly/steel-reports
Who Uses Steel Swaps?
• Mills
• Service Centres
• Automobile Manufacturers
• Construction Comp...
 Guarantees forward income for future steel
production at today’s rates
 Guarantees forward steel prices allowing
for fi...
1. Overview of the Steel Market
2. What are Steel Swaps?
3. How are Steel Swaps Used?
4. Worked Examples / Solutions
5. Av...
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) ...
• The Mill decides to use swaps to offset its exposure
• The Mill contacts FIS and places a ‘sell’ order for 750 lots of L...
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 Reven...
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 Reve...
1. Overview of the Steel Market
2. What are Steel Swaps?
3. How are Steel Swaps Used?
4. Worked Examples / Solutions
5. Av...
http://bit.ly/steel-reports
China Rebar / Cleartrade Steel / LCH.Clearnet
product index clearing house
clearing house LCH....
http://bit.ly/steel-reports
China HRC / Cleartrade Steel / LCH.Clearnet
product index clearing house
clearing house LCH.Cl...
http://bit.ly/steel-reports
Turkey Scrap / The Steel Index / LCH.Clearnet
product index clearing house
clearing house LCH....
http://bit.ly/steel-reports
N Europe HRC / The Steel Index / LCH.Clearnet
product index clearing house
clearing house LCH....
http://bit.ly/steel-reports
S Europe HRC / The Steel Index / LCH.Clearnet
product index clearing house
clearing house LCH....
http://bit.ly/steel-reports
USA HRC / CRU / CME Clearport
product index clearing house
clearing house CME Clearport
lot si...
1. Overview of the Steel Market
2. What are Steel Swaps?
3. How are Steel Swaps Used?
4. Worked Examples / Solutions
5. Av...
In Summary
http://bit.ly/steel-reports
 Indices – Third party price assessments that provide industry transparency
 Swap...
Next Steps
http://bit.ly/steel-reports
Get our free steel market reports + forward price curves
by email | steel@freightin...
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Steel swaps explained

  1. 1. +44 20 7090 1126 steel@freightinvestor.com http://bit.ly/steel-reports Introduction to Steel Swaps http://bit.ly/steel-reports 1
  2. 2. 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 http://bit.ly/steel-reports 2
  3. 3. Overview of the Steel market 0 200 400 600 800 1,000 1,200 1,400 1,600 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010e 2011e 2012e Global Steel Production VS Chinese Steel production (1,000 Metric Tons) World China 0 100 200 300 400 500 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Global Steel Trade (1,000,000 Metric Tons) http://bit.ly/steel-reports 3
  4. 4. 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% http://bit.ly/steel-reports 4
  5. 5. http://bit.ly/steel-reports 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. 5
  6. 6. 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 http://bit.ly/steel-reports 6
  7. 7. 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 http://bit.ly/steel-reports 7
  8. 8. What is a Steel Swap? 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 . http://bit.ly/steel-reports 8
  9. 9. What is a Steel Swap? 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. http://bit.ly/steel-reports 9
  10. 10. The Mechanics of Steel Swaps Trading http://bit.ly/steel-reports 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) 1 1 2 3 3 4 4 EXECUTIONCLEARING 10
  11. 11. 1. Overview of the Steel Market 2. What are Steel Swaps? 3. How are Steel Swaps Used? 4. Worked Examples / Solutions 5. Available Contracts 6. Summary & Next Steps Agenda http://bit.ly/steel-reports 11
  12. 12. http://bit.ly/steel-reports -400 -200 0 200 400 600 800 430 450 470 490 510 530 [Profit|Loss] 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 12
  13. 13. http://bit.ly/steel-reports Who Uses Steel Swaps? • Mills • Service Centres • Automobile Manufacturers • Construction Companies • White Goods Manufacturers • Pipe Manufacturers • Shipyards • Rail Infrastructure 13
  14. 14.  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? http://bit.ly/steel-reports 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 14
  15. 15. 1. Overview of the Steel Market 2. What are Steel Swaps? 3. How are Steel Swaps Used? 4. Worked Examples / Solutions 5. Available Contracts 6. Summary & Next Steps Agenda http://bit.ly/steel-reports 15
  16. 16. 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 http://bit.ly/steel-reports Confused? No Problem! Call us on +44 20 7090 1126 or email us at steel@feightinvestor.com and we’ll walk you through it 16
  17. 17. • 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 http://bit.ly/steel-reports Confused? No Problem! Call us on +44 20 7090 1126 or email us at steel@feightinvestor.com and we’ll walk you through it 17
  18. 18. 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 http://bit.ly/steel-reports Confused? No Problem! Call us on +44 20 7090 1126 or email us at steel@feightinvestor.com and we’ll walk you through it At the end of Q4 the settlement price on Northern Europe TSI HRC is calculated at €560 per metric ton Profit&Loss €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. 18
  19. 19. 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 http://bit.ly/steel-reports Confused? No Problem! Call us on +44 20 7090 1126 or email us at steel@feightinvestor.com and we’ll walk you through it 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 Profit&Loss 19
  20. 20. 1. Overview of the Steel Market 2. What are Steel Swaps? 3. How are Steel Swaps Used? 4. Worked Examples / Solutions 5. Available Contracts 6. Summary & Next Steps Agenda http://bit.ly/steel-reports 20
  21. 21. http://bit.ly/steel-reports 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 21
  22. 22. http://bit.ly/steel-reports China HRC / Cleartrade Steel / LCH.Clearnet product index clearing house clearing house LCH.Clearnet lot size 20 Metric Tons price quotation USD / metric ton (converted from CNY index) trading months Up to 24 Months Ahead ( Mths, Qrtrs & Yrs ) settlement Cash settled 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 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 22
  23. 23. http://bit.ly/steel-reports Turkey Scrap / The Steel Index / LCH.Clearnet product index clearing house clearing house LCH.Clearnet lot size 20 metric tons price quotation USD / metric ton trading months Up to 24 Months Ahead ( Mths, Qrtrs & Yrs ) settlement Cash settled 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 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 23
  24. 24. http://bit.ly/steel-reports N Europe HRC / The Steel Index / LCH.Clearnet product index clearing house clearing house LCH.Clearnet lot size 20 Metric Tons price quotation EUR / metric ton trading months Up to 24 Months Ahead ( Mths, Qrtrs & Yrs ) settlement Cash settled product North Europe – Hot Rolled Coil index The Steel Index 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 extras (e.g. non-standard dimensions) Excluded price point Net effective base price, ex-mill / N Eur Base Point 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 24
  25. 25. http://bit.ly/steel-reports S Europe HRC / The Steel Index / LCH.Clearnet product index clearing house clearing house LCH.Clearnet lot size 20 Metric Tons price quotation EUR / metric ton trading months Up to 24 Months Ahead ( Mths, Qrtrs & Yrs ) settlement Cash settled product South Europe – Hot Rolled Coil index The Steel Index 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 material surcharges (e.g. scrap surcharge) Included extras (e.g. non-standard dimensions) Excluded price point Net effective base price, ex-mill / S Eur Base Point 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 25
  26. 26. http://bit.ly/steel-reports 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 settlement Cash settled product US Midwest – Hot Rolled Coil index CRU grade For commercial quality gauge / width Extras excluded coil weight > 40,000lbs material surcharges (e.g. scrap surcharge) Included extras (e.g. non-standard dimensions) Excluded price point Net effective base price, ex-mill 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 26
  27. 27. 1. Overview of the Steel Market 2. What are Steel Swaps? 3. How are Steel Swaps Used? 4. Worked Examples / Solutions 5. Available Contracts 6. Summary & Next Steps Agenda http://bit.ly/steel-reports 27
  28. 28. In Summary http://bit.ly/steel-reports  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 28
  29. 29. Next Steps http://bit.ly/steel-reports Get our free steel market reports + forward price curves by email | steel@freightinvestor.com 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 1st 2nd Thank you for your time. We look forward to hearing from you soon. FIS – Brokers of Steel Swaps Leading the way in commodity derivatives. 29

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