Steel Swaps Explained

+44 20 7090 1126
steel@freightinvestor.com
http://bit.ly/steel-reports
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
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)

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)
1 1
2
3 3
4 4
E
X
E
C
U
T
I
O
N
C
L
E
A
R
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N
G
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2. What are Steel Swaps?
Agenda

-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

Who Uses Steel Swaps?
• Mills
• Service Centres
• Automobile Manufacturers
• Construction Companies
• White Goods Manufacturers
• Pipe Manufacturers
• Shipyards
• Rail Infrastructure
13

 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
14

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 steel@feightinvestor.com and we’ll walk you through it
16

• 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
17

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
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

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
Profit
&
Loss
19

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
21

China HRC / Cleartrade Steel / LCH.Clearnet
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
22

Turkey Scrap / The Steel Index / LCH.Clearnet
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
23

N Europe HRC / The Steel Index / LCH.Clearnet
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
24

S Europe HRC / The Steel Index / LCH.Clearnet
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
25

USA HRC / CRU / CME Clearport
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 | 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.
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