Steel and Scrap Swaps Webinar

Steel, Iron Ore and Scrap Metal
Risk Management Webinar
Thursday 17th Feb – 10:00 AM GMT
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http://bit.ly/steel-reports 1
A Quick Word About FIS
Freight Investor Services is dedicated to finding and developing innovative

solutions to the problems faced by our clients on a daily basis.
Over 10 years, we have aimed to become the foremost provider of liquidity and
facilitator of risk management products in five specialist commodity markets.
Today, FIS serves the needs of over 230 clients on a daily basis. We are the
leading derivatives brokerage by market share within each of our core markets.
Agenda
1. Overview of Scrap Metal
2. A Common Problem
3. What is a Swap?
4. Solving our Problem
5. Summing Up
6. Next Steps + Q & A
Worldwide Scrap Metal
Source: World Steel Dynamics
Scrap Metal in Steel Production
Worldwide Scrap Metal
The Steel Index CFR Turkish Scrap
http://www.thesteelindex.com/en/scrapprices/
TSI Correlations
Correlations with TSI CFR Turkish Scrap

Shredded N Europe Domestic Delivery 93.00%
Shredded N Europe Domestic Delivery Shredded Rotterdam Export 92.10%
Shredded North America Export FOB East Coast 95.80%
Chinese and Subcontinent Dry Bulk Ship Scrapping Prices > 91.20%
Chinese and Subcontinent Dirty and Clean Tanker Ship Scrapping Prices > 87.97%
LME Billet 91.4%
Source: AMM, TSI, World Steel Dynamics, LME
Agenda
2. A Common Problem
3. What is a Swap?
5. Summing Up
The Scenario
It is June, 2011: A steel mill would like to offer a fixed-price off-take

agreement to an important client for 240,000 tons of billet
produced from scrap evenly through 2012 (20,000 tons per month)
In order to service this agreement ( assuming a yield loss of 13% )

the mill has an exposure of approx. 276,000 tons of scrap metal
over the course of the year ( 23,000 tons per month )
The Problem
By signing an off-take agreement and guaranteeing sales volumes

the mill significantly reduces its operational risk.
However, since it has fixed its revenues but must continue to

purchase scrap on the volatile spot market it’s margins and cash
flow are now exposed to considerable financial uncertainty & risk.
Spot-Price Scrap Fixed-Price Billet Profit per Ton
Two Possible Solutions
(1) Periodically stockpile physical scrap during favourable markets to hedge

exposure on the approach and over course of 2012
a) Storage limitations and cost of carry
b) Limited trade finance
c) No guarantee of a favourable market in 6 months
(2) Use scrap swaps to hedge the price exposure up to 24 months in advance
and enter the spot market at its own convenience to purchase the scrap
In reality, depending on market conditions, a complementary combination of

both (1) and (2) usually presents the best course of action.
Agenda
2. A Common Problem
3. What is a Swap?
5. Summing Up
What is a swap?
A swap is
…a contractual agreement…
…brokered between ‘two counterparties’…
…to settle the difference in cash between…
• a price agreed today

– for a particular commodity (e.g. Ferrous Scrap Metal)
– for a specified period in the future (e.g. Calendar Year 2012)
• and the actual price of the commodity during that period

– as determined by an index (e.g. the TSI CFR Turkish Scrap Index)
What is a Swap?
For Example
1. It is June 2011 and the spot price of scrap (according to ‘The TSI CFR Turkish
Scrap Index’) is $444 per metric ton.
2. I think the price of scrap is going up and will average higher than $460 in 2012.
3. My counterparty disagrees and thinks the price will be lower than $460 in 2012.
4. Since we are both confident in our views we agree that we will review the
actual index average again at the end of 2012.
5. We agree a swap contract for 2012 with a strike price of $460
• So, for every US$ that the average index price for 2012 is higher than $460 my counterparty
pays me $1. Conversely, for every $1 it is less than $460 I pay my counterparty $1.
6. On Jan 1st 2013 we average the weekly values for 2012 and find that the actual
average for the year was $450.
7. I pay $450 - $460 = $10 to my counterparty .
What is a Swap?
In Reality
• Counterparties are scrap traders, steel mills, service centres, end users,
investment banks and hedge funds of various sizes.
• Individual trades are usually for multiples of 5,000 tons per month ( 5,000
tons >> $1 change in price = $5,000 exchanged)
• Trades are anonymously matched/facilitated 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 Swaps Trading
Swap Buyer 1 1 Swap Seller

EXECUTION
(Front Office) (Front Office)

Broker
(FIS)
3 3
Clearing Member Clearing House Clearing Member
(Back Office) (LCH.Clearnet) (Back Office)
CLEARING
4 4
Swap Buyer Swap Seller

(Back Office) (Back Office)
Combining Natural Exposure with Swaps
800 Taking a swaps position with the

opposite [ profit / loss ] to your natural
position in the physical market results in
600 the [ profits / losses ] from each position
cancelling each other out.
400 So whether steel prices increase or

decrease, the net [cost / revenue] you
[pay / receive] is thus fixed relative to
[ Profit | Loss ]
200 the spot market
Price per MT The size of the position and overall effect

0
430 450 470 490 510 530 on your net market exposure is highly
flexible.
-200
The position can be held to maturity (for
cash settlement) or flexibly reversed
-400 (closed out) by taking a second swap
position that is equal and opposite to
Physical Position Swap Position your first swap position.
Agenda
2. A Common Problem
3. What is a Swap?
5. Summing Up
The Problem
Confused? No Problem! Call us on +44 20 7090 1126 or email us at steel@feightinvestor.com and we’ll walk you through it
• Our Mill has a spot exposure of roughly 276,000 tons of scrap

metal over the course of 2012 from it’s off-take agreement.
• They are
1) Worried that scrap metal prices might increase, eliminating the margin
between their volatile costs and the fixed revenue from the billet.
2) At risk of losing money on their transaction or being forced to default on
their important client if the market turns significantly against them.
3) Unable to effectively allocate/invest working capital since they cannot
accurately forecast profit margins and must keep a large cash reserve.
The Solution
• The Mill decides to use swaps to offset its exposure
• The Mill contacts FIS and places a ‘buy’ order for 13,800 lots of LCH cleared swaps for
the Cal 12 period (20mt per lot x 13,800 lots = 276,000 mt).
• A broker at FIS negotiates a firm strike price with a ‘seller’ in the market at $376 per
metric ton for settlement against TSI’s CFR Turkish Scrap Index.
• The trade is agreed and confirmed and FIS and the Mill report the trade to LCH.
• The Mill has successfully hedged its net cost for the exposed volume of exposed scrap at
$376 per metric ton regardless of the actual price of the spot market in Q4.
The Result
At the end of 2013 the settlement price on TSI Turkish Scrap is calculated at $440 per metric ton
• The profit from the Mill’s swaps position is equal and opposite
+ $64
to the increase in the physical cost.
$376 Swap • As such, the net cost of scrap metal for the period of Cal 12 is
Profit & Loss
P&L
fixed at the strike price of the swap.
$440
• The Mill has found a way to fix the net price per ton of scrap
Average $/MT
TSI Turk Scrap metal
• 18 months in advance
Physical Position 23,000 tons x $440 x 12 months = - $121,440,000 • Without having to periodically enter the scrap market
for large volumes of scrap
Swap Position ( $440 - $376 ) x 23,000 x 12 = $17,664,000
Net Cost -$121,440,000 + $6,624,000 = - $103,776,000
-$103,776,000 / 276,000 = -$376 per metric ton
The Result
fixed margin
Spot-Price Scrap Fixed-Price Billet Net Scrap Price with Swaps
• The Mill fixed its overall margin well in advance.
• Regardless of spot price, the Mill was able to enter the spot market at its convenience and on a regular basis for small
tonnages reducing its overall costs of carry.
• Where each of its competitors was forced to default on their long-term off-take agreements or sink significant
quantities of cash maintaining the unprofitable agreement, this mill was comfortably able to honour its commitment to
its customer.
• The customer is delighted with the service provided by the Mill and decides to double its off-take order for 2013.
• Since the Mill had secured the profit it would receive in advance, it has been able to confidently allocate capital for a
second site to accommodate it’s new requirements.
Advantages Summary
Primary Advantages Secondary Advantages

 Secure Margins  Creates a secondary pool of liquidity to
 Reduce financial risk physical market
 Better Forecasting  Anonymous trading
 More efficient capital allocation  Low risk of default
 Better Service  Forward curve gives price discovery to
 Reduce Need for Stockpiling market expectations
 Lower Storage Costs  Flexible, quick adjustment of exposure
 Physical operations left in tact
 Competitive Advantage  Expertise already within company
Agenda
2. A Common Problem
3. What is a Swap?
5. Available Products
Turkey Scrap / The Steel Index / LCH.Clearnet
product index clearing house
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
product Turkey – Heavy Metal Scrap
swap specifications
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
index specifications
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
S Europe HRC / The Steel Index / LCH.Clearnet
product South Europe – Hot Rolled Coil
swap specifications

lot size 20 Metric Tons
price quotation EUR / metric ton

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
N Europe HRC / The Steel Index / LCH.Clearnet
product North Europe – Hot Rolled Coil
swap specifications

price quotation EUR / metric ton

grade Prime mild carbon steel EN10111 DD11 (or equivalent)
gauge / width 2.0 mm + / 1250 – 1600 mm
coil weight 10 – 25 metric tonnes
price point Net effective base price, ex-mill / N Eur Base Point
China Rebar / Cleartrade Steel / LCH.Clearnet
product China – Rebar
swap specifications

lot size 20 metric tons
price quotation USD
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
price point Prices sourced from 25 major cities across China
China HRC / Cleartrade Steel / LCH.Clearnet
product China – Hot Rolled Coil
swap specifications

price quotation USD / metric ton (converted from CNY index)
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
USA HRC / CRU / CME Clearport
product US Midwest – Hot Rolled Coil
swap specifications
clearing house CME Clearport

lot size 20 short tons
price quotation USD
trading months 24 consecutive months
index CRU
grade For commercial quality
gauge / width Extras excluded
coil weight > 40,000lbs
price point Net effective base price, ex-mill
Agenda
2. A Common Problem
3. What is a Swap?
5. Summing Up
In Summary
 Indices – Third party price assessments that provide industry transparency
 Swaps – A risk management tool that provides a flexible, cost-effective and

complementary 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 daily spot (index) and
forward (swaps) pricing for a wide range of steel products
• Get them free at http://bit.ly/steel-reports
Thank you, Next Steps and Q&A
Thank you for listening.

Q&A - Please don’t hesitate to ask us questions via the Webinar chat window
1st The Steel Index

Get our free steel market reports + forward price curves TSI give excellent presentations
on scrap metal and finished
by email | steel@freightinvestor.com
product markets that we and
online | http://bit.ly/steel-reports our clients have found
extremely useful in the past.
For more information on either

their indices or their free
2nd presentations we recommend a
call to:
Contact Arthur / Sam for a telephone or personal consultation
Tim Hard (Head of Steel)
in person | 80 Cannon Street, London, EC4N 6HL
+44 20 7645 9415
by telephone | +44 (0) 207 090 1126
online | http://bit.ly/steel-swaps Vaseem Karbhari (Sales)
+44 20 7645 9415

Steel and Scrap Swaps Webinar

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Steel, Iron Ore and Scrap Metal

Risk Management Webinar

Thursday 17th Feb – 10:00 AM GMT

The Webinar will begin shortly!

Freight Investor Services is dedicated to finding and developing innovative

1. Overview of Scrap Metal

4. Solving our Problem

6. Next Steps + Q & A

Source: World Steel Dynamics

Correlations with TSI CFR Turkish Scrap

Shredded N Europe Domestic Delivery Shredded Rotterdam Export 92.10%

Shredded North America Export FOB East Coast 95.80%

LME Billet 91.4%

Source: AMM, TSI, World Steel Dynamics, LME

1. Overview of Scrap Metal

4. Solving our Problem

6. Next Steps + Q & A

It is June, 2011: A steel mill would like to offer a fixed-price off-take

In order to service this agreement ( assuming a yield loss of 13% )

By signing an off-take agreement and guaranteeing sales volumes

However, since it has fixed its revenues but must continue to

Spot-Price Scrap Fixed-Price Billet Profit per Ton

(1) Periodically stockpile physical scrap during favourable markets to hedge

b) Limited trade finance

c) No guarantee of a favourable market in 6 months

In reality, depending on market conditions, a complementary combination of

1. Overview of Scrap Metal

4. Solving our Problem

6. Next Steps + Q & A

• a price agreed today

• and the actual price of the commodity during that period

Swap Buyer 1 1 Swap Seller

(Front Office) (Front Office)

Swap Buyer Swap Seller

800 Taking a swaps position with the

400 So whether steel prices increase or

200 the spot market

Price per MT The size of the position and overall effect

1. Overview of Scrap Metal

4. Solving our Problem

6. Next Steps + Q & A

• Our Mill has a spot exposure of roughly 276,000 tons of scrap

• The Mill decides to use swaps to offset its exposure

Net Cost -$121,440,000 + $6,624,000 = - $103,776,000

-$103,776,000 / 276,000 = -$376 per metric ton

Spot-Price Scrap Fixed-Price Billet Net Scrap Price with Swaps

• The Mill fixed its overall margin well in advance.

Primary Advantages Secondary Advantages

 Better Forecasting  Anonymous trading

 More efficient capital allocation  Low risk of default

 Better Service  Forward curve gives price discovery to

 Reduce Need for Stockpiling market expectations

 Lower Storage Costs  Flexible, quick adjustment of exposure

 Physical operations left in tact

 Competitive Advantage  Expertise already within company

1. Overview of Scrap Metal

4. Solving our Problem

6. Next Steps + Q & A

product Turkey – Heavy Metal Scrap

clearing house LCH.Clearnet

index The Steel Index

product South Europe – Hot Rolled Coil

clearing house LCH.Clearnet