TURKISH SCRAP BENCHMARK

www.thesteelindex.com

Stefan Swanepoel TSI Scrap Analyst London May, 2016

DISCLAIMER

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Introduction

TSI is a specialist price information service

• Impartial organisation focused on compiling prices for ferrous metal products

• Founded in in 2006 as subsidiary of the Steel Business Briefing (SBB) Group, acquired by Platts in July 2011

• Continues to operate under TSI brand as a separate unit within Platts, part of S&P Global

• Data-driven methodology using transaction data to calculate volume-weighted price indices

• TSI “Data Providers” submit spot transaction data to TSI under confidentiality agreement; physical market participants only (over 600 registered today)

• Submission direct to TSI database through secure on-line channel

• Data normalised and “cleaned”, minimising opportunities for manipulation/data bias

• Volume-weighted averages calculated for the day or week based on actual spot market transaction data

Introduction

TSI pioneered a methodology which uses actual spot transaction data to produce price indexes for use by the ferrous market

Scrap indices are used as the basis of settlement for futures and swaps contracts on LME, LCH.Clearnet, CME Group and Borsa Istanbul

European HRC and plate steel indices referenced in supply contracts. ASEAN steel benchmark referenced in floating priced deals

62% iron ore index is used by numerous exchanges to settle the overwhelming majority of all global iron ore derivatives trade

Our FOB Australia Premium coking coal price is entered into the majority of all index-linked supply contracts between producers and customers

Iron Ore

Scrap

Steel Coking Coal

Key Principles

To maximise industry participation and the accuracy of data submitted

To minimise opportunities for manipulation or subjectivity in the compilation of each index

To apply a consistent approach: TSI uses the same approach for compiling all its iron ore, steel, scrap and coking coal reference prices worldwide:

• legal agreements with relevant Data Providers active in the physical market

• secure confidential on-line data collection of actual transactions

• prices normalised to reference product specifications

• data ‘cleaned’ with outliers excluded

• volume-weighted averages calculated and published

Methodology

TSI “Data Providers” submit spot transaction data to TSI under confidentiality agreement

Physical market participants only (over 600 registered)

Representatives from all relevant points of the supply chain, buy and sell sides

Submission direct to TSI database through secure on-line channel

Data normalised and “cleaned” before volume-weighted averages calculated for the day or week

Legal Agreement

Submits price data through a secure

online system

Transaction data sample

Prices normalised 1

Outliers & high/low excluded

2 Buy/Sell balance 3

Volume–weighted averages calculated 4 Final

data set

TSI Prices Published

Methodology

Trades normalising to MORE and LESS than one standard deviation from the mean are excluded. So too are the unique lowest and highest prices

Data set included in index calculation proceeds to volume-weighting stage.

Data submissions exhibiting inexplicable trends or inconsistencies are also excluded

- - LP

+ +

+ 1 s.d.

- 1 s.d.

Data Submissions

HP

TSI Daily Turkish Scrap Benchmark Price

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350

Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16

US

$/t

Turkish HMS 1&2 80:20 Daily Index

Daily Normalised Price Submissions

Why Turkey?

Turkey is the single largest importer of ferrous scrap and the region acts as a genesis for pricing

Steel production via the secondary route (EAF-based), using scrap as a raw material feedstock

Turkish scrap import prices influence other key scrap trading regions such as the domestic US Midwest, Taiwanese and Indian containerized imports

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Ukraine Russia UK USA Rest of the world

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Turkish Scrap Imports

Key Global Scrap Exports 2015 (million tonnes)

Imports from diversified sources around the world but largely originate from US East Coast, Europe/Scandinavia (deep-sea) and Baltic regions (short-sea)

1.09

1.15

0.68

1.62

0.99

1.43

1.10

8.08

3.97

US Scrap Exports

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India Mexico South Korea Taiwan Turkey Rest of the World

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2013 2014 2015

The US is the single largest exporter in the world. Three inter-related scrap regions…Midwest (domestic), East Coast (exports to Turkey) and West Coast (exports to Asia)

Purchasing patterns in Turkey (as a bulk buyer) have a knock-on impact on scrap pricing in both the Midwest and containerised markets such as Taiwan and India

Virgin Iron versus Bulk Scrap

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3.5

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Scrap HMS #1&2 80:20 Ratio (RHS)

Despite recent price falls, scrap is more than three times the cost of iron ore per unit of Fe

Whilst Turkey’s EAF steelmakers cannot directly switch between scrap and iron ore, it may become more cost effective for them to re-roll semi-finished steel (billet) into rebar than melt scrap (i.e. the displacement effect)

Index Users

Physical market users include steel mills, miners, scrap yards, traders, distributors, service centres, steel processors and steel consumers

Physical market players use TSI prices in a variety of ways, including:

- for reference in price negotiations

- to track performance against the market

- for benchmarking

- as escalators and in clauses within supply/purchase contracts, triggering a price adjustment or renegotiation if the index moves by more than a defined amount

- to identify opportunities to take trading positions

- in index-linked pricing arrangements

- for hedging physical price exposure (locking in future revenues, costs or margins)

- for speculation (traders)

Financial market users include brokers, banks and exchanges

Indexing and hedging

Commodity buying and selling is a highly volatile practice and therefore requires risk management

To manage price risk, participants can hedge prices through exchange traded derivatives such as futures and swaps

Future contracts are standardized (i.e. each contract is the same quantity and date for everyone) and trade on exchanges

Clearing houses guarantee the trades and also ensure that every contract is honored

It can be seen as a form of insurance against adverse moves in the market

Indexing and Hedging – Direct Indexing

Trading firms view logistics, storage and other transformations as their core businesses, and so do not have an advantage in bearing price risk

Secondary benefits therefore arise from price indexing – as having secured a price acceptable to both parties, focus can shift to other areas of the customer-client relationship

Price

Quality

JIT delivery

Credit Lines

Single Invoicing Point

Consistency of Material

Spot Trade

Service

Quality

JIT delivery

Credit Lines

Single Invoicing Point

Consistency of Material

Indexed Trade

Indexing and Hedging – Dispelling the Myths!

Indexing does not commoditize products as it allows for preferences to be built into the index price.

If material produced is considered a value-added product then it can be sold at a premium fixed value or a percentage to the index value.

If a specific origin is viewed as ‘premium’ origin, it can be sold at index ‘+’ a fixed value, or a percentage value. Buyers may consider certain origins to be almost certain to reliably deliver on time, for example.

Using futures/derivatives contracts as a price risk management tool is not speculative measure!

On the contrary, it carries a myriad of benefits to users throughout the steel supply chain. It allows for forward planning, fixed price certainty and (certainty) of cash flows as well as an efficient allocation of capital resources.

Indexing and hedging

Indexing does not commoditize products as it allows for preferences to be built into the index price.

If a specific material is viewed as ‘premium’ material, it can be sold at index ‘+’ a fixed value, or a percentage value. Buyers may consider certain mills to produce a physical premium product, for example.

If a specific origin is viewed as ‘premium’ origin, it can be sold at index ‘+’ a fixed value, or a percentage value. Buyers may consider certain origins to be almost certain to reliably deliver on time, for example.

If buyers (e.g. pipe and tube) buy in bigger volumes, that advantage can be built into the price e.g. index ‘-’ an agreed value. Discounts or premiums can be built in to the index price for credit lines, or any number of commercial terms buyers or sellers value.

LME Scrap Futures

Launched November 2015 alongside LME’s Steel Rebar contract

Cash-settled futures contract with a 12-month forward curve and a lot size of 10 tonnes

~40,000 tonnes (4,000 lots) traded since launch

“Based on the development so far, Stemcor feel these launches have been the most successful in the commodities space since iron ore swaps.”

Phillip Price, Head of Market Risk Management and Derivatives Trading at Stemcor

First voice-brokered trade executed in May by INTL FCStone Ltd on behalf of Stemcor – indicating contracts are being accepted as risk management tools for the steel industry

Ferrous Scrap Futures

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Cu

mu

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ots

Cle

are

d

LME Forward Curve

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Turkish Imports HMS 1&2 80:20, CFR Turkish Port

US Domestic Shredded, Delivered Mill

Indian Imports, Shredded, CFR Port

Taiwan imports HMS 1&2 80:20, CFR Port

Forward Curve

Market Update - Example

Turkish Scrap Update – Week beginning 23 May, 2016 Trading activity is yet to resume in the Turkish scrap market, however, latest bid and offers saw TSI’s HMS #1&2 80:20 scrap CFR Turkey port benchmark end today at US$283/tonne. Steel prices in Asia, in particular, the price of Chinese-origin billet, continues to be the main concern for scrap market participants as further price deviations between billet and scrap is expected to reduce appetite for the raw material. Historically Taiwanese containerized import and Turkish bulk import scrap prices have moved in tandem, with an R2 value of 0.96 confirming their close relationship. Furthermore, the Turkish scrap price has consistently traded at a premium of US$20-40/t between August 2012-14 and in the US$20-60/t range since then. The recent substantial price decline in the Taiwanese imports market has in turn created an unprecedented price differential between the two, with the Turkish price currently trading at a US$109/t premium. The assumption is that this significant differential will soon correct back to its historical range, but whether Taiwanese import prices recover or Turkish scrap prices plummet, remains to be seen. Players in the market were uncertain as to where Turkish prices will level out, however, it is believed that stocks will soon run out at mills and hence demand uncertainty will subside as buying resumes.

Contact

To subscriber to bi-weekly market updates follow up with us directly on the details below Stefan Swanepoel London TSI Scrap Analyst Office: +44-20-7176-6533 Email: stefan.swanepoel@spglobal.com