1 Merchant Trade Capital: Unlimited, Costless Capital? A. How much does it take? Identifying Capital Components B. What’s the cost? Pricing Trade Capital Components C. Will market bear the cost? Structural Mitigants (Capital Management)
Jan 01, 2016
1
Merchant Trade Capital: Unlimited, Costless Capital?
A. How much does it take? Identifying Capital Components
B. What’s the cost? Pricing Trade Capital Components
C. Will market bear the cost?Structural Mitigants (Capital Management)
2
A. How Much (Capital) Does it Take?Identifying Capital Components
• “Lending” (Deploying) Capital – Credit Assets– Sales Payment cycle (net/25)
– PRMAs (MTM Assets): Probabilistic Capital Deployed
• “Borrowing” (Sourcing) Capital– Credit Liabilities– Purchases: (same payment cycle)
– PRMLs (MTM Liabilities): Probabilistic Capital Sourced
– Why/how is this a bad thing?
3
[A/R slide]
$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
$3,000,000
$3,500,000
$4,000,000
$4,500,000
$5,000,000
1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 91 96 101
106
111
116
P50 (Expected)
P95 (Potential)
Days
Credit Asset (A/R Exposure)
4
-$5,000,000
-$4,500,000
-$4,000,000
-$3,500,000
-$3,000,000
-$2,500,000
-$2,000,000
-$1,500,000
-$1,000,000
-$500,000
$0
1 7 13 19 25 31 37 43 49 55 61 67 73 79 85 91 97 103
109
115
P50 (Expected)
P95 (Potential)
Days
Credit Liability (A/P Exposure)
5
[MTM +/- slides]
-$800,000
-$600,000
-$400,000
-$200,000
$0
$200,000
$400,000
$600,000
$800,000
$1,000,000
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37
months
Credit Asset (MTM+ Exposure)
Credit Liability (MTM- Exposure)
6
B. What’s the Cost?Pricing Trade Capital
• ‘Lending’ Commodity / Position (Credit Assets)– Market Price of Credit (Credit Spreads and Default Probability)
– Portfolio Diversification
– Term Structure Sensitivity (credit theta)
– Subordination (contractual and structural)
• ‘Borrowing’ Commodity / Position (Credit Liabilities)– Uncommitted Capital / Incomplete Capital
– BalanceSheet Liquidity Stress/Tax
– Missing Piece: Contingent Capital (Backstop)
– Cost of Contingent Capital?
7
[CS term slide]
0 bps
50 bps
100 bps
150 bps
200 bps
250 bps
300 bps
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
A
BBB
BB
B
Credit Spread Term Structure by Rating Class
0 bps
50 bps
100 bps
150 bps
200 bps
250 bps
A BBB BB B
30-d
365-d
ComPaper vs Near-term Spreads
8
“Fully-loaded” Capital Cost: Example #1 A/Rs & A/Ps
• Example: Purchase at GasDaily; 10,000 MMBtu/d; and
Sale at GasDaily; 10,000 MMBtu/d
– How Much Capital?• Lend Capital (Sale): A/R Credit Risk Assumed
• Borrow Capital (Purchase): A/P BalanceSheet Liquidity Consumption
– Cost of Capital?• Counterparty Default Risk
• BalanceSheet Stress
– Incremental increase in committed capital revolver
9
$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58
0 - 31 dys 32 - 60 dys
Days
One-Month Sale (10,000MMBt/d @ index)
($2,500,000)
($2,000,000)
($1,500,000)
($1,000,000)
($500,000)
$0
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58
0 - 31 dys 32 - 60 dys
Days
One-Month Buy (10,000MMBt/d @ index)
10
"Fully-Loaded" Capital Cost-to-Carry: A/Rs & A/Ps
Notional Throughput:10,000 MMBtu/d x $6.45 /MMBtu x 31 days = $2,000,000
Credit Cost of Carry:period cost
1 31 days : x 80 bps x 1/12 th = 667
31 - 60 days : x 80 bps x 1/12 th = 1,333
2,000
$.006 /MMBtu
Liquidity Cost of Carry:period cost
1 31 days : x 40 bps x 1/12 th = 333
31 - 60 days : x 40 bps x 1/12 th = 667
1,000
$.003 /MMBtu
Fully "Loaded" Capital Cost: $.010 /MMBtu
average exposure revolver capacity cost
$1,000,000
$2,000,000
average exposure
$1,000,000
$2,000,000
credit spread
11
“Fully-loaded” Capital Cost: Example #2 PRMAs & PRMLs
• Example: BUY: 1-Year Fixed-Price Swap; 10,000 MMBtu/d
SELL: 1-Year Fixed-Price Swap; 10,000 MMBtu/d
– Capital Identified• Capital Deployed (Sale): Potential MTM Credit Risk Assumed
• Capital Sourced (Purchase): Potential MTM Liability/Liquidity Assumed
– Cost of Capital• Counterparty Default Risk
– Credit Spreads (or Default Probability and Recovery)
– Term Structure: One-Year; delcining volume
• BalanceSheet Stress– Incremental increase in committed capital revolver?
12
PRMA / PRML Capital Probablility Distribution
-6,000,000
-5,000,000
-4,000,000
-3,000,000
-2,000,000
-1,000,000
0
1,000,000
2,000,000
3,000,000
4,000,000
5,000,000
6,000,000
7,000,000
8,000,000
9,000,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14
13
1 2 3 4 5 6 7 8 9 10 11 12P 95 5,270,998 7,117,949 8,180,281 8,733,384 8,889,395 8,708,106 8,226,119 7,467,817 6,450,384 5,186,418 3,685,420 1,954,708
P 90 4,019,165 5,377,352 6,135,226 6,509,512 6,589,193 6,422,208 6,038,275 5,457,489 4,694,263 3,759,386 2,661,194 1,406,288
P 80 2,571,937 3,403,288 3,849,725 4,054,776 4,077,762 3,950,891 3,694,316 3,321,808 2,843,361 2,266,560 1,597,350 840,518
P 75 2,041,114 2,689,730 3,032,820 3,185,663 3,195,983 3,089,742 2,883,220 2,587,567 2,210,900 1,759,395 1,237,908 650,364
P 70 1,573,070 2,065,320 2,322,126 2,433,253 2,435,904 2,350,344 2,189,298 1,961,498 1,673,310 1,329,586 934,152 490,103
P 65 1,146,540 1,500,215 1,682,337 1,758,934 1,757,392 1,692,642 1,574,069 1,408,119 1,199,496 951,793 667,844 349,945
P 60 748,090 975,724 1,091,477 1,138,791 1,135,694 1,092,022 1,013,959 905,755 770,517 610,617 427,927 223,968
P 55 368,321 478,919 534,466 556,519 554,026 531,869 493,121 439,894 373,730 295,810 207,066 108,253
P 50 - - - - - - - - - - - (0)
P 45 (363,015) (469,191) (521,201) (540,601) (536,338) (513,297) (474,549) (422,206) (357,811) (282,544) (197,337) (102,947)
P 40 (726,522) (936,180) (1,037,550) (1,074,074) (1,063,782) (1,016,508) (938,440) (833,827) (705,778) (556,663) (388,358) (202,384)
P 35 (1,096,646) (1,408,726) (1,557,559) (1,609,176) (1,590,966) (1,517,866) (1,399,264) (1,241,610) (1,049,614) (826,871) (576,219) (299,960)
P 30 (1,480,644) (1,895,819) (2,090,918) (2,155,718) (2,127,437) (2,026,355) (1,865,211) (1,652,749) (1,395,351) (1,097,883) (764,184) (397,365)
P 25 (1,888,178) (2,409,205) (2,650,093) (2,726,159) (2,685,165) (2,553,112) (2,346,319) (2,075,974) (1,750,234) (1,375,313) (956,105) (496,576)
P 20 (2,333,752) (2,966,271) (3,253,325) (3,338,533) (3,281,309) (3,113,958) (2,856,725) (2,523,475) (2,124,297) (1,666,868) (1,157,230) (600,264)
P 15 (2,842,385) (3,596,699) (3,931,481) (4,023,127) (3,944,485) (3,735,093) (3,419,688) (3,015,176) (2,533,838) (1,984,999) (1,375,982) (712,694)
P 10 (3,466,319) (4,361,952) (4,748,063) (4,841,879) (4,732,888) (4,469,536) (4,082,045) (3,591,018) (3,011,381) (2,354,431) (1,629,019) (842,260)
P 5 (4,359,199) (5,441,290) (5,887,054) (5,973,244) (5,813,365) (5,468,582) (4,976,880) (4,364,029) (3,648,608) (2,844,615) (1,962,960) (1,012,376)
1 2 3 4 5 6 7 8 9 10 11 12P 95 3,514 4,745 5,454 5,822 5,926 5,805 5,484 4,979 4,300 3,458 2,457 1,303
P 90 2,679 3,585 4,090 4,340 4,393 4,281 4,026 3,638 3,130 2,506 1,774 938
P 80 1,715 2,269 2,566 2,703 2,719 2,634 2,463 2,215 1,896 1,511 1,065 560
P 75 1,361 1,793 2,022 2,124 2,131 2,060 1,922 1,725 1,474 1,173 825 434
P 70 1,049 1,377 1,548 1,622 1,624 1,567 1,460 1,308 1,116 886 623 327
P 65 764 1,000 1,122 1,173 1,172 1,128 1,049 939 800 635 445 233
P 60 499 650 728 759 757 728 676 604 514 407 285 149
P 55 246 319 356 371 369 355 329 293 249 197 138 72
P 50 - - - - - - - - - - - (0)
P 45 121 156 174 180 179 171 158 141 119 94 66 34
P 40 242 312 346 358 355 339 313 278 235 186 129 67
P 35 366 470 519 536 530 506 466 414 350 276 192 100
P 30 494 632 697 719 709 675 622 551 465 366 255 132
P 25 629 803 883 909 895 851 782 692 583 458 319 166
P 20 778 989 1,084 1,113 1,094 1,038 952 841 708 556 386 200
P 15 947 1,199 1,310 1,341 1,315 1,245 1,140 1,005 845 662 459 238
P 10 1,155 1,454 1,583 1,614 1,578 1,490 1,361 1,197 1,004 785 543 281
P 5 1,453 1,814 1,962 1,991 1,938 1,823 1,659 1,455 1,216 948 654 337
Probabilistic Capital (Assets and Liabilities)
Distribution of Cost of Capital
14
"Fully-Loaded" Capital Cost-to-Carry: PRMAs & PRMLsNotional Throughput: 10,000 MMBtu/d x 12 month Swap BUY and SELL
Credit Cost of Carry:period Average Exposure cost
month 1 : $110,870 x 80 bps x 1/12 th = $739month 2 : $147,553 x 80 bps x 1/12 th = 984month 3 : $167,678 x 80 bps x 1/12 th = 1,118month 4 : $177,318 x 80 bps x 1/12 th = 1,182month 5 : $178,971 x 80 bps x 1/12 th = 1,193month 6 : $173,986 x 80 bps x 1/12 th = 1,160month 7 : $163,202 x 80 bps x 1/12 th = 1,088month 8 : $147,187 x 80 bps x 1/12 th = 981month 9 : $126,350 x 80 bps x 1/12 th = 842
month 10 : $100,997 x 80 bps x 1/12 th = 673month 11 : $71,368 x 80 bps x 1/12 th = 476month 12 : $37,651 x 80 bps x 1/12 th = 251
$10,688$.0030 /MMBtu
Liquidity Cost of Carry:period Average Exposure cost
month 1 : $103,093 x 40 bps x 1/12 th = 344month 2 : $130,474 x 40 bps x 1/12 th = 435month 3 : $142,651 x 40 bps x 1/12 th = 476month 4 : $146,014 x 40 bps x 1/12 th = 487month 5 : $143,199 x 40 bps x 1/12 th = 477month 6 : $135,635 x 40 bps x 1/12 th = 452month 7 : $124,217 x 40 bps x 1/12 th = 414month 8 : $109,556 x 40 bps x 1/12 th = 365month 9 : $92,094 x 40 bps x 1/12 th = 307
month 10 : $72,168 x 40 bps x 1/12 th = 241month 11 : $50,041 x 40 bps x 1/12 th = 167month 12 : $25,927 x 40 bps x 1/12 th = 86
4,250$.0012 /MMBtu
Fully "Loaded" Capital Cost:
credit spread
$.0041 /MMBtu
revolver capacity cost
$.0083 /MMBtux2
15
C. Will Market Bear the Cost? Structural Mitigants & Capital
Management
• Position Consolidation– Consolidation Factor (gross vs. net throughput )– Cleared Products– Capital Management Opportunity
• Market Structure– Price Discrimination despite Counterparty Anonymity?– Example: best available price (price stack ‘depth’)– Credit risk premium embedded?
• Capital Advantages?
16
Objective: Buy 50,000 MMBtu/d, prompt month
"AA" bid price stack view
"BBB" bid price
stack view
"B" bid price stack view
Counterparty Stack
A 10,000 MMBtu/d 7.250 7.250 7.250
B 10,000 MMBtu/d 7.272 7.272 7.272
C 10,000 MMBtu/d 7.294 7.294 7.294
D 10,000 MMBtu/d 7.315 7.315 7.315
E 10,000 MMBtu/d 7.337 7.337 7.337
F 10,000 MMBtu/d 7.359 7.359 7.359
G 10,000 MMBtu/d 7.381 7.381 7.381
H 10,000 MMBtu/d 7.404 7.404 7.404
I 10,000 MMBtu/d 7.426 7.426 7.426
J 10,000 MMBtu/d 7.448 7.448 7.448
K 10,000 MMBtu/d 7.470 7.470 7.470
L 10,000 MMBtu/d 7.493 7.493 7.493
Average Purchase Price 7.294 7.342 7.386Credit Premium -0.048 -0.093