Steel Presentation July 2010

Managing price volatility in the steel industry

– A Producer perspective

Robert SheldonNew Products Manager

What is risk?

• Supply/demand imbalances• Lack of information on prices and inventories• Uncertainty, Volatility = RISK

• What does it mean for you?– Lost orders; customers walking away from deals?– Reduced margins?– Missed targets?

How do you deal with this?

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200

400

600

800

1,000

1,200

1,400

Feb

-08

Apr

-08

Jun-

08

Aug

-08

Oct

-08

Dec

-08

Feb

-09

Apr

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Jun-

09

Aug

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Oct

-09

Dec

-09

Feb

-10

Apr

-10

Trading Date

$ p

er t

on

ne

Cash

3 Month

15 Month

LME Mediterranean Steel Price

Risk management / Hedging

• What is it?

• How does it work?

Two distinct markets

Futures Market (forward market)Material at the steel billet stage (wholesale)Market Participants: LME Members

Financial institutionson behalf of: Industry

Investors

Physical MarketMaterial at any stage of productionMarket Participants: Producers

Re-rollersMerchants / TradersStockistsConstruction companies

Hedge Example

• Scenario:– Company fixes a standard sales price for billet (del. Sep.’10) at a

level that reflects acceptable profit margin on goods sold– Company wants to lock in budgeted price for billet sale now for

Sep. 2010 based on scrap purchased now• Risk of not hedging: Company misses budget and margins suffer• Market Structure: Cash = 500/t, Sep. ‘10 futures = 500/t• Strategy:

– Step 1: Sell Sep. Billet futures now when buy scrap– Step 2: Liquidate (buy back) Sep. when physical billet sold/priced

in

Scenario 1 LME Billet

falls: $400/mt

Scenario 2 LME Billet

rises: $600/mt

Sep.‘10 Billet Sell (2) 400 600

LME Billet Sep. Sell (1)

500

500

Sep. LME Billet Buy (2) 400 600 Futures P/L +100 -100

Net Sell Price 500 500

Producer “Price Fixing Sell” Hedge

Benefits of LME steel futures

• Access to a transparent reference price• Protection against price movements• Ability to offer long-term fixed sales prices and lock in a

margin• Swap physical material between locations on an LME

brand basis

• Ability to meet budgets.• Protect inventory from falling prices.

Producer ConstructionScrap Re-roller Trader Stockist

Benefits of LME Steel Futures

• Collateralise inventory, lower financing.• “Pre-paid forward”- financing.• Sell excess product in periods of over supply.• A source of product in periods of under supply. • Physical product can be delivered against

futures.• Hedge physical purchases in times of strong

demand. • Index bonds and trade finance lines to the LME

price.

LME Steel Billet – Progress so far

Launch to date

  Far East Mediterranean TOTAL

Lots 3,249 98,396 101,645

Tonnes 211,185 6,395,740 6,606,925

Turnover to June 1st

($millions) 126.75 2,539.44 2,666.19

Monthly Volume and Market Open Interest

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2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

Feb

-08

Apr

-08

Jun-

08

Aug

-08

Oct

-08

Dec

-08

Feb

-09

Apr

-09

Jun-

09

Aug

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Oct

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Feb

-10

Apr

-10

Vo

lum

e (

lots

)

-

500

1,000

1,500

2,000

2,500

3,000

3,500

MO

I

Mediterranean Steel Billet

Max monthly MOI

Launch to 01-Jun-10

Volume and Monthly Open Interest (MOI)

Steel producers with listed brands

• 35 companies, 14 countries (7 Turkish)

• 42 mills (8 Turkish)

• 155 different brands/grades of product approved for LME delivery

LME Mediterranean Billet: Price & Stock

Source: Thomson Reuters Datastream

LME Mediterranean Billet Price (Cash) and Warehouse Stock

2008 2009 20100

200

400

600

800

1000

1200

1400

0

10

20

30

40

50

60

70

80x 1,000

LME Cash Price (U$/MT) Warehouse stock (Thousand tonnes)

Cash Price Closing Stock

0

200

400

600

800

1000

1200

1400

1600

Jan-

08

Apr

-08

Jul-0

8

Oct

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Jan-

09

Apr

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Jul-0

9

Oct

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Jan-

10

Apr

-10

LME Med Billet (3M)

Scrap: CIS Black Sea Export(Steel Orbis)

Rebar: 8-12 mm TurkeyExport FOB (Steel Orbis)

Last 2 years – LME vs

Price Delta

Scrap 93% 79%

Rebar 98% 86%

Good correlation - LME billet price, Turkish export scrap & rebar prices

Real life examples

• Colakoglu Metalurji, Turkish producer

• A.N. Other, Turkish producer

Colakoglu Metalurji, Turkish producer (3 million mt/year)

• Needed to purchase physical billet for Colakoglu’s downstream operations due to a production shortfall

• Bought 3,250mt of physical product in the form of LME warrants

• Took delivery from LME approved warehouse in Tekirdag

• Price was also attractive at the time

A.N. Other - Turkish producer

• Wanted to buy scrap ($700/mt in 2008) but did not want to commit to only buy scrap in case billet prices fell and they were exposed to the market

• Couldn’t sell billet at the price they needed to ($1200/mt) and customer could always renege on the contract if market dropped

• Bought physical scrap in the nearby month (July) and sold LME billet futures for 3 consecutive months forward (August, September, October).

• Prices then collapsed as construction projects were hit not only by high rebar prices but lack of available credit

• Producer was not affected by these dramatic events because of their LME hedge

• Managed to sell billet in the physical market but were protected because of their financial hedge

How do you go about it?

• Talk to an LME Member Bank/Brokerage• Discuss strategy in conjunction with an

LME Member, putting in place necessary resources and internal procedures

• Set up a standard Futures and Options Agreement

• Make an initial trade to develop experience• Begin to ramp up hedge program

THANK YOU

Robert Sheldon