Commodity Webinar - v7

Shane Randolph

Managing Director, Opportune

Sanjay ThoppilSolution Consultant, Reval

February 25, 2015

Commodity Risk: How to Tame the Dragon, Protect Revenues and Reduce Costs

2

About Reval

Founded in 1999, Reval is headquartered in New York, and employs a team of over 400 global staff dedicated to providing solutions to enable best practice Treasury and Risk management in 12 regional offices and support centers around the globe.

We strategically partner with over 600 clients in over 20 countries including all 4 of the Big 4.

Our global coverage model means we have teams of experts based around the world to support you on a 24x7 basis.

3

About the Speakers

Shane Randolph

Managing Director, Opportune

Sanjay Thoppil

Solution Consultant, Reval

Agenda

o Market Trends and Business Challengeso Role of Commodity Risk Management within Treasuryo Risk Management Framework o Hedge Accounting Considerations

4

5

Polling Question

o How would you rate your company’s exposure to commodities? a) Low

b) Moderate

c) High

d) Hard to gauge

6

Market Trends and Business Challenges

Commodity Price Volatility

o Commodity prices are driven by a number of variables; however, recent price volatility is largely driven by energy price volatility– Transportation costs– Energy for processing– Fertilizer components for crops

o Countries with energy based economies will also experience exchange rate volatility (ie. Russia)

o The energy market reinvents itself in three ways– Geopolitically– Technologically – Price movements up or down

7

8

$1.0

$3.0

$5.0

$7.0

$9.0

$11.0

$13.0

$15.0

$20.0

$40.0

$60.0

$80.0

$100.0

$120.0

$140.0

Gas

$/m

mbt

u

Oil $

/bbl

WTI Spot Brent Spot Henry Hub Spot

Current Oil & Gas Pricing

7-YEAR WTI, BRENT, & HENRY HUB NATURAL GAS SPOT PRICES

Sourcess: U.S. Energy Information Agency, Capital IQ, Barclays: Global 2014 E&P Spending Outlook, December 9, 2014. Market data as of 1/23/15.

9

World Oil Production

10

Primary North American Oil and Gas Shale Drilling

11

Primary North American Oil and Gas Areas of Operation

Source: American Petroleum Institute, January 2014

Gulf of Mexico

Not shown: Alaska and Canada

12

Breakeven Pricing

13

Supply and Demand Drivers of Price Contraction

Driver Impact and Considerations

Excess North American supply

Record U.S. production is driving excessive supply from increased shale and GOM plays.

Shale producers are victims of their own success. Continued downward pressure on oil and gas prices will create an

environment where the economics of many deepwater and unconventional plays cannot be sustained or justified.

OPEC and foreign production

The Saudis lead OPEC and are intent on curbing North American production “in the interest of restoring market equilibrium“. There is a focus on defending longer term stability of own markets vs. balancing near term global pricing.

OPEC’s sustained output at 30.0 mmbbl/day furthers available foreign oil in the market.

Continued production expected from Brazil; stable Russian production is desired internally given imperative of oil and gas industry to its economy. Libya remains a wildcard.

Strong dollar Oil is priced in $USD in the global markets. A stronger dollar decreases purchasing power in foreign currencies. Larger emerging market concerns.

Weakened consumer demand

European and Asian growth forecast reductions. Years of high gas prices at the pump constrained spending in connection with

secular shifts. Moderate weather curbing heating and air conditioning.

Sources: Goldman Sachs The New Oil Order October 26, 2014; Deloitte Oil and Gas Reality Check 2014, Opportune analysis and market research.

History Repeats Itself

14


15


16


17

History Repeats Itself-1986

18


19


20


21


22


23

24

$40.0

$50.0

$60.0

$70.0

$80.0

$90.0

$100.0

$110.0

$120.0

WTI Spot WTI Increase Threshold WTI Decrease Threshold

Capex Budgets Reduced

OIL PRICE THRESHOLDS FOR INCREASE/REDUCED CAPEX

Source: Barclays: Global 2014 E&P Spending Outlook, December 9, 2013. Market data as of 1/23/15.

25

Recent Capital Expenditure Pullback Announcements

"We are setting our 2015 capital budget at a level that we believe is prudent given the current environment [a 20.0% reduction vs. 2014]“

- ConocoPhillips, December 8, 2014

“The company is estimating the total fiscal 2015 capital program to range from $670 million to $690 million ($450 million annualized run rate), down from a previously announced $815 million”

- Energy XXI, November 5, 2014

"Given the recent pullback in crude oil and natural gas prices, our initial budget for 2015 includes a capital expenditure range of $240 to $260 million, a significant decrease from 2014 capital spending.“

- Swift Energy, November 6, 2014

"In response to low oil prices, the Company plans to suspend its oil directed drilling activity in its Eagle Ford shale properties in South and East Texas and in the Tuscaloosa Marine shale in Mississippi.“

- Comstock Resources, December 18, 2014

"With the recent weakness in crude oil pricing, Warren is focusing its 2015 development program on its natural gas properties and budgeting capital expenditures in line with cash flows…[and] deferring its crude oil development activity in the Wilmington oil field at this time.“

- Warren Resources, December 10, 2014

"Management has decided to further reduce the 2015 development program given the current commodity price environment. Emerald released two of three operated rigs in the last two weeks.”

- Emerald Oil, December 11, 2014

“Given the recent decline and uncertainty around future oil prices, we have decided to reduce our 2015 capital spending [by 50.0%] to a level that we believe can maintain production and build liquidity”

- Denbury, November 14, 2014

"Apache said it expects to spend $4 billion on its North American fields in 2015, a 26 percent drop from the $5.4 billion it had budgeted for the United States and Canada this year.“

- Reuters, November 20, 2014

"This revised budget prudently aligns our capital expenditures to lower commodity prices, targeting cash flow neutrality by mid-year 2015 “

- Continental Resources, December 22, 2014

"In a lower oil price environment there's nowhere to hide…It’s going to affect all markets equally, and North America will probably be adjusting as we go into 2015...There are going to be rigs laid down."

- Mark McCollum, EVP and CFO of Halliburton, December 10, 2014

Polling Question

o Has your company assessed how rising energy prices could impact the company, directly and indirectly? a) Yes

b) No

c) Not Sure

26

27

Role of Commodity Risk Management Within Treasury

Commodity Risk Operating Models

BasicManager

Silo risk manager

Proprietary trader

Portfolio risk manager

• Risks ignored or addressed inconsistently through the organization

• Exposures inaccurately identified

• Material risks managed centrally

• Focus on policy compliance with timely and cost effective execution

• Supports organization's objectives

• Manages entire portfolio incorporating asset correlations

• Specialist risk managers

Value Add

• Trades for profit using value add strategies optimizing key drivers

• Alignment of risk management and organization strategy

• Organization has competitive edge on the market

• Specialized proprietary traders

Business Alignment

Typically only specialized oil,

gas, mining and electricity trading

companies

Typical corporate commodity risk manager

28

29

• Ongoing volatility• Systems and data

infrastructure• Skilled staff• Hedge accounting• EMIR

Transformation Objectives

o Ultimately deliver greater shareholder value through:– Commodity risk management in line with risk appetite– Greater visibility and certainty of exposures– Enhanced control environment– Holistic management of company financial risks

• Business case• Budget• Governance• Controls• Efficiency• Change• Business unit buy in

External ChallengesInternal Challenges

Recent Experience and Use Cases

Price certainty & protecting operating

marginAdding value to

shareholders and achieving

competitive advantage

Greater visibility and identification of

exposures

Reduced counterparty risk

exposure

Integrated planning with procurement

Improved control environment

Reduction in hedging costs

Holistic management of company risks

30

Commodity center of excellence….

Within TREASURY

“Beverage manufacturer’s treasury team worked with Reval to create an end-to-end solution that would ensure all data flows arecaptured, automated, protected and shared between procurement, finance and treasury.” - Diageo

“2013 Treasury Risk Survey published in gtnews indicates that 44% of treasurers are already responsible for commodity risk management.”

“As much as 40-50% of the cash flows at risk of a company that has exposures to multiple interest rates, foreign currencies and commodities can be reduced just by considering the correlations amongst the asset classes.”

“The team now enjoys the multiple benefits of reduced P/L volatility, better pricing, reduced supplier basedrisk, enhanced control, transparency and reporting, and an improved environment for effectivecommodity risk decision-taking.” - Coca-Cola Hellenic

30

31

Polling Question

o How do you currently manage your commodity exposures? a) Not currently managing

b) In Excel

c) In Treasury Management System

Corporate Commodity Risk

32

Commodity Purchase through Procurement with a Fixed Price Contract

Commodity Purchase with Procurement Purchasing at a Variable Price and Treasury Acquiring a Hedge to Lock-in the Fixed Price

Fixed Price Contract

Market Rate Procurement Contract

Hedge to Create Fixed Price


o Procurement manages relationship with supplier, both supply chain risk and price risk

o Forces supplier to manage commodity price risko Supplier will add a pricing premium for the serviceo Corporates may have better negotiation leverage than suppliero Supplier may not be any better at understanding and managing price

risk

33


o Decouples commodity supply risk from price risk. o Supplier and procurement focuses on delivery logistics.o Treasury generally maintains risk management knowledge and resources.

They are better equipped to manage price risk. o Allows treasury to select hedge horizon and adjust hedge coverage at their

will.o Treasury may have historically focused on FX and IR risk and will need to

develop commodity expertise.o Creates increased accounting demands for tracking hedges.

34

35

Polling Question

o What hedging strategies do you use to manage your exposure to the market risk of commodity prices?a) Fixed price contracts with suppliers

b) Financial derivative contracts

c) We don’t hedge commodities

36

Risk Management Framework

Risk Management Framework

37

Risk Management Objective

Commodity risk management policy formalizes a common objective with stakeholders.o The objective identifies the specific risk that the entity

desires to mitigate– Supply Chain Risk– Stock Price– Adjusted EBITDA/ Profit Margins– Cash Flows

o Lack of a shared objective may lead to disparate results and a “profit center” approach to hedging

38

Infrastructure

Infrastructure required to promote risk mitigation at a portfolio level and to report if exposure is within risk tolerance level and communicate these results to stakeholders:

39

o Organizational structure to reduce inefficiencies or conflicting actions by internal teams

o Systems to capture and monitor necessary data

o Human capital with experience and capabilities to manage commodity risks

Analytics

Analytics and other monitoring tools are used to validate if the strategy was executed and if objective was met:o Effectiveness of hedgeso Optimization of instrumentso Price transparency

40

Use of Analytics in Strategy

41

42

Hedge Accounting Considerations

43

Hedge Accounting: Decision

COSTS

The cost of implementation

On-going maintenance of documentation

Additional resources and audit fees

BENEFITS

Reduce earnings volatility

Re-evaluate hedge strategies

Improve management reporting

US GAAP vs. IFRS

44

IFRS Qualifying Hedged Risks

o Something other than the entire fair value change or cash flow variability of an item.

o Provided component is separately identifiable and reliably measured.

45

Polling Question #3

o Do you currently apply hedge accounting (ASC 815) on your derivatives portfolio?a) Yes, we use the long-haul method

b) Yes, we use the critical terms match method

c) No, we take the mark to market of the derivative to the P&L

d) No, we qualify for the normal purchase/normal sales exemption

e) No, we don’t hedge

46

The Power of Cloud TRM

CASH MANAGEMENT• Bank statement retrieval• Bank account management• Cash positioning and reconciliation• Payments and Payment Factory• In-house banking and Pooling• Multi-lateral Netting• Forecast and Liquidity Planning

• Debt & Investments Management• Intercompany Loans• Limit Monitoring

• Accounting

• Performance Evaluation and Reporting

LIQUIDITY MANAGEMENT

ACCOUNTING AND COMPLIANCE

RISK MANAGEMENT• Integrated Market Data• Exposure Quantification / Management• Multi-Asset Class Derivative Valuation

including IR, structured rates, FX, energy, agriculture, metal, equity, credit)

• Credit adjusted valuations• Hedging Strategy• Back Office and Accounting• Strategy Evaluation and Performance

Measurement

• Compliance with ASC 815(FAS 133 and FAS 161), ASC 820(FAS 157), IAS 39, IFRS 7, IFRS 9, and IFRS 13

• EMIR and Dodd-Frank Reporting

• Inventory & Activity Reporting• General Ledger• Audit Controls

47

Questions?

Shane RandolphManaging Director

Opportune LLP

Direct: 918.728.5631

Email: [email protected]

Sanjay Thoppil

Solution Consultant

Reval

Direct: 646.376.4095

Email: [email protected]

For More Information

48

A copy of the presentation slides and webinar recording will be emailed to all participants

Reval - Treasury and Risk Management

@RevalTRM

facebook.com/RevalTRM

google.com/+RevalTRM

treasurygrapevine.com

JOIN THE CONVERSATION

http://www.linkedin.com/groups?gid=870477

https://twitter.com/revaltrm

http://www.reval.com/knowledgesource/Pages/blogs.aspx





Commodity Webinar - v7

Documents

Transcript of Commodity Webinar - v7