Steel Scrap Hedging. Young-Jin (Jin) Chang Director Research & Product Development November 12-13, 2012

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1 Steel Scrap Hedging Young-Jin (Jin) Chang Director Research & Product Development November 12-13, 2012

2 Today s Agenda - Why Hedge Your Price Exposure? - Who Needs to Manage Price Risk? - Contract Specs and Market Data - Hedging Examples - How to Get Started with Risk Management 2

3 Why hedge?

4 Volatility is here to stay Since 2010, majority of iron ore pricing has shifted from long term fixed to short term monthly pricing Along with iron ore, many steel raw materials are shifting from long term fixed to index based floating long term prices Globalization and wide use of internet has made information to flow much more quickly Demand for steel and raw materials will continue for a long term from developing countries 4

5 Global trends are changing In Asia, ferrous products and volumes are increasing rapidly. (Iron ore, Rebar, etc) Asian steel-related products are now widely traded and have sufficient market depth to serve other regional markets that want long-term fixed prices Early adopters of the ferrous contracts are becoming niche market players because they are able to get longer term fixed price contracts. This gives their commercial operations greater price stability Much of the domestic manufacturing and steel industry is looking at this tool to help mitigate the risk and stabilize the price 5

6 Hedging One more tool to manage your price over time. Transferring unwanted risk to those wanting to take on risk. Think of it as buying insurance for your business. Reduces or eliminates risk by taking two positions that will offset each other if prices change.

7 Why should a firm manage risk? Better forecast your earnings quarterly, semi-annually and annually and smooth out cash flow Reduce Debt Cost: Better collateralization Improve long-term planning and budgeting Better credit rating and lower your borrowing cost Ability to sell/buy at a fixed price up to 2 years Become a niche market supplier Focus on the core business instead of speculating = Increased Shareholders Value for both public and private companies 7

8 Why hedge through CME group? CME Group offers an open, fair and anonymous trading environment, delivering equal access to markets and pricing information The complete book of prices is transparent to every customer and transaction costs and fees are fully disclosed. You know if you re getting bad prices from your counterparties CME Clearing is behind every trade. No Default 8

9 Who Needs to Manage Price Risk?

10 Commercials Risk Management The steel industry can achieve their long term goals of price and margin certainty by using futures. They can reduce their exposure to adverse price movements by transferring their risk to others. Examples of Steel Industry Hedgers: Scrap processors, mining firms, steel producers, steel services center, banks: They want to protect themselves against falling prices for products or financial assets that they own or produce and need to sell. Manufacturers, steel consumers, steel-processing companies, financial firms: These firms want to protect themselves against rising prices for raw materials or financial assets they need to buy. 10

11 Investors Investors accept price risk with the hope that they will profit by correctly anticipating the movement and direction of prices. At any moment, based on their position, perspective, and timeframe, some traders will be looking to buy while others will be looking to sell. Who are the investors? Merchants and Traders (iron ore, coking coal, scrap, steel) Investment Fund Managers Banks Proprietary Trading Firms Individuals 11

12 Contract Specs and Market Data

13 U.S. Midwest Domestic Hot-Rolled Coil Index Futures Product Symbol Venue Contract Size Globex: HRC ClearPort: HR CME Globex, CME ClearPort 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 per short ton Minimum Price Fluctuations $1.00/short ton Listed Contract Months 24 months Floating Price The 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 13

14 U.S. Midwest HRC Steel Monthly Volume and Month-end Open Interest 18,000 monthly volume month end open interest 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,

15 US Midwest #1 Busheling Ferrous Scrap (AMM) Futures Contract; Launch Date: 9/10/2012 Product Symbol Venue Contract Size Hours All times are NY/EST Unit Price U.S. Midwest #1 Busheling Ferrous Scrap (AMM) Futures (BUS) CME Globex, CME ClearPort 20 Gross Tons 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 Valued in U.S. Dollars and Cents per gross ton Minimum Price Fluctuations $0.01 per gross ton Listed Contract Months Floating Price Settlement Type Trading is conducted for 24 months The floating price for each contract month is equal to the 10 th of the month for the price assessment published for that given month by the AMM U.S. Midwest #1 Busheling Ferrous Scrap Index. If 10 th calendar day falls into a holiday or weekend, the price will settle on the immediate following business day. Business days are based on the U.S. Public Holiday calendar. Financial Exchange Rules Contract specifications are in Chapter 601 of the NYMEX rulebook 15

16 U.S. Midwest Busheling Ferrous Scrap Monthly Volume and Month-end Open Interest monthly volume month end Open Interest 50 0 sept, 2012 oct,

17 Bid and Offers are posted on the website 17

18 What a financial contract will NOT do... All transactions are settled in cash without physical delivery. Additionally, the contracts will: NOT capture the price of every specification/grade/size/gauge of material NOT attempt to capture the price represented in every location. (Logistics, freight and localized demand makes this impossible) NOT remove the need to establish bilateral physical relationships between you and your customer 18

19 Hedging Examples

20 How Hedge can be used. - Steel Producer: Consumer A would like to buy 1Q, 2013 at fixed price. You can now go to futures market to see where you can buy the scrap for 1Q, You put in your margin and other cost and provide your customer with a fixed price. - Scrap Processor: You re bidding on a demolition project that will take one year to take it apart. You have to bid at fixed price. Now you can look at futures and sell some of the tonnage in advance with fixed margin to take off the price volatility risk. = If you fixed the price and margin, you should be indifferent about the market swing. 20

21 Grade Correlations Based on 2 years of AMM Index (Jan, Dec, 2011) Grade and Index comparisons Correlation #1 Busheling/HMS #1 Busheling/Shredded HMS1/Shredded Busheling Midwest/Chicago HMS1 Midwest/Chicago Shredded Midwest/Chicago

22 How to Get Started with Risk Management

23 CME Group Contact Details Chicago Young-Jin (Jin) Chang New York Bob Biolsi Bob.Biolsi@cmegroup.com Miguel Vias Miguel.Vias@cmegroup.com London Harriet Hunnable Harriet.Hunnable@cmegroup.com Martin Evans Martin.Evans@cmegroup.com Singapore Michelle Zhang Michelle.Zhang@cmegroup.com 23

24 Brokers Contact Details and references Standard Steel Trading Jonathan Putman Crunch Risk, LLC Andre Marshall Kataman Metals Brad Clark Credit Suisse Dan Kim INTL FC Stone Spencer Johnson JP Morgan Jeff Kabel Macquarie Futures USA Inc David Coates Jefferies Nick Webb Wells Fargo Tony Bandanza Flack Steel (reference) David Feldstein ext 3524 Cargill (reference) Brian Hatlevig

25 Product-Specific Resource Centers: Latest Stories Market Commentary Quotes and Volume Quick Links Education Materials Product Highlights 25

26 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. The Globe Logo, CME, Chicago Mercantile Exchange, and Globex are trademarks of 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. 26

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