Managing Steel Price Risk

Managing Steel Price Risk

Prepared and Presented by CME GroupJune 20, 2011

http://www.cmegroup.com

© 2010 CME Group. All rights reserved 2

Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a

leveraged investment, and because only a percentage of a contract’s value is required to trade,

it is possible to lose more than the amount of money deposited for a futures position. Therefore,

traders should only use funds that they can afford to lose without affecting their lifestyles. And

only a portion of those funds should be devoted to any one trade because they cannot expect to

profit on every trade.

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Chicago Mercantile Exchange Inc. CBOT® and the Chicago Board of Trade® are trademarks of

the Board of Trade of the City of Chicago. NYMEX, New York Mercantile Exchange, and

ClearPort are trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark of

Commodity Exchange, Inc. CME Group is a trademark of CME Group Inc. All other trademarks

are the property of their respective owners.

The information within this presentation has been compiled by CME Group for general purposes

only. CME Group assumes no responsibility for any errors or omissions. Although every attempt

has been made to ensure the accuracy of the information within this presentation, CME Group

assumes no responsibility for any errors or omissions. Additionally, all examples in this

presentation are hypothetical situations, used for explanation purposes only, and should not be

considered investment advice or the results of actual market experience.

All matters pertaining to rules and specifications herein are made subject to and are superseded

by official CME, CBOT, NYMEX and CME Group rules. Current rules should be consulted in all

cases concerning contract specifications.


© 2010 CME Group. All rights reserved

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CME Product Listings: Ferrous Product Listings

Steel

Hot-Rolled Coil (US)

Hot-Rolled Coil (European)

Steel Billet (Black Sea)

Ferrous Scrap HMS 80/20

(Turkey)

Iron Ore

62% FE, N. China (Platts)

62% FE, China (TSI)



Expanding Globally

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Principal Economic Roles of a

Commodity Futures Exchange



What is an Exchange?

An exchange is a location, either physical or electronic, where people gather

to locate other market participants, determine a fair price and exchange the

risk associated with holding on an asset that may fluctuate in price

• Futures are traded on regulated Exchanges

• Exchanges do not trade, influence or set prices.

• Price discovery occurs at the exchange either electronically or via “open outcry” in trading

pits

• Now 80% of CME Group volume conducted electronically, enhancing the access,

transparency and speed of the market

• Commodity Futures Trading Commission (CFTC) regulates futures industry just as the SEC

regulates stock industry in the U.S.

• Transactions processed and guaranteed by centralized Clearing House

• Clearing House requires performance bonds from Clearing Members to secure each

transaction

• Futures are “marked-to-market” daily, i.e., traders pay losses and collect profits daily



• Price Discovery

Prices are determined:

• In a transparent, competitive market

• By market participants (not the Exchange which is marketplace)

• Disseminated throughout the world instantaneously through

commercial information vendors

• Price Risk Management

• Price risk can be shifted to parties with the opposite risk

profile or to speculators who provide market liquidity by

taking the other side of your trade.

CME Group

10


Who Trades Futures?



Commercial Hedgers

Hedgers use the futures markets to reduce their exposure to adverse price

movements by transferring their risk to others. Their goal is long-term price

certainty

Examples of Hedgers include:

• Agricultural companies, oil companies, mining firms, and banks: They want to

protect themselves against falling prices for the products or financial assets that they

own or produce and need to sell.

• Manufacturers, food-processing companies, financial firms: These firms want to

protect themselves against rising prices for raw materials or financial assets they

need to buy.

12



Investors

• Investors accept price risk in the hope they will profit from correctly

anticipating the market’s movement and direction.

• At any moment, based on their position, perspective and time frame, some

traders will be looking to buy while others will be looking to sell.

Examples of investors include:

• Investment fund managers

• Banks

• Proprietary trading firms

• Individual traders

13


Why Do They Use Our Products and Services?



Anonymity & Transparency

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consistently tight spreads in our key products

15



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Safety

16

Understanding Futures


What is a Futures Contract?

• Financial instruments are derived from an underlying cash market.

• These instruments are classified as futures, forwards, options, swaps, and

or, a combination of these, e.g. “swaptions”.

• Underlying cash markets can be represented by price indices, thus also

becoming a derivation of the actual commodity.

• Derivatives can be traded on regulated exchange markets or Over-The-

Counter (OTC).

• For example

– Steel futures are a derivative of HRC steel and are traded on CME’s

Globex platform.

– Swaps are derivatives on HRC Steel are traded in the OTC bilateral

market (These trades can then be novated into the CME Clearinghouse

on a post execution basis)


What is a Futures Contract?

Futures contracts are agreements to buy or sell a commodity at a date in

the future. Everything about a futures contract is standardized except it’s

price. The price for a futures contract is what’s determined in the trading pit

or on the electronic trading system of a futures exchange.

What is Standardized on a futures contract:

•Commodity

•Quantity

•Quality

•Delivery date

•Delivery point or cash settlement

•Note…All futures are traded on an organized exchanged


In today’s business environment, effective risk management is a business imperative. It encourages investment and economic progress around the world.

It also depends on the tangible benefits that CME group delivers:

• Diverse user base

• Proven liquidity

• Global distribution

• Unsurpassed clearing – virtually eliminating counterparty credit risk

• Diverse multi-asset product base

Benefits


Hedging

• Hedging is simply a way to manage the uncertainty of prices over

time (taking the unknowns and making them known).

• Hedging minimizes the risk of financial loss due to adverse price

changes over time:

• Improves visibility of returns

• Better manage your cash flow

• Hedging is a means of transferring unwanted risk to those

wanting to take on risk.

• Trying to reduce or eliminate risk by taking two positions that will

offset each other if prices change.


Futures Market Terms

• Contango - price of steel for future delivery is higher than the spot

price. Traditionally due to interest rates, insurance and storage

costs.

• Backwardation - price for spot delivery of steel is higher than for

future delivery. Traditionally due to tight supply.

• Convergence - as a futures contract approaches its last day of

trading, there is little difference between it and the cash price.

Connecting to CME:CME GlobexCME ClearPort


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Mexico City Hub


Trading on CME Globex - Requirements

Customers must satisfy three requirements to begin trading

1. Establish a business relationship with a Clearing Firm

2. Obtain, license or develop a CME Group-certified trading application

• Use an application provided by your FCM or broker

• Develop your own proprietary system

• License from a third-party system provider (ISV)

• License a CME Group provided application

3. Establish platform connectivity

• Direct connectivity

• Indirect connectivity through a third-party provider (e.g., broker, ISV,

datacenter)


Trading on CME Globex - Connectivity

Customers can connect to CME Globex directly or indirectly

• Directly Connected

• Order your own line to CME Globex

• Both customer and CME Group-managed options available

• Indirectly Connected

• Connect to CME Globex via your broker, FCM, Clearing Firm, data center / facilities provider

If you decide to establish a new, direct connection to CME Group and your Clearing firm approves, contact CME Global Account Management (GAM) for details.

Access details on web site at www.cmegroup.com/networkaccess

http://www.cmegroup.com/networkaccess


CME ClearPort

A comprehensive set of flexible clearing services for the global OTC market

• To substantially mitigate your counterparty risk

• To provide neutral settlement valuations

• To access the advantages of security, efficiency and confidence while

still trading off-exchange

CME ClearPort provides clearing services across multiple asset classes

• Launched in 2002 to provide centralized clearing for natural gas

• Since then, product breadth, volume and liquidity have grown

substantially

27

CME Clearing


• Performance

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Robust and scalable CME Globex platform

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– Approx. $101B performance bonds

– Approx. $8B of that in excess

• Provide capital efficiencies and

cross-margining/multi-lateral

netting benefits

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business and longer-term OTC

growth opportunities

Providing Confidence in an Uncertain World

Largest clearing organization in the world


Margins

• Margin Requirements - Good faith deposits which can be used to

cover adverse movements in future prices

• Initial Margin

• Variation Margin

• Adjusted as market volatility necessitates

Margin: Initial Maintenance

Member/Hedge $800 $800

Spec. $880 $800


Position Limits

• A predetermined position level set by regulatory bodies for a

specific contract or option.

• Position limits are created for the purpose of maintaining stable

and fair markets. Contracts held by one individual investor with

different brokers may be combined in order to gauge accurately

the level of control held by one party.

• Spot month position limit: 3,000

• Any/All months accountability: 20,000


Marked to Market

• At the end of each trading day and all following days that your position

remains open, the contract value is "marked-to-the-market"; your account

is credited or debited based on that day's trading session. This system

gives futures trading rock-solid credit standing because losses are not

allowed to accumulate.

• If your account falls below the maintenance level (a set minimum

performance bond per outstanding futures trade), your broker will contact

you for additional funds to replenish it to the initial level. Of course, if your

position generates a gain, you can withdraw any excess funds from your

account.

CME HRC Steel Futures Contract


Contract Specifications for the HRC Steel

Product Symbol HRC

Venue CME Globex, CME ClearPort

Contract Size 20 Short Tons

Hours

All times are NY/EST

CME Globex: Sunday-Friday 6:00 p.m. – 5:15 p.m. with a 45 minute break each day beginning at 5:15pm

CME ClearPort: Sunday-Friday 6:00 p.m. - 5:15 pm with a 45 minute break from 5:15PM to 6:00PM

Unit Price Valued in U.S. Dollars and Cents per short ton

Minimum Price

Fluctuations$1.00 per short ton

Listed Contract Months Trading is conducted for 24 months

Floating PriceThe floating price for each contract month is equal to the average price calculated for all available price

assessments published for that given month by the CRU U.S. Midwest Domestic Hot-rolled Coil Steel Index.

Settlement Type Financial

Exchange Rules Contract specifications are in Chapter 920 of the NYMEX rulebook

34


HRC Monthly Futures Settle On CRU’s Weekly Price AssessmentsContract is financially settled on the monthly average of price assessments

Underlying Physical Trade: • CRU collects transactions executed for prompt delivery periods

• Report cash deals collected during weekly sample periods

By Month

CRU Calculation Week 1

Price A

Data

Week 2

Price B

Data

Week 3

Price C

Data

Week 4

Price D

Data

Week

5th

Reporting Date Price A

1st

Wed

Price B

2nd

Wed

Price C

3nd

Wed.

Price D

4th

Wed

Settlement Type: Monthly Pricing “Future”

(Price A + B + C + D) / 4 = Settlement Price

Trading: • Contracts are listed by consecutive months out 18 months

• Last trading day is business day prior to last Wed. of each month

Other Issues: • Months with 5 Wednesdays will use all 5 prices for settlement of future contract

• Criteria for inclusion is date of price release, not if assessment falls into month, e.g. 1st

Wednesday of month covers the data for the last week of previous month.

35

(Add 5th week and divide by 5)


0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

Oct

-08

Dec

-08

Feb

-09

Ap

r-0

9

Jun

-09

Au

g-0

9

Oct

-09

Dec

-09

Feb

-10

Ap

r-1

0

Jun

-10

Au

g-1

0

Oct

-10

Dec

-10

Feb

-11

Ap

r-1

1

Vo

lum

eU.S. Midwest HRC Steel Monthly Volume

and Month-end Open InterestMonth-end OI Monthly Volume


0.00

100.00

200.00

300.00

400.00

500.00

600.00

700.00

800.00

900.00

1000.00

Oct

-08

Dec

-08

Feb

-09

Ap

r-0

9

Jun

-09

Au

g-0

9

Oct

-09

Dec

-09

Feb

-10

Ap

r-1

0

Jun

-10

Au

g-1

0

Oct

-10

Dec

-10

Feb

-11

Ap

r-1

1

$ p

er

ton

U.S. Midwest HRC Steel Spot Settlement Price

Spot Settlement

$225 $300$160

$340


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CME Group Contact Details

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39

Introduction to the ETI platform 0

Derivatives – A users perspective

Steel Success Strategies

June 20th, 2011

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.)

Cargill Confidential

Agenda

• Cargill Overview

• Derivative overview

• Steel Consumer Example

• Service Center Example

1


From our modest roots in the United State’s Midwest, Cargill has grown to be a global leader

2010 FORTUNE Global 500 ($US M)*

1. Wal-Mart Stores 408,214

2. Royal Dutch Shell 285,129

3. Exxon Mobil 284,650

4. BP 264,138

5. Toyota Motor 204,160

6. Japan Postal Holdings 202,196

7. Sinopec 187,518

20. Allianz 125,999

35. Verizon Communications 107,808

• Cargill founded in 1865

• Remains family owned and

headquartered in Minneapolis

• All transactions and relationship with

external stakeholders are bound with

strong ethics and corporate

responsibility.

• Employee numbers total 131,000

in 66 countries

• Financially stable organization with

A2 Long Term debt rating from

Moody’s and A from S&P

• In China we operate over 30 plants

and employ over 4000 people on the

mainland

*Source: FORTUNE magazine July 26 , 2010 2

Cargill 107,900


3

Cargill is composed of 75 businesses organized around four major areas

Agricultural & Animal Nutrition

We buy, process and distribute grain, oilseeds and other commodities to

makers of food and animal nutrition products. We also provide crop and

livestock producers with products and services. We are one of the leading

companies in the meat market. Through Mosaic we are a major producer

of fertilizer.

Food

We provide food and beverage manufacturers, foodservice companies

and retailers with products, and health-promoting ingredients and

ingredient systems.

Financial

We provide our agricultural, food, financial

and industrial customers around the world

with risk management and financial

solutions. These include financing and

exposure to underlying commodity

investments.

Energy, Transportation & Industrial

We serve industrial producers and

consumers of energy and primary raw

materials in oil and gas and metals and

mining. Our freight business is a world

leader in the shipping of dry and wet

goods.

Connectivity across our operations enables us to seamlessly serve our customers

V


Petroleum Power

Steel Raw

Materials

4

The Energy ,Transportation and Industrial (ETI) businesses use our

extensive knowledge of markets, logistics and supply chains to

create value for our customers

We are a global leader in the origination, supply, transportation and

risk management of commodities both for Cargill businesses and

for our external customers

Base Metals

Coal ETI

Platform Emissions

&

Renewable Risk

Management

Services Ocean

Transport

Steel

Products

Natural Gas


Steel Hedging – Why?



6

Is this how you feel sometimes when you get home?

How can companies manage price volatility and the risks associated with the

rapid rise and fall of commodity prices?


• 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 only dangerous for those without physical market knowledge and trading/risk management strategy

• Derivatives are only for speculators – No. Industry players (e.g. mills, warehouses and steel consumers)

can use derivatives to hedge risk

– Yes speculators can participate but they bring liquidity and take risk

• Indexes are inaccurate – 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

7

A Few Myths About Derivatives

It is important to understand the physical market fundamentals behind the

commodity, and then how to apply derivatives to manage the risk


Steel Derivatives

8

Long Steel (producers)

• Steel Mills

• Trading companies

• Service Centers

Short Steel (consumers)

• OEM’s

• Service Centers

• Construction

Financial Companies

• Banks

• Brokers

Hedge Funds

• Private money

• Banks

• Hedge Funds

• Pension Funds

Role and Benefit

Role:

• Bring together buyers and

sellers

• Give market access to end

users

Benefit: Additional service

they can offer their clients.

Role and Benefit

Role: Provide Physical

delivery of product – HRC.

Benefit:

• Ability to hedge and lock in

margin on fixed price

contracts

• Sell forward

Role and Benefit

Role: Provide liquidity

Benefit: Additional market

outlet to invest capital for

investors to express their

view or hedge their risk

Role and Benefit

Role: Provide physical

liquidity of product – HRC

Benefit:

• Ability to hedge and lock in

fixed prices for extended

period of time. (ex. Buy fixed

price derivative contract and

take physical delivery on

floating price CRU.

Cargill


Reduce Risk - Hedging

So your over all profit is fixed

Profit

Time

9

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

the opposite risk


0

Steel Hedging – How?


Cargill Confidential •Example: End user (Pipe Maker, Metal Building, Barge Manufacture) CRU HRC price and NYMEX HRC Contract

After a very strong first quarter, the HRC market is now correcting with CRU down from $888 to $758 per ton.

The forward market curve is in backwardation (future price lower than spot) : Oct 2011 traded recently at 730 You trade and your future price is fixed at 730

11

$700

$710

$720

$730

$740

$750

$760

$770

Forward curve

$300

$400

$500

$600

$700

$800

$900

$1,000

4-M

ar

1-A

pr

29

-Ap

r

27

-May

24

-Ju

n

22

-Ju

l

19

-Au

g

16

-Se

p

14

-Oct

11

-No

v

9-D

ec

6-J

an

3-F

eb

3-M

ar

31

-Mar

28

-Ap

r

26

-May

23

-Ju

n

21

-Ju

l

18

-Au

g

15

-Se

p

13

-Oct

10

-No

v

8-D

ec

5-J

an

2-F

eb

2-M

ar

30

-Mar

27

-Ap

r

25

-May

$ p

er

sho

rt t

on

U.S. Midwest Domestic HRC Steel index futures

CRU


Example: CRU HRC Index and NYMEX Contract

Case 1: From current 758 spot prices fall.

At maturity (Oct 2011) the CRU price is 700

Case 2: From current 758 prices rally.

At maturity (Oct 2011) the CRU price is 850

730

850

700

For paper settlement, on end Oct 2011, the buyer gives the seller

the difference ie 730 - 700 = 30 usd/nt

Physical effective sales/buy price: 700

Paper transaction : 30

Total transaction price: 730

For paper settlement, on end Oct 2011, the buyer receives from the

seller the difference ie 850-730 = 120 usd/mt

Physical effective sales/buy price: 850

Paper transaction: -120

Total transaction price: 730

12

On June 20th 2011 the Oct 2011 HRC price has been “fixed” to 730, with the paper

transaction’s gains/losses offsetting any losses/gains on the physical market.

The price risk has been hedged

730


Fixed price to end user • An end user needs to get a fixed price for 3,000 tons of HR sheets delivered to its plant; 1,000 tons

per month over Oct-Nov-Dec 2011. The end user asks a quote from the service center he is working with.

Different options:

• Option 1 – The service center can buy the 3,000 tons ex-mill on the spot market and storesit for 4 months incurring interest, using capital and storage space.

• Option 2 – The service center asks a mill for a fixed price for 3,000 tons delivered over Sept-Oct-Nov 2011. The mills are not willing to give a fixed price or provides a price with surcharge or higher price than current spot market price.

• Option 3 – The service center considers the future market (Nymex HRC) and sees that he can fix the price of its coils at $730, assuming it can buy coils on a floating index CRU.

Option 3: more details

1. The service center agrees with a mill to get 1,000 tons per month of coils produced in Sep-Oct-Nov and delivered to the service center. The coils will be priced out at the average of the CRU during Sept-Oct-Nov 2011.

2. The transportation and processing time will be less than four weeks so that the service center can deliver the sheets on time to the end user if they buy the prior months production.

3. The service center will fix the price of this floating contract by buying Sept-Oct-Nov on the Nymex HR. The service center can find a seller at $730.

With this mechanism in place, the service center is able to offer a fixed price to its customer at $730 + transportation cost + processing cost + margin.

Whatever the price of steel CRU is over this period, both the service center and the end user will have their margin fixed thanks to this contract


1

4

NEED TO UPDATE

Sep-11 Oct-11 Nov-11

Scenario 1: price strong

A HR price (cru) $875 $850 $880

B FIXED PRICE 730 + cost + margin 730 + cost + margin 730 + cost + margin

C buy physical steel $875 $850 $880

(B-C) gain/loss on physical ($145) + cost + margin ($120) + cost + margin ($150) + cost + margin you sell your steel at $780 but buy it from the mill at $875

(A-$735) hedge gain/loss $145 $120 $150 you bought the contract at $730

pnl cost + margin cost + margin cost + margin

Scenario 2: price weak

A HR price (cru) $700 $650 $640

B FIXED PRICE 730 + cost + margin 730 + cost + margin 730 + cost + margin

C buy physical steel $700 $650 $640

(B-C) gain/loss on physical $30 + cost + margin $80 + cost + margin $90 + cost + margin you sell your steel at $780 but buy it from the mill at $700

(A-$735) hedge gain/loss -$30 -$80 -$90 you bought the contract at $730

pnl cost + margin cost + margin cost + margin

The scenarios can be applied to cold-rolled or galvanized as well


Thank You

1

5

Steel price volatility and CRU’s steel

price assessments

Prepared for:

CME Steel Price Risk SeminarNew York, June 20th, 2011

Prepared by:

Robert EdwardsManaging Consultant - Steel

2

Presentation plan

1. Price volatility along the steel supply chain

How much has this really increased?

How have steel industry participants responded?

2. An overview of CRU’s steel price assessments

Which markets do we cover?

How do we arrive at our price assessments?

3. What is the likelihood that steel prices will remain as volatile in the future?

What factors have led to the recent increase in steel price volatility?

To what extent will these factors remain in place?

3

Price volatility along the steel

supply chain

4

Fact: since 2004 there’s been a dramatic increase in price

volatility along the whole steel supply chain

0

50

100

150

200

250

300

350

400

450

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

CRUspi Iron ore Coking coal CRUmpi

“Steel” prices, January 2007 = 100

Data: CRU Analysis.

5

Focussing on finished steel prices, the standard deviation

in the CRUspi global index has increased almost four-fold

since 2004

0

5

10

15

20

25

30

35

40

45

50

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

CRU Steel Price Index (CRUspi), standard deviation

Data: CRU Analysis.

Pre-2004 average: 4.4 points

Post 2004 average: 16.9 points

6

Meanwhile, the range between the lowest and highest

observations seen during any given year – another popular

measure of volatility – has shown a similar increase

0

20

40

60

80

100

120

140

160

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

CRU Steel Price Index (CRUspi), range

Data: CRU Analysis.



7

This increased volatility has occurred against a back-drop of

very high prices and so it was initially buyers who tended to

be the most proactive in their response

50

75

100

125

150

175

200

225

250

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

CRU Steel Price Index (CRUspi), mean

Data: CRU Analysis.



8

Steel industry participants have responded to this increase

in price volatility in some imaginative ways

Spot buyers have looked at ways to transfer their price risk:

they’ve entered into “variable cost contracts” with their customers.

they’ve introduced surcharges.

they’ve made use of the “Over The Counter” (OTC) and exchange traded derivative

products available.

Contract buyers, meanwhile, have moved away from long term, fixed price

contracts and have increasingly shown a preference for “index-based”

pricing programmes.

these programmes can be based on the actual assessment of the market price (index),

although tend to be based on the changes in this assessment.

Index-based pricing programmes: example 1

Using the absolute index value

Jan Feb Mar Q1 Apr May Jun Q2 Jul Aug Sep Q3

Index

price 655 625 615 632 558 540 500 533 450 425 510 462

Selling

price - - - - - - - 632 - - - 533

Hot-rolled coil, US$/s.ton

Example: The price received for Q3 shipments

(US$533/s.ton) is equal to the average index

value for the previous quarter (US$533/s.ton).

Index-based pricing programmes: example 2

Using the period-on-period change

Jan Feb Mar Q1 Apr May Jun Q2 Jul Aug Sep Q3

Starting price - - - 650 - - - - - - - -

Index price 655 625 615 632 558 540 500 533 450 425 510 462

Change in index - - - (27) - - - (99) - - - (71)

Change in price - - - - - - - (27) - - - (99)

Selling price - - - - - - - 623 - - - 524

Hot-rolled coil, US$/s.ton

Example: The price received for Q3 shipments (US$524/s.ton)

is equal to the previous quarter’s price (US$623/s.ton), plus the

index change for the previous quarter (minus US$99/s.ton).

Starting price is arrived at through negotiation and is used to

determine the actual price for the first quarter of the programme

only: thereafter the previous quarter’s price is used and the

quarter-on-quarter change in the index is applied to this.

From previous quarter.

11

An overview of CRU’s steel

price assessments

12

CRU’s steel price assessments - coverage

CRU makes assessments of over 200 steel market prices on a regular

basis.

CRU’s assessments cover the following commodities:

steelmaking raw materials, including iron ore, coking coal, coke, scrap, pig iron, DRI and

HBI, as well as bulk ferroalloys.

semi-finished and finished steel products, including billet and slab, wire rod, reinforcing

bar, merchant bar, structurals, hot-rolled coil, cold-rolled coil, galvanised coil and plate.

CRU’s assessments cover the following regions:

North America, Europe, India and East & South East Asia.

major import and export prices.

and assessments of local prices in South America and the CIS coming soon.

13

Each of our assessments adopts either “level 1.0”, “level

1.5” or “level 2.0” procedures, depending upon the demands

of the final market

Level 1.0 Level 1.5 Level 2.0

Frequency: Monthly Weekly Weekly

Data collection method: Telephone survey Electronic via CPCP Electronic via CPCP

Data requested: Price only Price only Price and volume

Audit clause: No No Yes

Calculation method: “Subjective” average Arithmetic average Weighted average

Analyst input: Yes Yes Yes

14

Level 2.0 assessments

Product definitions:

Refer to standardised trades and are strictly adhered to.

Example: US domestic price for hot-rolled coil.

spot purchases for forward delivery, which will vary.

fob mill East of the Rockies.

base price for commercial quality material, in coils of at least 40,000lbs.

within standard tolerances.

extras for gauge and width are excluded.

delivery charges and taxes are excluded.

raw materials surcharges (where applicable) are included.

15


Data providers:

Collectively represent the whole supply chain.

Industry participants must satisfy our criteria for becoming a data provider.

they must be in a position to submit data relating to actual transactions.

Data providers are required to sign a “data providers’ agreement”.

this covers their responsibilities and confidentiality issues.

Data providers are required to provide both price and volume data.

volume data is equal to the volume of orders to which the contributor’s price submission

refers.

all submitted data should relate to orders that have been placed in the previous week.

16


Data providers: what do they get out of it?

The opportunity for their transactions to be taken into account…

…and the following package of benefits:

access to CRU’s historical price assessments for the market(s) that they contribute data.

CRU’s weekly price assessments for the market(s) that they contribute data.

access to CRU’s steel industry analysts via monthly calls.

an annual “white paper” relating to the market(s) that they contribute data.

the opportunity for a CRU steel analyst to present CRU’s outlook at their offices.

introductory offers for CRU’s analysis reports, conferences and license agreements.

17


Raw data collection and storage:

Data is collected electronically via the “CRU Price Collection Platform”

(CPCP).

data providers are provided with a username/password which gives access to the CPCP.

price and volume data is submitted via the CPCP.

Data collection is looked after by “CRU Indices”.

this is a company in itself and is separate from other aspects of CRU’s business.

Data storage.

incoming data is stored on a database for verification if required.

18


Error detection procedures – raw data:

Specific statistical checks are in place to detect errors in data submissions.

each price submitted must fall within the “acceptable price range” set by CRU’s steel

analysts.

each data providers’ price submission is compared with its previous price submissions.

each data provider’s volume submission is compared with the average volume of its

previous submissions.

Those submissions which fail these checks, and which are deemed

implausible, are not included in the calculation of the final assessments.

Beyond these specific checks, the “data providers’ agreement” gives CRU

the right to verify the data submitted.

19


Calculation procedures for final price assessments:

CRU’s assessments are a weighted average of the submissions received.

Weightings are determined by the volume data submitted.

The maximum volume weighting given to an individual price submission is 30%.

Calculation of the final price assessments is system generated, under the

control of “CRU Indices”.

20


Error detection/resolution – final price assessments:

Final assessments are subject to an “observation period” before release.

CRU steel analysts “pass” the final price assessments.

those that appear reasonable are released for publication.

if an assessment is flagged-up as suspect:

the index team audits the data collection/assessment calculation procedures.

if this fails to identify an error, a “cleansed version” of the raw data (which will include

the price and volume information of each participant, but NOT their identity) is sent to

CRU’s steel analysts.

any suspect contributions are removed from the price assessment calculations.

No adjustments are made after the assessments have been published.

21


Dissemination of the final price assessments:

CRU’s assessments of steelmaking raw materials prices.

available via CRU’s Steelmaking Raw Materials Monitor and license agreements.

CRU’s assessments of steel metallics prices.

available via CRU’s Steel Metallics Monitor and license agreements.

CRU’s assessments of steel long products prices.

available via CRU’s Steel Long Products Monitor and license agreements.

CRU’s assessments of steel sheet products prices.

available via CRU’s Steel Sheet Products Monitor and license agreements.

CRU’s assessments of steel plate products prices.

available via CRU’s Steel Monitor and license agreements.

22

What is the likelihood that steel prices

will remain as volatile in the future?

23

The recent increase in price volatility along the steel supply

chain has been driven primarily by a renewed period of

strong growth in steel demand, driven by emerging markets

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

1900

1905

1910

1915

1920

1925

1930

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

World demand for steel, crude steel equivalent, m tonnes

Data: World Steel Association, CRU Analysis.

Post-industrial revolution Post-war reconstruction Developed economies’

stagnation

BRIC

growth

6%1%7%CAGR: 3%

24

In fact, the apparent consumption of finished steel in BRIC

countries increased at a CAGR of 15% between 2001 and

2010, compared with around 1% for the rest of the world

0

50

100

150

200

250

300

350

400

450

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

World BRIC Other world

Apparent consumption of finished steel, m tonnes per quarter

Data: CRU Analysis.

25

But let’s face facts: we say it’s been BRIC countries that

have driven the growth in steel demand – it’s really just

been China

0

25

50

75

100

125

150

175

200

225

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

China India Russia Brazil

Apparent consumption of finished steel, m tonnes per quarter

Data: CRU Analysis.

26

Such growth has put large parts of the steel supply chain

under enormous pressures, and at times supply has simply

been unable to keep pace with the growth in demand

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

Baltic Capesize Index

Baltic Capesize Index

Data: Baltic Exchange, CRU Analysis.

27

The upshot is that raw materials and finished steel markets

have often ended up in shortage, and it’s the dipping in and

out of shortage that has driven the increase in price volatility

0

50

100

150

200

250

300

350

400

450

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

CRUspi Iron ore Coking coal CRUmpi

“Steel” prices, January 2007 = 100

Data: CRU Analysis.

28

A further factor that has contributed to price volatility,

particularly for finished products, relates to the physical

speculation that many buyers engage in

2

3

4

5

6

7

8

9

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

End-month inventories

US service centre inventories of carbon flat-rolled products, m s.tons

Data: MSCI, CRU Analysis.

29

Looking ahead, steel demand is forecast to grow at a similar

pace to that seen during the last ten years, although the

contributions of BRICs vs developed countries will be closer

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

1900

1905

1910

1915

1920

1925

1930

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

World demand for steel, crude steel equivalent, m tonnes

Data: World Steel Association, CRU Analysis.

6%

1%

7%

CAGR: 3%

6%

30

And while we do not expect any prolonged periods of

physical shortages, the supply chain will at times struggle to

keep pace with the growth in demand…

…leading to short periods of physical shortages…

…leading to continued price volatility

31

Thanks for your attention!

32

Please address questions or comments relating to this

presentation to:

Robert Edwards

Managing Consultant - Steel

CRU Group

31 Mount Pleasant

London

WC1X 0AD

Tel.: +44 20 7903 2119

Fax.: +44 20 7833 5634

Email: [email protected]

mailto:[email protected]

CME Group – CMA NAVigateTM

OTC Derivatives Valuations

Transparency

Independence

Operational efficiencies

20th June 2011

Agenda

A brief break away from your metals world

An Introduction to CMA and our Core Skill Sets

CMA NAVigate - Independent valuations services

Data, pricing, challenge/ resolution Process

The importance of independent valuations

Brief thoughts on price discovery:

Auctions for price discovery – Elysian Liquid Platform

Appendices

2

A Break from Your Metals World

An introduction to CMA

What we do in the Credit Markets

Can it be applied to the Steel Market?

3

About CMA (a CME Group Company)

CMA Corporate Overview:

CMA is a leading global financial information and technology services company

with offices in London and New York

We provide independent data, valuations, and OTC pre-trade pricing technology

solutions in order to bring clarity to the OTC markets, reduce risk and improve

operational efficiency

Our client base includes the most significant institutional participants in the

financial markets such as Investment Banks, Hedge Funds, Asset Managers, and

Fund Administrators

CMA has been owned by the CME Group, the world’s largest derivatives

exchange, since 2008

Recently CMA has taken charge of LIQUIDTM - an adaptable screen based

system for communicating market prices and holding auctions

4

A Brief Break Away From Metals

Firstly, I am not a metals man!

My product specializes in providing independent valuations for OTC

derivative contracts for:

Credit Default Swaps

Interest Rate Swaps

FX Options

Our core skills include:

Unstructured data collection, cleaning, modeling

Transparency of valuations process

Easy to use tools for managing the valuations process

I ask whether these techniques and services may be applied to

the new steel markets… and I could become a metals man.

5

CMA NAVigate

Independent valuations service for

OTC Markets

Independent, transparent valuation services

are key to healthy market function

6

Challenges in Providing Valuations in OTC Derivative Markets

Firms trading OTC derivative products face a challenging mark-to-

market environment:

Market structure issues

Fragmented OTC pricing (difficult to collect, liquid v’s illiquid)

Human discretion vs. automation

Operationally burdensome

Tedious manual tasks

Data and Model Risk

Investor & regulatory scrutiny

Demand for automation, transparency

Increased expectation of independence and arms-length valuation

7

CMA and NAVigate: Core Skills

How exactly do CMA & Navigate help in the valuations process?

“All OTC Valuations are the product of: Initial data, Modeling assumptions,

Price Creation, Price feedback… Leading to more initial data (Appendix I)”

CMA captures & cleans market data (millions of OTC prices a week)(Appendix II)”

NAVigate extrapolates data sets using market standard techniques

NAVigate prices derivative contracts using in house pricing engines

NAVigate presents the results, inputs and methods used

The result: independently generated, transparent, accurate valuations

8

CMA NAVigate Overview

9

Web-based, multi-asset class valuation platform

Applications

• Independent , transparent Valuations with Challenge function

• Reporting, Outsource difficult to manage model risk and data risk.

• Third parties: simplify valuation-based interaction between hedge funds,

administrators, custodians and other third parties such as auditors.

Work

Flow

Bespoke report creation

Transparent data inputs

Generate reports on the fly

Tiered user access for

collaboration on valuation details

Centralize access across

departments and third parties

Immediately resolve trade

upload issues

Flexible mapping for trade id’s

Add/delete trade on the fly

Complete transparency right

down to cashflows of each trade

Create and manage sub-

portfolios

Integrated Support

Integrated IM, email & phone support

Screen sharing allows for quick problem

resolution

Wiki based knowledge base online

The NAVigate Front End

10

•Data inputs

•Modeled data

•Calibrated models

• Detailed outputs

•Web delivered

•Intuitive

•Interactive Challenge Service

•Clean timely valuation reports

CMA NAVigate Valuation Service application to Steel Markets?

In general a complete valuations service in any market

needs some or all of NAVigate’s features

Correctly executed, third party pricing, with the ability to

challenge and give feedback provides a healthy

environment for market functions.

Could CMA NAVigate help aspects of the Steel market?:

Market data collection

Market standard pricing techniques

Providing a level of third party independence

This should lead to healthy market innovation.

11

LIQUIDTM– Overview

Independent valuations service for

OTC Markets

Independent, transparent valuations

are key to healthy market function

12

Key Features of LIQUIDTM Use in Auctions

INFORMATION TO FOLLOW

13

Appendices

Appendix I:

General Valuations process for OTC

Derivative products

Appendix II:

Unstructured data flow in CDS markets

Appendix III

Key websites to find out more

Appendix I: General Valuation Process for Derivative Product

Nothing can be priced in a vacuum. Pricing in any market is an

iterative process based on feedback:

15

Collect observable market price data

Extrapolate observable data

Price derivative structures using extrapolated

data set and calibrated models

Receive Feedback from the

Market on your price in the form

of more prices

Collect this new observable

market data!

Adjust assumptions and models.

Refine pricing

Price derivative structures again

Receive Feedback from the

Market on your price in the form

of more prices

Collect this new observable

market data!

7/6/201116

Appendix II: Flow of information in Credit Default Swap Markets

Banks (The sellside)

-Provide the liquidity. They

are on one side of every

deal

HF and Asset managers

– (The Buyside)

Inter dealer brokers

Traders at Banks provide 2 way

markets over Bloomberg messages,

Bloomberg IM to the Buyside

Banks use Interdealer brokers to

enable anonymous trade amongst

themselves.

They send Bloombergs as well as IM

chat and voice to communicate the

markets.

The IDB’s use bloomberg and chat to

communicate markets.

Markets are 1 way

Bloomberg mail , attachments and Voice

- information is highly unstructured

Hedge funds receive thousands of

messages every day containing many

more thousands of quotes

Bloomberg mail , attachments and Voice

- information is highly unstructured

Appendix III – References for more information

Find out more about CMA:

http://www.cmavision.com

Find out more about NAVigate:

http://www.cmavision.com/products-solutions/independent-otc-valuations/

Find out more about LIQUIDTM

http://www.elysiansystems.co.uk/products.html

Find out more about CME Metals:

http://www.cmegroup.com/trading/metals/

17

http://www.cmavision.com/








http://www.elysiansystems.co.uk/products.html

http://www.cmegroup.com/trading/metals/

Thank you

Gareth Moody

Head of Valuations – NAVigate

[email protected]

+1 646 351 8793

For more information on managing steel price risk, please contact:

Patricia Cauley, Director of Metals [email protected]

mailto:[email protected]


Managing Steel Price Risk

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