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Introduction to
Steel Swaps
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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
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Overview of the Steel market
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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
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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)
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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%
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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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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
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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
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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 .
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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.
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The Mechanics of Steel Swaps Trading
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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 I
N G
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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
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-400
-200
0
200
400
600
800
430 450 470 490 510 530
[ P
rofi
t |
Lo
ss ]
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
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Who Uses Steel Swaps?
• Mills
• Service Centres
• Automobile Manufacturers
• Construction Companies
• White Goods Manufacturers
• Pipe Manufacturers
• Shipyards
• Rail Infrastructure
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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?
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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
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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
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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
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• 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
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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
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At the end of Q4 the settlement price on Northern Europe TSI HRC is calculated at €560 per metric ton
Pro
fit
& L
oss
€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.
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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
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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
Pro
fit
& L
oss
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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
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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
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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
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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
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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
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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
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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
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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
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In Summary
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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
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Get our free steel market reports + forward price curves
by email | [email protected]
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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