erlend engelstad, marex spectron - rice dynamics, benchmarking and risk management for kalimantan...
DESCRIPTION
Erlend Engelstad, Vice President – Business Development, Marex Spectron delivered this presentation at Kalimantan Coal 2014 in Balikpapan Indonesia. This event brings together 120+ senior executives, and decision makers from government, mining, infrastructure, shipping and supply sectors to discuss new policies and strategies for tackling the current and emerging issues within the burgeoning Kalimantan coal sector. Visit the website to find out more: http://bit.ly/KalimantanCoal2014TRANSCRIPT
USE OF INDICES AND RISK MANAGEMENT TOOLS FOR
KALIMANTAN COAL
PREPARED FOR:
3RD ANNUAL KALIMANTAN COAL PREPARED BY:
ERLEND ENGELSTAD SENIOR RESEARCH ANALYST BASIC RESOURCES RESEARCH GROUP
BALIKPAPAN, INDONESIA 3RD SEPTEMBER 2014
2
• Pioneers in coal derivatives and physical coal brokerage
• Hybrid execution facility for coal derivatives
• Multilingual specialist team arranging physical coal transactions
• Reputable research desk providing insight across the energy complex
• Global coverage from offices in Europe, Asia and the US
• Awarded #1 Inter-Dealer Broker in Coal by SGX in 2013
• Awarded Research House of the Year by Energy Risk in 2014
About Marex Spectron
• One of the world's largest privately owned brokers of financial products in the commodities sector and a leader in brokering physical energy products.
• Significant market share in the energy, metals, freight, environmental and agricultural markets – both on-exchange and over-the-counter. We are also a premier specialist broker of financial futures, foreign exchange and securities.
• We are a major provider of market information products – research, analytical reports, live market screens and price feeds
• Marex Spectron currently employs around 600 people, with the group’s global headquarters in London and offices across Europe, Asia and USA.
Marex Spectron and Coal
3
4wk annualized volatility – Indonesia Sub-bit
• Volatility is an central measure of risk, and can be expressed in terms of probabilities (i.e. VaR) or in $ scenarios as below.
• Although volatility in coal markets is at relatively low levels compared to 2008 (with spikes above 150%), prices are extremely sensitive to short term supply/demand tightening.
• Short term volatility can rise significantly on;
• Short term tonnage supply squeeze in the dry bulk fleet.
• Cyclical weather patterns impacting infrastructure and production.
• Geopolitical uncertainty (i.e. Ukraine).
• Environmental and protectionist measures from governments.
• When is hedging not necessary? • If you know for certain where the price will go. • If you can pass along your costs to end users.
Return distributions (weekly)
The Case for Hedging
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
$0
$20
$40
$60
$80
$100
$120
Aug08 Aug09 Aug10 Aug11 Aug12 Aug13 Aug14
4wk annualized volatility Indonesian Sub-bit (4,900)
0
5
10
15
20
25
30
35
40
-5.0
%
-4.5
%
-4.0
%
-3.5
%
-3.0
%
-2.5
%
-2.0
%
-1.5
%
-1.0
%
-0.5
%
0.0
%
0.5
%
1.0
%
1.5
%
2.0
%
2.5
%
3.0
%
3.5
%
4.0
%
4.5
%
5.0
%
Mo
re
Nu
mb
er
of
ob
serv
ati
on
s
Newcastle 6000 Indonesia sub-bit
Sensitivities 4900 NAR @ $53.40 (15 Aug 2014)
30000
50000
70000
90000110000130000
$-
$200,000
$400,000
$600,000
$800,000
$- - $200,000 $200,000 - $400,000 $400,000 - $600,000 $600,000 - $800,000
Source: IHS McCloskey, Marex Spectron Research
Source: IHS McCloskey, Marex Spectron Research Source: IHS McCloskey, Marex Spectron Research
4
• Derivatives such as swaps, futures and options are contingent claims on future cash flows from a counterparty (either a company, or a clearing house)
• The value of the claim (which may also be negative) is dependent on the movement of an underlying instrument
• The concept of commoditization stems from several underlying assumptions;
• You have a tangible cash flow in the underlying market (exposure)
• Your product is easily replaceable in the marketplace (substitutability)
• There are many buyers/sellers of your product (liquidity)
• Facilities for credit and clearing are available (financing + counterparty risk)
• Volatility = uncertainty in gains/losses; and leads to
• Unpredictable earnings
• Potential squeeze on profit margins
• Tighter credit lines with banks
• Shorter tenures and stricter payment terms
• Potential agency problems
Exposures with 0%, 50% and 100% hedge in place for Q1 2014
Commoditization and hedging
$57
$58
$59
$60
$61
$62
$63
Dec13
Jan
14
Fe
b14
Ma
r14
Ap
r14
Ma
y14
INDO 100% hedged @62 50% hedged @62
Source: Marex Spectron Research
HEDGING IS THE TRANSFER OF RISK BY TAKING AN OPPOSITE AND OFFSETTING POSITION IN AN EQUIVALENT PRODUCT
1) DIRECTION
Am I long, short or neutral the underlying?
2) PERIOD
Which swaps contract period matches my
physical exposure?
LONG (buy) Pay fixed
Receive floating
Gains value if market > swap price
SHORT (sell) Pay floating
Receive fixed
Gains value if market (spot) price <
swap price
TWO INITIAL POSITIONS FOR A SWAP:
3) VOLUME
Am I hedging 100% of my underlying exposure
Am I using a proxy?
4) TRADING OUT
When should I unwind my position?
CONSIDERATIONS BEFORE PLACING A HEDGE:
Go long costs & short revenue
6
Unstable ratios affecting calculation of hedging volume
• Basis risk is the mismatch between properties in physical trading vs the assumptions made in index production, i.e.:
• Bespoke contract idiosyncrasies (premiums/discounts)
• Breakdown in a priori assumptions (covariance, hedge ratio)
• Delivery locations outside the index scope
• Rule of thumb;
• If you’re short the market, you are long the basis (and vice versa)
• Monitor magnitude of changes between spot and futures market
• Prudent surveillance of portfolio risks
• Exchange for Physical (EFP); simultaneous sale of physical cargo while buying a futures contract – links performance & price
Benchmarking Indonesian Coal
Basis Risk
60%
65%
70%
75%
80%
85%
Aug12 Nov12 Feb13 May13 Aug13 Nov13 Feb14 May14 Aug14
Indo 4900 vs Newc Indo 4900 vs Indo hi-bit (basis 6000)
30 31 32 33 34 35
China India Korea Taiwan
Pricing power FOB Indonesia
$55
$65
$75
$85
$95
$105
$115
$125
$135
HBA NEWC Sub-bit basis NEWC
Source: IHS McCloskey, Marex Spectron Research
Source: IHS McCloskey, Marex Spectron Research Source: Marex Spectron Research
7
Correlations – Argus/McCloskey Indonesia indices
• Choosing an index product for hedging a cargo;
• Does it represent price changes in my underlying exposure (direction and magnitude)?
• Does it reflect the quality of my cargo? Can nonlinear properties be objectively quantified? (i.e. Platts’ ash discount)
• Is the granularity of assessments sufficient to avoid timing risk?
• The only liquid instrument that exclusively accounts for Indonesian coal price movements is the Argus/McCloskey Sub-Bituminous index;
• Published every Friday
• Assessed independently and anonymously through surveys,
trades weighted more than bids/offers
• Diverse participant distribution (25% producers, 25% end
users, 50% traders)
• Uses the FISTA contract ports and normalizes for freight
differentials
• Choosing an instrument; swaps, futures, EFRP, EFS, Blocks….?
• Effectively most of these are equivalent and/or fungible instruments in terms of their economics and execution
• Some differences occur in terms of regulations, time windows, margin requirements and reporting conventions
• Many regulations are still pending approvals, harmonization and implementation
• In the coal market, most participants refer to SWAPS (although contract is a future)
Newcastle 6000 versus Indonesia sub-bit (4900 NAR)
The case for hedging
Indo Sub
Sub-bit
(3,800 GAR)
Indo Sub
Sub-bit
(4,200 GAR)
Indonesian
Sub-bit
(4,900)
Indo
Mid-Bit
(5,500)
Indo
Mid-Bit
(6,000)
Indo Hi-
Bit
(>5,850)
Indo Sub
Sub-bit
(3,800 GAR) 100%
Indo Sub
Sub-bit
(4,200 GAR) 97% 100%
Indonesian
Sub-bit
(4,900) 76% 82% 100%
Indo Mid-Bit
(5,500) 64% 70% 93% 100%
Indo Mid-Bit
(6,000) 64% 70% 93% 100% 100%
Indo Hi-Bit
(>5,850) 52% 59% 82% 89% 89% 100%
$50
$55
$60
$65
$70
$75
$80
$85
$90
$95
$60 $70 $80 $90 $100 $110 $120 $130
Ind
o 4
900
Newcastle 6000
Source: IHS McCloskey, Marex Spectron Research
8
Global coal derivatives volumes 2000-2013 (million metric tonnes)
• Liquidity in coal derivatives in Asia Pacific increasing on the back of;
• Continued high demand for coal; concentrated supply
• Decrease in the use of long term pricing mechanisms; move towards spot market
• Liberalization of electricity markets (albeit work in progress)
• 9.43mill tonnes traded on Indonesia sub-bit index in 2013 – 2.5mill tonnes traded in Jul-14 alone
• 12mill tonnes traded on API8 in 2013 – expected to double in 2014
• With the Atlantic and Pacific basins becoming more disconnected from each other, market participants are increasingly looking for credible, liquid benchmarks for their Asian coal exposure
Liquidity in Indonesian Sub-Bit derivatives volumes
Liquidity in coal markets
-
500,000
1,000,000
1,500,000
2,000,000
2,500,000
3,000,000
Jan
11
Ma
r11
Ma
y11
Jul1
1
Se
p11
Nov11
Jan
12
Ma
r12
Ma
y12
Jul1
2
Se
p12
Nov12
Jan
13
Ma
r13
Ma
y13
Jul1
3
Se
p13
Nov13
Jan
14
Ma
r14
Ma
y14
Jul1
4
Sub-Bit Trend
500
1,000
1,500
2,000
2,500
3,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
API2 API4 Newc Indo API8 API5
Source: SGX, CME, ICE, Marex Spectron Research
Source: SGX, CME, ICE, Marex Spectron Research
9
• A clearing house is a central counterparty that significantly reduces (in effect, eliminates) the risk of default through good-faith deposits (collateral) and variation margins.
• In addition to the elimination of counterparty risk and cash flow management, The benefits of clearing are reduced capital requirements, margin offsets between related positions, and netting of portfolio returns.
• Margins are set on proprietary formulas where the main component is volatility, designed to account for assumed liquidation costs in case of default
• Major clearers for Indonesian coal derivatives are CME, SGX and ICE
Clearing & Other Instruments
INSTRUMENT DESCRIPTION INDEX PROVIDER QUALITY CLEARING PROVIDED?
API 4 FOB Richards Bay Argus / McCloskey 6,000kc NAR ICE, CME, SGX
API 2 CIF ARA Argus / McCloskey 6,000kc NAR ICE, CME
NEWC FOB Newcastle globalCOAL 6,000kc NAR ICE
API 8 CFR South China Argus / McCloskey 5,500kc NAR CME, SGX, ICE, HKEX
Indonesia Sub-Bit FOB Indonesia McCloskey 4,900kc NAR CME, SGX, ICE
API 5 FOB Australia Argus / McCloskey 5,500kc NAR CME, SGX Source: SGX, CME, ICE, Marex Spectron Research
FUNDAMENTAL DRIVERS IN THE COAL MARKET FOCUS ON ASIA PACIFIC
11
Price arbitrage vs. Imports (China)
Price arbitrage vs. Imports (India)
• All top 3 importers of thermal coal are either heavily dependent on the price arbitrage between domestic and imported coal (China and India) or the prices of natgas and CO2 emissions (EU)
• Chinese imports under pressure due to falling arb. Incentive
• Imports in to India were also weak for the bigger part of 1H 2014 due to sharp rupee devaluation in 2013 and aggressive pricing of domestic coal. Situation is gradually changing as Coal of India increased sharply the domestic price
• In the case of EU, wide open climate spreads was driving the surge of coal burn in 2012-2013. The spread is now closing…
Climate spread vs. Imports (EU27)
Medium-term drivers: Import arb
-$40
-$30
-$20
-$10
$0
$10
$20
$30
5.00
10.00
15.00
20.00
25.00
30.00
Jan11 Jun11 Nov11 Apr12 Sep12 Feb13 Jul13 Dec13 May14
Mln t Differential (rhs) Imports
0
2
4
6
8
10
12
14
16
18
20
-$20
-$15
-$10
-$5
$0
$5
$10
$15
$20
Jan11 May11 Sep11 Jan12 May12 Sep12 Jan13 May13 Sep13 Jan14 May14
Mln t/month Differential Imports
-10
-5
0
5
10
15
20
25
30
35
400
500
600
700
800
900
1000
1100
1200
1300
Jan11 May11 Sep11 Jan12 May12 Sep12 Jan13 May13 Sep13 Jan14 May14
Climate spread Coal burn
-$15
-$5
$5
$15
$25
$35
$45
Jan14 Feb14 Mar14 Apr14 May14 Jun14
IndonesiaAustralia
-$15
-$10
-$5
$0
$5
$10
$15
Jan14 Feb14 Mar14 Apr14 May14 Jun14
Russia
USA
S.Africa
Colombia
12
Medium-term S&D drivers: Trade flows shift
Atlantic: CIF ARA price >/< Average
Pacific: CIF China price >/< Domestic
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2012 2013 2014 2015
US
South Africa
Colombia
Russia
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2012 2013 2014 2015
Australia
Indonesia
Atlantic: Exports growth
Pacific: Exports growth
• The Asian trade has also declined but for different reasons
• Decline of the Chinese domestic price is starting to close the Arbitrage gap with the imported coal.
• Both Indo and Aus coal are losing competitiveness – export growth from the #1 and #2 exporter in the world will slow.
• Price differentials driving the trade flows
• Colombia and Russia competitive on the European market while USA and S. Africa are quickly losing market share
• The trend is expected to continue well into 2015 with Russia gaining further market share
13
Share of unprofitable export capacity
Long-term supply drivers (Global)
• Significant amount of mining output (20-25% of total) already unprofitable
• The process of Idling and/or permanently closing capacity is very likely to continue at these levels
• Mining capacity utilization is already declining – sure sign of capacity closures
0%
13.7%
25.4%
49.2%
76.1%
98.2%
3.3%
1.2%
Unprofitable export capacity
Thermal coal mining capacity utilization
Production vs. Average cost of production (current year)
450.1 mln t
333.9 mln t $54.75
$71.21
$50
$55
$60
$65
$70
$75
300
320
340
360
380
400
420
440
460
PACIFIC ATLANTIC
Average production price ($/t, rhs) Production capacity (mln t)
$30
$40
$50
$60
$70
$80
$90
$100
$110
$120
$130
$140
$150
Jan12 May12 Sep12 Jan13 May13 Sep13 Jan14 May14
FOB NWC
FOB RB
FOB RUS
FOB COL
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
100%
Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14
TOTAL ATL TOTAL PAC
14
Major exporters (Mln t/quarter)
Exports growth rate
• Indonesian exports likely to stabilize around 108 mln/quarter
• Same for Australia @ 50mln/quarter
• Russia the only major growth region
Long-term supply conditions
• Export YoY growth rate diagram confirms these findings
• Russia the highest growth region for exports
0
20
40
60
80
100
120
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2F
Q3F
Q4F
Q1F
Q2F
Q3F
Q4F
2011 2012 2013 2014 F 2015 F
Indonesia Australia Russia
Colombia South Africa US
-40%
-20%
0%
20%
40%
60%
80%
100%
Q1 Q2 F Q3 F Q4 F Q1 F Q2 F Q3 F Q4 F
2014 F 2015 F
US South Africa Colombia Russia Australia Indonesia
15
Major importers
Imports growth rate
• China to continue with similar import rates for another year or so
• India the only other major destination
Long-term demand conditions
• China and India to dominate the import market in 2014-2015
-
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2F
Q3F
Q4F
Q1F
Q2F
Q3F
Q4F
2011 2012 2013 2014 F 2015 F
China Japan South Korea IndiaTaiwan Germany UK
-40%
-30%
-20%
-10%
0%
10%
20%
30%
Q1 Q2 F Q3 F Q4 F Q1 F Q2 F Q3 F Q4 F
2014 F 2015 F
UK Taiwan Japan China South Korea India Germany
Strictly private and confidential
Disclaimer This presentation has been prepared by Marex Spectron for information purposes only. Marex Spectron does not give any representation or warranty, whether express or implied, as to the accuracy, completeness, currency or fitness for any purpose or use of any information in this presentation. Information in this presentation should not be considered as advice, or as a recommendation or solicitation to purchase or otherwise deal in securities, investments or any other products. It has been prepared for institutional clients is not directed at retail customers and does not take into account particular investment objectives, risk appetites, financial situations or needs. Recipients of the presentation should make their own trading or investment decisions based upon their own financial objectives and financial resources. This presentation may contain forward looking statements including statements regarding our intent, belief or current expectations with respect to Marex Spectron’s businesses and operations, market conditions, results of operation and financial condition, capital adequacy, specific provisions and risk management practices. Readers are cautioned not to place undue reliance on these forward looking statements which may be subject to change without notice. While reasonable care has been used in the preparation of forecast information, actual results may vary in a materially positive or negative manner. Forecasts and hypothetical examples are subject to uncertainty and contingencies outside Marex Spectron’s control. Past performance is not a reliable indication of future performance. The Marex Spectron® group of companies includes Marex Financial Limited, Marex USA Limited, Marex North America LLC, Marex Hong Kong Limited, Spectron Energy Services Limited, Marex Spectron Asia Pte Limited (individually and collectively “Marex Spectron”). This presentation was approved by Spectron Energy Services Limited (“SESL”). SESL is incorporated under the laws of England and Wales (company no. 03938219 and VAT registration no. GB 872 8106 13) and is regulated by the Financial Conduct Authority (registration no. 193027). SESL’s registered address is at 155 Bishopsgate, London, EC2M 3TQ.
FINANCIAL COAL DESK LONDON: +44 20 074 2087 Nick Lygoe, Co-Head of Financial Coal SINGAPORE: +65 64 130 055 Arne Petter Kolderup, Senior coal swaps broker USA: +1 212 584 3896 Ian Tapsall, Head of US Financial coal PHYSICAL COAL DESK LONDON: +44 20 7074 0889 James Ash, Physical coal broker SINGAPORE: +65 6413 0055 Samaan Rahman, Physical Coal Broker USA: +1 646 312 6473 James Bleuer, Physical coal broker FERROUS METALS DESK OSLO: +47 2389 4218 Kristian Thunes, Head of Ferrous metals SINGAPORE: +65 6413 0060 Benjamin Beng, Iron Ore broker COMMODITIES RESEARCH DESK LONDON: +44 2076 5563 57 Georgi S. Slavov, Head of Basic Resources Research Group SINGAPORE: +65 6413 0045 Erlend Engelstad, Senior Research Analyst