Docstoc
EXCLUSIVE OFFER FOR DOCSTOC USERS
Try the all-new QuickBooks Online for FREE.  No credit card required.

gary

Document Sample
gary Powered By Docstoc
					Hedging With Financial Instruments
          - Workshop -
            Paper Recycling
        Conference & Trade Show

               New Orleans
               June 23, 2002.

                   Gary Helik
          Tradition Financial Services
            ghelik@tfsbrokers.com
TOPICS

    Why Hedge?
    Some Hedging Basics
    Market Pricing
    Forward Price Behavior for Recovered
     Fiber
    Hedging Examples for Recovered Fiber
    Hedging RCP in an Open Market
    Change + Pain = Gain
    Q+A


                                            2
Why Hedge?
Why Hedge?


  Hedging is RISKY
   Look at Enron!
  Why sell forward for less than I can get
   now?
  Hard to follow „financial‟ compared to my
   „physical‟




                                               4
 Why Hedge: Services




COMMODITY PRICE HEDGING = CUSTOMER RETENTION AND GROWTH




                                                    5
Why Hedge: Producer




  COMMODITY PRICE HEDGING = AVOIDING PRICE RISK

                                                  6
Price: Main Profit Driver for Paper Producer

                Impact of +/- 10% factor change on ROCE




                                                          7
Hedging Case Study: Finance Thesis

             Using Forward “Contracts”

  Background
    subject: M-Real paper business
    finance thesis - Helsinki School of Economics, Finland
    measured effect of 1 to 3 yr financial contracts (swaps)
      • 20,000 price simulations




                                                           8
Hedging in Paper Manufacturing:
Finance Thesis

     “Floating” = Landlord w/o Leases



    LOSSES                        Mean 719 Euros

                                  St. Dev 510 Euros

                                   Skewness 29%




                                                9
Hedging in Paper Manufacturing:
Finance Thesis

      Using “50% Forward Contracts”



                                  Mean 729 Euros
     LOSSES

                                  St. Dev 434 Euros

                                   Skewness 27%




                                               10
Hedging in Paper Manufacturing:
Finance Thesis

     Using “85% Forward Contracts”


                                  Mean 746 Euros

                                  St. Dev 354 Euros
      LOSSES

                                  Skewness 18.4%




                                               11
Forecasts Give Poor Price Signals


       Oct 2000   Dec 2000   May 2001   Jan 2002




                                        Forecasts: Wall St Bank
                                        Futures: Pulpex
                                        Actual: RISI US




                                                                  12
Forecasts Give Poor Price Signals
RISI Newsprint Price Forecasts –– Q1 2000 to Q1 2002




        July 2000     Jan 2001     July 2001         Jan 2002


    Jan 2000
                                               “Irrational
                                               Exuberance”
                      Actual

    Forecasts: US based private
               Forecasting
               Service          Bad price signals = bad business decisions



                                                                             13
Hedging: Supply Chain Effects
COMMODITY PRICE HEDGING = PRICE PREDICTABILITY IN THE
                          CUSTOMER SUPPLY CHAIN
                          HEDGE
                      PACKAGING PRICE




        HEDGE                             PROVIDE PREDICTABLE
       RCP PRICE                          END PRODUCT PRICE




                           EARNINGS                             14
                         PREDICTABILITY
Some Hedging Basics
Defining Price

 Spot                 Contract             Forward
   per                  good for             > 1 month,
    transaction -         month, or until       extended
    daily (or             “further              duration
    intraday)             notice”              physical or
     • no discounts        • less               financial
     • specific              discounts
       transaction         • monthly
       volume                volume, tied
     • whse pickup           to annual
       in days               volume
   physical or
    financial


                                                              16
Types of Forward Agreements

  Physical Agreement                  Financial Agreement
    Pros                                   Pros
      • no intermediaries                       • ISDA contract
      • direct, easy                            • fungability
      • low cost                                • more counterparties

    Cons                                   Cons
      • contract                                • new to RCP
        enforceabilty                             = uncertainty
      • setting price level                     • change: people,
      • nonfungability                            skills, technology

            FUNGIBLE: “freely exchangeable for or replaceable
            by another of like nature or kind in the satisfaction
            of an obligation”                                           17
Hedging Price --> A MANAGEMENT TOOL


•   What is Price Hedging?
    - Using financial structures to replace unknown future prices
      with known future prices
    - Re-engineering transaction cash flows to a desired profile
    - Revenue (or cost) line becomes predictable
    - Fungible --> transactions can be reversed by taking opposite side
•   Cash-settled financial instruments based on fully enforceable ISDA
    contracts locking in price and volume terms against an index
     - focuses management to exert control over price and operations
     - allows creative pricing solutions



                                                                   18
Components of a Financial Price Hedge

                     ISDA documents --> legal framework for OTC swaps
                        - standardized, fully enforceable, global contract
                        - Pulp & Paper, currency, interest rates, energy, metals, etc.




                     Price index --> to settle the contract
                        - independent & objective public record of price




   OCC #11
  50,000 TPY
    3 Years           Transaction specifics
  $70/Ton(2)
July 1, 2002 start
                                           (1)   International Swap and Derivatives Association
                                           (2)   Prices and volumes are for illustrative purposes only.
                                                                                                          19
Financial Swap --> A Fixed Price Arrangement

                                       Buyer receives
                                             cash
                                          from Seller
                                   relative to Index Price
  Agreed Fixed
      Price




                                       Seller receives
                                            cash
                 Spot Price              from Buyer
                   Index              relative to Index
                                             Price
  Time

                                                     20
Example Swap Transaction
--> Matching Financial Hedge to Physical Business
OCC Buyer purchases 1000 t/m of physical OCC on a floating price basis.
Separately she buys a financial swap to lock-in a fixed $50/t price for the OCC
for a 6 month period, 1000 tons/ month, indexed to OBM .
FINANCIAL                                      PHYSICAL
                                        Cash                  NET PRICE -
              6 Mo    OBM Index         Flow                     offset
   OCC        Swap      Price           from                  physical to
 USD/TON      Price    (Hypothetical)   Swap   Buying Price    financial     HEDGED:
                                                                              SMALL
  Sep         50           40           -10        40             50          PRICE
  Oct         50           42            -8        42             50        MOVEMENTS
  Nov         50           44            -6        44             50
  Dec         50           48            -2        48             50
  Jan         50           55            5         55             50
  Feb         50           60           10         60             50
  Mar         50           63           13         63             50
 AVERAGE      50           50            0         50             50
                                                                            UNHEDGED:
HIGH VALUE    50           63           13         63             50          LARGE
LOW VALUE     50           40           -10        40             50          PRICE
                                                                            MOVEMENTS
  RANGE       0            23           23         23             0

             Hedging neutralizes effect of spot price movements                   21
Hedging: When is the Right Time?
Price
Level
                 ZONE OF MISSED OPPORTUNITY
 800




                    I want to sell at the high”
 750




                                                                      Sellers abundant but
 700                                                                  buyers disappearing
                                                                       as price becomes
                                                                         prohibitive for
 650                                         ZONE OF                      intended use
                                              PRICE
 600
                                           ENGINEERING
                       Buy into Weakness                    Sell into Strength
 550




 500




               Buyers abundant but
               sellers disappearing
 450



              as price level becomes                 ZONE OF MISSED OPPORTUNITY
                  unfavorable vs                        I want to buy at the low”
 400
              production economics

       Time                                   Bulls Make Money,
                                              Bears Make Money,
                                              Pigs Get Slaughtered                     22
Price Cap --> Protecting Against Higher Prices.
  The cap buyer (ie. food company) pays an up-front per-ton premium (fee) to the
  seller (ie. Liner producer). If the spot price exceeds the strike price, the
  cap buyer is compensated. Otherwise, no compensation is required .


    Index or                                  Cap Buyer receives
   Spot Price                                 compensation from
                                                  Cap Seller




                     Cap Strike Price
                                                               No compensation
                                                                   required


  Time

                                                                                   23
Price Floor --> Protecting Against Lower Prices
 The floor buyer (ie. RCP generator) pays an up-front per-ton premium (fee)
 to the floor seller (ie. Liner mill). If the spot price falls below the floor strike price, the
 floor buyer is compensated by the floor seller. Otherwise, no compensation is required.


          Index or
         Spot Price                                No compensation
                                                       required


                             Floor Strike
                                Price



        Floor Buyer receives
        compensation from
            Floor Seller
  Time
                                                                                            24
Price Collar--> Combined Cap and Floor

         Index or
        Spot Price                                            Cap buyer receives
                                                                compensation
   Cap Strike Price




                                                                 No compensation
                                                                     required

                                                             Floor buyer receives
                                                                compensation
                  Floor Strike Price
 Time
  A collar protects against adverse price movements, at a cost of giving up favorable
  price movements. The cap buyer is compensated above the cap strike price while
  the floor buyer is compensated below the floor strike price. The strike price of the
  cap and floor can be structured so that the transaction has zero premium cost.

                                                                                   25
Physical & Financial Coexist, but are Separate
           PHYSICAL                FINANCIAL



         Product Settlement     Cash Settlement
            Spot price
             Discounts             Price --> FIXED
              Volume            for any time period
           Specifications              Volume
              Delivery
         Technical Support




          Risk Exposures        Risk Exposures
          • price               • counterparty credit
          • volume              • index tracking
          • quality             • internal controls
          • logistics

                                                        26
„Market‟ Pricing
 „One Way‟ Market Pricing
    Pulp & Paper
     Traditional             Buyers have key
       Pricing                market info
Duration     30 DAYS            see real offers
                                able to compare with
                   Seller        other buyers

                   Seller    Sellers don‟t always
                              have exact
     Buyer         Seller     benchmarks
                                illegal to discuss
                                 offers w/competitors
                   Seller       clearing level
                                 depends on
                   Seller        anecdotal info
                                                        28
„Open‟ Market Pricing

              SPOT +
             FORWARD
              PRICES                    Open Markets
buyer                         seller      regulators & industry
            BID | OFFER
                                           analysts support
buyer                         seller       transparency
             Spot /
             OTC /                        buyers, sellers,
buyer                         seller       investors have equal
            Futures
buyer                         seller       access to price
            Market
                                          neutral transaction
buyer                         seller       clearing
                                          forward prices work
   Used by Metals, Energy,                 like „live‟ forecasts
   Currencies, Bonds, Stocks…..


                                                               29
  Open Market Example: Fx Options
  (Volbroker)

 TFS
 Volbroker
 Partner
 Banks
- CitiGroup
- Deutsche Bank
- Goldman Sachs
- JP Morgan
Chase
- Royal Bank of
Scotland
- UBS Warburg




                                    30
Open Market Example: Pulp and Paper




                                      31
Forward Price Behavior -
Recovered Fiber
Swap Prices: OCC




                   33
Swap Prices: ONP




                   34
Hedging Examples
Recovered Fiber
   RCP Price Exposure
                                       PRODUCT FLOW

                       GENERATORS
                                      BROKERS
                       • RETAIL                                 PAPER MILLS
                       • INDUSTRIAL
                       • MUNICIPAL                    PACKERS


    PRICE EXPOSURE        HIGH           MED            HIGH         HIGH

BUSINESS SENSITIVITY      MED            HIGH           HIGH         HIGH

 HEDGING NECESSITY        HIGH           MED            HIGH         HIGH




                                                                       36
Transaction Structures: Packer
                 PRODUCT FLOW

GENERATORS

• RETAIL                                   PAPER MILL
• INDUSTRIAL
• MUNICIPAL                     PACKER

 Packer bidding on 1 yr contract OCC from retail
  generator - 1000 t/m
 What contract possibilities exist?
     #1) Physical: bid fixed, sell floating
         Financial: sell fixed swap
        • lock in spread via financial hedge
     #2) Physical: bid fixed physical with some upside
          participation to generator
         Financial: buy price cap for upside participation
                     sell fixed financial to lock in spread   37
OCC Hedging Scenarios


                CASES 1 & 2
               12 & 18 Month
                   Hedges       CASE 2
                               12 Month
                                Hedge      CASE 3
                                          12 Month
                                           Hedge




                                                     38
2000: 12 & 18 Month Hedges, July Start

   CASE #1              CASE #2




                                   39
2001: 12 Month Hedge, Jan & July Starts

     CASE #3             CASE #4




                                    40
Hedge Summary




                41
Hedging RCP in an Open Market
Transition To Open Market –
Individual Customer Supply Agreements
Buyer / Seller negotiate price / volume annually (or less often);
outcome of price discussion is a premium or discount level relative to
floating market clearing price

                   CUSTOMER                       INDIVIDUAL
                                                  CUSTOMER
Premium       CONTRACT NEGOTIATION               AGREEMENTS
to Market
                                                 + % Customer A   PRICE
                                                 + % Customer B   FLOATS
                                                                  AT
                   FLOATING OPEN MARKET PRICE                     OPEN
                                                 - % Customer C   MARKET
                                                 - % Customer D
Discount
to Market


                                                                     43
Open Market Transaction Flow
 INITIAL      FIRM’S                                     FINAL
 POSITION   OBJECTIVE                                   POSTION

             BUYER                                         BUYER
            HEDGES                                         BOUGHT
              50%                                       50% FOR 1 YR;
            FOR 1 YR                                     50% FLOATS
  BUYER                          BID | OFFER
                                OPEN MARKET
 FLOATING                       TRANSACTION              HEDGES OFFSET
 POSITION                                                FLOATING EXPOSURE
            SELLER
            HEDGES
 SELLER       25%                                          SELLER
            FOR 1 YR                                        SOLD
                                                        25% FOR 1 YR;
                                                         75% FLOATS
                         AVERAGE DAILY
                         OPEN MARKET
                         TRANSACTION
                         PRICE
                                               SELLER INVOICES BUYER FOR
                                               TOTAL MONTHLY VOLUME
                        AVERAGE MONTHLY
                                               @ AVERAGE OPEN MARKET
                        OPEN MARKET
                                               MONTHLY PRICE W/ADJUSTMENTS
                        TRANSACTION
                                               PER INDIVIDUAL AGREEMENT
                        PRICE
                                                                        44
Separating Price From Supply



 Sellers can                                     Buyers can
  achieve                                         achieve
 • No monthly          Seller            Buyer   • No monthly
   haggling,                                       haggling
   renegotiations
                                                 • Long term
 • Focus on added                                  agreements
                                Open
   values, long term
                                Market           • Product focused
   relationship
                                                   on service and
                                 Price
                                                   quality

                         • Use open market
                           to separately
                           manage price


                                                                     45
Change + Pain = Gain
Creating Shareholder Value Requires
Breaking Down Barriers Between Silos


REVENUE        --          COST           =   SHAREHOLDER
                                                 VALUE
   SALES    MERCHANT      PRODUCTION
   GROUP     GROUP          GROUP




 • volume    contracted     • fiber
 • price     forwards       • labor
                            • energy
                            • capacity
                            utilisation                 47
Why Hedge?

  Give customers price choices beyond „spot‟

  Business Predictability
    Manage timing of price moves
      • revenue/cost control --> margin control


  Financial Engineering
      • financial leverage
      • credit enhancement
      • equity valuation



                                                  48
Why Hedge ? …. Earnings Consistency +
Knowledge of Forward Market Conditions


FLOATING
                                   Financial
                                   predictability
                                     + consistent
                                      operations
                                         • capex
                                         • R&D
 CONTRACTED
                                         • people
 FORWARD -->   1 YEAR
                                     + customer
                                      choices
           2 YEARS                   + market
     3 YEARS                          signals
                                     + share value
   4 YEARS                           - debt cost
                                     capital structure
  5 YEARS


                                                     49
Buyers and Sellers Can‟t Change Markets,
But Must Know How To Respond Appropriately
  Managing a profit process shouldn‟t be left to
   chance when it comes to price
    Do forecasts provide proper market direction?
    Is a short (30 day) price window sufficient to
     manage long term business goals?
    Has a floating price been a successful way to
     create shareholder value?
    Can transacting in open markets with forward
     prices practices ensure more profit certainty ?
  Bad price signals = bad business decisions

                                                  50
      Thank You                             ……..Q & A
 TFS-ICAP top broker                           TFS-ICAP top broker
  Currency Options Categories:                   Exotic Options Categories
     USD / Euro                                    USD / Euro Barriers
     USD / Japanese Yen                            USD / Japanese Yen Barrier
     USD / Swiss Franc                             USD / Sterling Barrier
     USD / Canadian Dollar                         Other Barriers
     USD / Australian Dollar                       Binary / Digital
     USD / Norwegian Krone                         Hybrids / Trigger
     Euro / Sterling                               Volatility / Variance Swaps
     Euro / Japanese Yen                           Average Rate Options
      2001 Risk Rankings:
      Source Risk Magazine September 2001           Long-dated Options



TFS - most combined 1 st and 2nd place positions in energy markets
 • oil, electricity, electricity options and weather
       U.S., London, Frankfurt, Singapore
       2002 EPRM Rankings
       Source EPRM Magazine February 2002



                                                                              51

				
DOCUMENT INFO
Shared By:
Categories:
Stats:
views:16
posted:7/3/2011
language:English
pages:51