seoul 2016

THE STEEL INDEX (TSI) ASEAN Steel Import Competition Oscar Tarneberg, Regional Head, Asia

www.thesteelindex.com

Platts Event, June 28th 2016, Seoul, S. Korea

Agenda

- TSI (The Steel Index) Introduction

- How many tonnes will China export in 2016?

- N. Asian steel export strategies: time to re-examine?

- ASEAN buyer regret: is price everything? - A changing ASEAN bloc 2016-2020 (internal + Aus)

- The TSI ASEAN index

- Indexing and hedging

TSI Introduction

The Steel Index is a specialised pricing service, that has served the steel industry since 2006.

TSI pioneered a methodology which uses actual spot transaction data to produce price indexes for use by the ferrous market. The methodology employed provides a high degree of confidence for many different types of use. For example:

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

◊ TSI’s scrap indices are used by NASDAQ, LCH & LME

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

◊ Our steel indices are entered into supply-contracts in Europe for stable supply at spot market linked prices. In ASEAN they are entered into floating price deals (i.e. “we will sell at TSI ASEAN June average”).

Iron Ore

Coking Coal

Scrap

Steel

Agenda







How many tonnes will China export in 2016?

It’s a pressing question for ASEAN. China is the most proximate country to large parts of ASEAN.

Freight rates are low by historical standards.

Overcapacity and falling domestic Chinese demand has been clearly evident from 2014 onwards.

China (and N.Asia in general) is predominantly a BOF-based producer, procuring raw materials on a spot basis and selling finished products on a spot basis, too.

By contrast, ASEAN producers are largely EAF-based. Scrap supply is less price-elastic than virgin raw materials. As a result of many years of booming Chinese demand, raw material supply has been rising sharply for Blast Furnace consumption, reducing prices. Essentially, EAF production is handicapped by cost in comparison to BF production.

Despite fast growing steel demand in ASEAN, local producers have been stymied over recent years competing with a lower cost of production, low freight rates and a combination of structural export strategy from North to South, along with China using exports to balance production/demand.


History is rarely a good guide to the future in equity markets, but it is instructional to recall recent trends in Chinese exports.

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Source: China customs data

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So…How does China look in context with other steel producing exporters?

(Net exports minus imports). South Korea saw the shipbuilding crown move to China in 2010, followed by a new build collapse. Germany and Italian exports are variable, but on a downward trend, while Turkey sees continual shrinkage of exports as others target their export markets.

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Source: Import/Export Data World Steel Statistics

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So…How does China look in context with other steel producing exporters?

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(Net exports minus imports). Japanese exports over this period can be characterised as ‘the great moderation’ – After a 2010 surge, net exports remain remarkably stable.


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So…How does China look in context with other steel producing exporters? Huge.

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(Net exports minus imports). China, however, sees exports take a very different path. Data here does not even cover 2015 - China’s ‘breakout’ year, where exports rose by 20.3% year-on-year from those of 2014, to over 112 million tonnnes.

Where previously there were two different ‘orders’ of exporter magnitude,

2014 began to show the emergence of three different orders.

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Back to the question: how many tonnes will China export in 2016?

2016 year-to-date shows the first quarter eclipsing Q1 2015 by over 2 million tonnes.

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Source: China customs data/TSI

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2016 year-to-date shows the first quarter eclipsing Q1 2015 by over 2 million tonnes. Extrapolating the Q1 trend, adjusted for historic export surges, puts full-year export tonnage at over 124 million tonnes: 12 million tonnes higher, year-on-year.

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Building in a low-case scenario (-10% to trend) of strong domestic Chinese demand hoovering up more tonnage, this year could see a minor (2mmt) increase on 2015. A slip in domestic demand (+10% to trend) could see a larger (19mmt) increase on 2015: net 133 million tonnes.


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Agenda







Time for North Asian Countries to re-examine export strategy? Very different sales strategies exist within the region.

• China is the quintessential ‘spot’ player for both procurement and sales strategies (or linked to spot indices).

• All BOF producers, almost without exception.

• This strategy ensures that no individual mill ends up buying or selling for significantly more than their peers.

• The downside for companies competing against Chinese producers is that they therefore face an enormous bloc of mills who are structurally forced to act as a herd.

• This ‘herd’ turns very quickly: when one producer runs for the exit (looks to export markets). Conversely, when the domestic market demand is high, all companies seek to service homeland customers.

• This forces a high degree of competition among exporters – which is all price-based competition - in a rapidly moving market.

• Can other N. Asian sellers keep up with Chinese price fluidity in a “hyper spot” market? Strategies not changed.

Spot

Term

Time for North Asian Countries to re-examine export strategy? Price moves are sudden and can be very pronounced.

We just witnessed an upward stampede with it’s origins in mid-December. Prices rose US$208/t in four months: price volatility of 56% of the commodity price.

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Time for North Asian Countries to re-examine export strategy? Non-China origin pricing not as fluid as Chinese prices. Japan.

Japanese-origin material tends to be offered with 1-2 week validity. As prices fell, the constant readjustments took time to implement. At the same time, when prices rose, offers failed to rise as fast, with the outcome being Japanese material priced flat to Chinese origin and even at a discount!

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Time for North Asian Countries to re-examine export strategy? Non-China origin pricing not as fluid as Chinese prices. Taiwan.

Premiums for Taiwanese material saw similar shifts as it struggled to keep up with the rapidity of price movements originating in mainland China.

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Time for North Asian Countries to re-examine export strategy? Very different sales strategies exist within the region. S.Korea.

The same was true for S. Korean material.

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Time for North Asian Countries to re-examine export strategy? Very different sales strategies exist within the region. India.

India has been a different case after tariffs shielded their domestic market, making prices more attractive to those of ASEAN…or elsewhere. However, the price rises in ASEAN have tempted offers out, particularly as mills run output while awaiting an end of year demand pickup.

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Time for North Asian Countries to re-examine export strategy? Sell-side export structure currently incoherent. Encourages buyers to continuously switch sources.

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Japan-origin premium Taiwan Premium S. Korea Premium India Premium

N.Asian HRC offer spreads can be as wide as US$45/t and are constantly shifting as companies look to gain competitive advantage through price.

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Agenda







ASEAN buyer-regret. Is price everything? When is a bargain buy not a bargain? About 12 weeks later…

Defaults are ticking time bombs. They cost time, reputation and money. Almost every time, they are related to opportunity cost (prices rise or fall on the run-up to delivery).

How many could have been avoided if indexing had been employed?

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Bookings made during the price trough…

…Ran into troubles at delivery time. Reduced shipment tonnages, re-negotiations , changing sources, outright defaults etc.

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ASEAN seller-regret. Is price everything? When is a great sale not great? A few weeks prior to loading…

Default risks are not confined to one origin or destination or the buy or sell side. They occur at the upside and downside. They are also completely unnecessary.

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ASEAN HRC

Russian defaults

Chinese defaults

ASEAN starts to return the default ‘favour’ to China

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ASEAN seller-regret. Is price everything? In some cases! Opportunity cost mounted up very quickly, to over US$100/t.

With the spread between historically concluded spot deals and spot prices soaring over US$100/t, it not surprising to see commercial tension

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Agenda







A changing ASEAN bloc 2016-2020

The ASEAN free-trade-agreement comes on-stream during this period.

ASEAN’s first integrated operations POSCO/Krakatau in Indonesia continue their production ramp-up. Operations here are anticipated to expand to over 6mmtpa in time.

ASEAN’s largest integrated operation Formosa Steel recently lit furnace 1 in Ha Tinh, Vietnam. A second furnace is anticipated to light next year, pushing output to eventually 7+mmtpa post ramp-up.

As these furnaces ramp-up, the balance of regional EAF/BOF production will alter. The former has a tough balancing act for buying expensive scrap (relative to ore/cc) or importing (inevitably) Chinese billet.


So internal price-competitive ASEAN supply is set to be increasing over near-term.


So internal price-competitive ASEAN HRC supply is set to be increasing over near-term.

Chinese export output is anticipated to at least keep level with that of 2015.




Russian mills are unlikely to see a resurgence in OCTG trade and will likely continue to enjoy domestic currency weakness, making US$ trade attractive.





South Korea’s Dongkuk/POSCO has their Brazil JV firing up now, slab from there will likely be Asia-bound.






Australia’s domestic demand looks weaker over this year, which will likely force exports to rise from recent levels.







Japanese exports are likely to remain stable.








India has been in and out of the ASEAN market recently, but has come back in after the price surge. They will prioritise the tariff-protected local market, but export ‘surplus’ to maintain higher utilisation rates.








India has been in and out of the ASEAN market recently, but has come back in after the price surge. They will prioritise the tariff-protected local market, but export ‘surplus’ to maintain higher utilisation rates.

Taiwan seems unlikely to export less in the near-term.


ASEAN has all the hallmarks of being a hyper-contested market over this period.

Will it be (destructive) price-based competition?

Agenda







The TSI ASEAN HRC index – why should I care?

The index is a Chinese origin price – by far the world’s largest steel exporter.

However, it also includes price inputs from Japan, S. Korea, Taiwan and India.

These countries account for over 66% of 2015 global steel production. Many of these markets have a strong correlation with domestic prices also.

ASEAN prices are inevitably shaped by the prevailing import prices available from any external source.

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The TSI ASEAN HRC index

TSI Reference Product for Hot Rolled Coil, ASEAN imports • Product specification:

- Grade: Prime mild carbon steel SAE 1006, SPHC or SPHT-1 (or equivalent)

- Gauge: up to 3mm; Width: 900-2000mm

- Coil weight: 10-30 metric tonnes

- Order size: 500 metric tonnes minimum

- Excluding surcharges and extras (e.g. non-standard dimensions, order sizes)

• Origin: China

• Pricing point: CFR Singapore Port

• Price units: US$ per metric tonne

Other Permissible Inputs:

• Product specifications:

- Grade: Prime mild carbon steel JIS G 3101 SS400 (SPHC) or Q235 (or equivalent) with gauge: 3-7mm

• Origins: Japan, South Korea, Taiwan and India

• Destinations: CFR port in Vietnam, Thailand, Singapore, Philippines, Mynamar, Malaysia, Laos, Indonesia, Cambodia and Brunei

Index Specification

• Normalisation factors applied are:

- Grade: SS400 SAE 1006

- Origin

- Destination (controlled market tariffs)

- Freight rate differentials

The TSI ASEAN HRC index

• Normalisation differentials are not fixed. They are adjusted whenever necessary to reflect the prevailing average values being applied to spot HRC transactions in the ASEAN market

• TSI tracks and updates these values regularly. It analyses the transaction data submitted into its systems, together with firm bid and offer data collected, for different grades, origins and destination ports to determine the latest average differentials in the market. It then tests its findings by engaging with market participants before updating the normalisation values applied

• Note: Published tariff rates are not applied directly as the normalisation differentials for destinations other than Singapore. This is because spot market behaviour demonstrates that the tariffs applicable do not necessarily equate to the price differentials appearing into these markets. The reasons for this are complex, including in some cases reflecting the reality that some variable tariffs are applied at individual mill level, rather than flat rates

SAE 1006 US$0/t

SS400 -US$10/t

Chinese Mill US$0/t

Chinese (Premium) Mill

US$10/t

India -US$10/t

S.Korea US$10/t

Taiwan US$10/t

Japan US$10/t

Singapore US$0/t

Vietnam US$1/t

Thailand US$2/t

Indonesia US$2/t

Grade Differentials*

Origin Differentials*

Destination Differentials*

* Examples of normalisation differentials applied on May 9, 2016

Normalisation Processes

Agenda







Indexing and hedging

•Steel sales/purchasing is a difficult task, hampered by uncertainty and volatility. •Indexing offers a way to tame volatility. •And provides predictability in an uncertain world.

•Indexing “fixes” a price. •Over a fixed period. •Often with fixed tonnages.

•And gives a clearer view on where the price will move in future.

Indexing and hedging – Indexing example

An example 8 week time period shows that purchasers are at risk several times of buying at ‘peak’

weeks during a month.

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It also shows that sellers are at risk several times of selling at ‘trough’ weeks during a month.

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Using an index on a month-on-month basis neatly truncates week-on-week peaks and troughs…

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If applied the following month, or delivery month, timing related price risk is also eliminated . In this example of a rising market, it has offered price protection against the rise via the lag...

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BUT, the arrangement is “fair” – no party ‘wins’ or ‘loses’ over time. Delay in price change gives both parties an increased planning horizon.

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Consistency of Material

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

Spot Trade Indexed Trade

Indexing and hedging – 2nd Example

Remember this slide? By the time delivery came around prices were US$115/t above when they were struck. What if they decided to use a ‘floating price’ i.e. agree to transact at the average price of the delivery month?

Bookings made during the price trough…

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Indexing and hedging – 2nd Example

By using the index in a floating price for March delivery, the price is no longer US$115/t above current spot. The furthest spot moves above index (which is average of the month) is US$25/t.

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Neither buyers nor sellers can feel ‘cheated’. Orders will be fulfilled, relationships not destroyed, customers will receive material because the (spot)opportunity cost does not become too great.

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Indexing and hedging – dispelling misconceptions

• Indexing does not commoditise products. 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 (pipe and tube, for example) buy in bigger volumes, that advantage can be built into the price, for example 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.

• Companies can also hedge ASEAN HRC prices using the index, too.

Hedging – prices that could have been locked in…

We all know how prices have moved…

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However, prices would have moved very differently for companies who took positions out in October (and some did).

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They would have moved very differently for companies who took positions out in March (and some did).

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They would have moved very differently for companies who took positions out in April (and some did).

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They would have moved very differently for companies who took positions out in May, too.

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Tight correlations make ASEAN HRC import index ideal for hedging underlying price exposure

The ASEAN index is for Chinese-origin HRC delivered into China.

China leads pricing regionally, the daily correlations of our non-China origins are as follows.

As ASEAN BOF production rises , it will have to keep up with China too (i.e. strong correlation too).

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The absolute $ value of the spread between CFR and FOB has been falling, as well:

TSI ASEAN HRC Monthly Correlations (R²) to:

Platts China HRC Exports (FOB)

Full history (53 months) 99.6%

36 Months 99.7%

24 Months 99.5%

12 Months 99.9%

Annual Spread from TSI ASEAN HRC Index US$/t

Spread to Platts China FOB US$/t

2013 38

2014 32

2015 14

2016 YTD 10

The correlations between TSI’s ASEAN CFR HRC index and FOB China HRC prices are strong. Over any time period, they remain sustained, too.

Tight correlations make ASEAN HRC import index ideal for hedging underlying price exposure

Thank you!

If you have any questions please email [email protected].

The analysts below are connected to the asean@ address & look after the following markets:

Anh Nghiem: Vietnam, Thailand, Singapore,

Eric Zhu: Hong Kong, Taiwan, Singapore, China

Terry Chuay: Indonesia, Malaysia, Cambodia, Myanmar

Julie Jiang: Mainland China

Oscar Tarneberg: Japan, South Korea

Tim Hard: Australia, India

Vaseem Karbhari: EU Imports of Asian HRC

Kurt Fowler: US Imports of Asian HRC

We look forward to hearing from you soon.

mailto:[email protected]

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