Derivatives and Risk

Management – user perspective

Athens, Greece

September 24th 2010

CONFIDENTIAL. This document contains trade secret information. Disclosure, use or reproduction outside Cargill and inside Cargill, to or by those employees who do not have
a need to know is prohibited except as authorized by Cargill In writing. (Copyright Cargill, Incorporated 2007. All rights reserved.)
The reality for the steel industry however is that change is coming……

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A Few Myths About Derivatives

• Derivatives are dangerous

– Hedging and risk mitigation, when correctly done, is a valuable tool and
reduce the market risk, i.e. allows to lock in margin
– Derivatives are onlyy dangerous
g for those without p
physical
y market knowledge
g
and trading/risk management strategy

• Derivatives are only for speculators

– No
No. Industry players (e.g.
(e g mills,
mills warehouses and steel consumers) can use
derivatives to hedge risk
– Yes speculators can participate but they bring liquidity and take risk

• Indexes
I d are inaccurate
i t
– Indexes are only as good as the data collected
– From our experience, the CRU HRC pricing reflect the physical spot market
quite well

• Paper markets cause additional volatility

– Steel, Iron ore and Scrap, which historically have had no paper markets,
have been some of the most volatile markets in the world
– Industries with paper can actually be less volatile

It is important
p to understand the physical
p y market fundamentals behind
derivatives, and then how to apply derivatives to manage risk

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Who are the main players in a steel Derivative market?

Role and Benefit Role and Benefit

Role: Bring together buyer Role: Provide Physical
and seller for financial delivery of product – HRC.
liquidity
q y of p
product – HRC
Financial  Steel  Benefit: Ability to hedge and
Benefit: Additional service Companies Producers lock in margin on fixed price
they can offer their clients. contracts. (ex. Sell paper
• Banks • Steel Mills
• Brokers
B k • Trading 
T di fixed price contract and
companies delivery physical on CRU
floating price)

Role and Benefit Hedge Funds Steel  Role and Benefit

Role: Provide financial • Private money Consumers Role: Provide physical
liquidity of product – HRC • Pension Funds • OEM’s liquidity of product – HRC
• Service Centers
S i C t
Benefit: Additional market • Construction Benefit: Ability to hedge and
outlet to invest capital for lock in fixed prices for
investors to express their extended period of time. (ex.
view or hedge their risk Buy fixed price contract and
take delivery on floating price
CRU.
All 4 sectors must pplay
y an active role for the derivative market to develop
p
and provide the necessary liquidity for a healthy and active exchange but
the industry (steel producers and users) must want the tool
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How to use financial tools

1. Lock in profits
– Financial tools allow the consumer to lock in their future cost of steel 
Fi i l t l ll th t l k i th i f t t f t l
ensuring them that when the produce their product 6‐12 months later they 
will know their cost ensuring a margin

2. Manage price risk
– Because of the increase in steel price volatility companies who must hold 2‐
3 months of inventory are exposed to significant losses in a rapidly falling 
market. The proper use of risk management products would allow these 
consumers the ability to de‐risk their exposure to heavy losses by entering 
i
into futures sales contracts
f l

Financial tools when used correctly and in conjunction with physical delivery
can provide increased opportunities to reduce risk and lock in profits
 Reduce Risk ‐ Hedging

Profit
So your over all profit is fixed

Time

Hedging is removing exposure or risk by offsetting it with something of

the opposite risk

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Iron Ore, Steel and Freight Derivatives

• Example: Iron Ore TSI index and SGX forward prices
Today is Sept 21th, 10: After a price run
Today is Sept 21 , 10: After a price run‐up
up  The forward market curve is in 
The forward market curve is in
during the summer the Iron Ore market  Backwardation  (future price lower than 
corrected in Aug and has found a new floor  current) : 
in the last few days and current price is  March 11 traded today (Sept 21th 10) at 
140.00 124.00

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 Example: Iron Ore TSI index and SGX forward prices

Iron Ore, Steel and Freight Derivatives
Case 1: From current 140 prices fall. Case 2: From current 140 prices rally.
At maturity (Mar 2011) the TSI price is 90 At maturity (Mar 2011) the TSI price is 170

170
140

140

90

For paper settlement , on end Mar 2011, the buyer For paper settlement, on end Mar 2011, the buyer
gives the seller the difference ie 124 -90 = 34 receives from the seller the difference ie 170-124
usd/mt = 46 usd/mt

Physical effective sales/buy price: 90 Physical effective sales/buy price: 170

Paper transaction : 34 Paper transaction: -46
Total transaction price: 124 Total transaction price: 124
On 21.09.10, the Mar 2011 Iron Ore price has been “fixed” to 124, with the paper transaction’s gains/losses 
offsetting any losses/gains on the physical market. 
The price risk has been hedged 
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Spot Price and Indices Comparison

The Iron Ore spot price has remained quite volatile over the past 1 year

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 0.00
200.00
400.00
600.00
800.00
1000.00
1200.00

Januaary‐05

Th
Marrch‐05
May‐05
M
Juuly‐05
Septembber‐05
Novembber‐05
Januaary‐06
Marrch‐06
May‐06
M

The pastt 5 years h

Juuly‐06

CRU (nt)
Septembber‐06

d
Novembber‐06
Januaary‐07
Marrch‐07
May‐07
M
Juuly‐07
Septembber‐07

have demonstrated
Novembber‐07

AMM Bushling (Chicago)
Januaary‐08

t t d steel
Marrch‐08
Hot Rolled Coil, Pig Iron and Scrap Prices

May‐08
M
t l and Juuly‐08
we expect this trend will continue into the future Septembber‐08
Novembber‐08
Januaary‐09
Ryan Notes "Mean"

Marrch‐09
May‐09
M
d raw material

Juuly‐09
Septembber‐09
Novembber‐09
t i l price

Januaary‐10
Marrch‐10
May‐10
M
Juuly‐10
i volatility

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l tilit and
d
 OI (MT) Nymex Volumes and Open Interest Volumes (MT)
Derivative Volume Evolution 250,000 70,000

3,500,000 60,000
200,000
3,000,000 50 000
50,000
Iron Ore Swap Volumes
2,500,000 150,000 40,000
2,000,000
100,000 30,000
1,500,000
20 000
20,000
1,000,000
50,000
500,000 10,000

0 0 0

SGX Volume (mt) LCH Volume (mt) Total Volume (mt)

Volumes Open Interst (MT)
OI (MT) LME Med Volumes and Open Interest Volumes (MT)
250 000
250,000 120 000
120,000
SHFE Rebars
R b
1800000 6000000
100,000 1600000
200,000 5000000
1400000

0 ton)
0 ton)
80,000 1200000 4000000
150,000

lots (x10
1000000

lots (x10
3000000
60,000 800000
100,000 600000 2000000
40,000 400000
1000000
200000
50,000
20 000
20,000 0 0

0 0
28.04.2008 28.04.2009 28.04.2010
Volume Open Int
Volumes aggregate open interest

Derivative markets are picking up in both volume and participants as price

volatility continues to impact results and expectations in the Ferrous Industry
Issues to watch going forward

• LME Billet warehouse
– LME has opened a North America Billet warehouse that will allow a 
true global delivery for its billet contract

• Scrap Exchange
– A number of indexes are looking to launch a scrap exchange

• More and More counter parties are coming into the Ferrous 
D i ti
Derivative markets
k t
– Automotive, Energy, Service centers, Appliance, Heavy equipment

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Change is coming to our industry so don’t spend your efforts trying to stop the
change but rather work with Cargill to help see how change can enhance your
business 12
• Thank You

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