Presentation on theme: "The LME and Lead Hedging Introduction to Hedging for Lead and Battery Producers 13 th Asian Battery Conference, Shanghai Wednesday 1 September, 2009 Rick."— Presentation transcript:
The LME and Lead Hedging Introduction to Hedging for Lead and Battery Producers 13 th Asian Battery Conference, Shanghai Wednesday 1 September, 2009 Rick Holmes Mitsui Bussan Commodities (Aust.) Ltd T 61 2 9256 9599 C 0411 474 800
2 Agenda Introduction The LME and its functions Users of the LME and Price Discovery Mechanics of the LME metals market, Official prices Manufacturers Price Risks Hedging Risks in a simple form Slightly more on Hedging with options A Few essentials if setting up an LME Trading Department. Conclusion and Questions
3 The London Metal Exchange Established in 1877 for the risk management of metals business “Not for profit” organization - formalized trading in the market with: – Fixed trading times – Standard contract specifications – Providing a transparent source of price discovery Provides 24 hour principal to principal market Annual volume of $10.24 trillion with more than 95% of its business coming from overseas, the exchange currently has 5.13 million tonnes of metals on warrant in 516 warehouses in 38 locations globally.
4 LME membership trading categories Description Can Issue LME Contracts Authorized (Financial Services Act) Member of LCH for Metals Member of FSA Trading Rights May Solicit Brokerage Minimum # Net Worth Requirement 1. Ring Dealing Member Yes FreelyYes£ 5mm 2. Associate Broker Clearing Member Yes FreelyYes£ 5mm 3. Associate Trade Clearing Member No YesNo May only deal with 1, 2, or 4 – not with each other No£ 2.5mm 4. Associate Broker Member Yes NoYesFreelyYes£ 5mm 5. Associate Trade Member No Only 1, 2, or 4No£ 50,000
7 LME Volumes and facts The LME, the worlds largest non ferrous exchange it is more than 130 years old. In 1992 Lead volume was 1 million lots, 2 million in 1994, 6.1 mil in 2008 Annual total volume was 93 million lots in 2007, in 2008 it was 113 mil lots Daily value of trade is between $8,000 and $10,000 million.
8 Roles of the Exchange Price DISCOVERY and provide Daily “official price” – (LME is an International Reference Price) Price Risk HEDGING MECHANISM, by providing a futures and options market that allows prices to be locked in. Delivery / Supply of LAST RESORT, by authorizing a warehouse system.
9 The London Metal Exchange - Trading The LME is the world’s premier non-ferrous metals market, with highly liquid contracts The main users of the LME are: – Producers – Consumers – Merchants/Traders – LME market makers (Category 1 and 2 – see next slide) – Funds CTA’s, Discretionary Funds ($10 billion) – Other speculators LME contracts are traded in US$, but are cleared in US$, Sterling, Euro & Yen
10 LME Trading Days Today-you cant trade 2 Days forward-The cash date, earliest trade day Week days-trade every one for 3 months Wednesday-Trade each Wed for 3-6 mths 3rd Weds.-6 mths to 27 mths (Pb)..longer for Cu Trading through: Open outcry in ring trading sessions and kerb LME 24 hour inter office telephone market. Electronic trading via LME Select 1am to 7pm London time
11 The LME periods in each day Periods of Liquidity (LME/OTC): – Pre-Market: 8.00 – 11.50 (all London times) – AM Rings/Kerb: 11.45 – 13.05 – Lunchtime Kerb: 13.15 – 14.45 – PM Rings/Kerb: 14.55 – 17.00 – Lates: 17.00 – 18.00 (COMEX close) – Late NY: 18.00 – 22.00 – Overnight/Far East Market: 22.00 – to Pre-Market “Open” Special times each day. – Official Price each day at close of 2 nd AM ring – Evening evaluation at 5.00pm
12 Large industrial companies have become more pro-active in managing these exposures “Ford has a commodity hedging program that uses primarily forward contracts and options to manage the effects of changes in commodity prices on the automotive sector’s results…such contracts are executed to offset our exposure to the potential change in prices mainly for various non-ferrous metals (e.g. aluminum).” (Ford Motor Company, 10-K) “The company operates internationally, with manufacturing and sales facilities in various locations around the world and utilizes primarily forward and option contracts to manage its…commodity exposures.” (10-Q) “The corporation is exposed to volatility in the prices of raw materials used in some of its products and uses forward contracts…to manage some of these exposures.” (United Technologies Corp., 10-K) “Anheuser-Busch is exposed to…commodity price risks. The company utilizes derivative financial instruments, including futures contracts, swaps and options to manage certain of these exposures.” (Anheuser Busch Cos. Inc., 10-K) “We are subject to market risk associated with changes in…certain commodity prices. In order to manage the volatility relating to our more significant market risks, we enter into forward contracts and…commodity swaps.” (Tyco International Ltd., 10-K) “Alcoa might be required to purchase aluminum to supplement its internal production. These purchases expose the company to the risk of higher aluminum prices. To hedge this risk, Alcoa enters into long positions, principally using futures and options. Alcoa also purchases certain other commodities, such as fuel oil, electricity and copper, for its operations and enters into futures and options contracts to eliminate volatility in the prices of such products.” (Alcoa Inc., 10-K)
13 Exposures are front page headlines China Aviation Incurs $550 million in losses in derivatives trading Sojitz Holdings Corporation said it lost $172.8 million from commodities trading
14 The Lead Forward Market Today’s cash price2117+8a contango 3month price2125-28a back 15 month price2097-37a back 27 month price2060
15 LME Price Differentials Contango – If the price for delivery on an earlier date is lower than the price for a later date Backwardation – If the price for delivery on an earlier date is greater than that for a more forward date Spread – The price difference between two prompt dates is called the spread which may be in contango or backwardation
17 Battery Makers Non hedged position A Simple Transaction without LME Hedge Cost Revenue Buy Physical Lead @3500 /mt3500 Conversion 200 8weeeks later Sell BatteriesPb2700 +Conversion cost200 Total37002900 LOSS800/mt
18 What Is Hedging? A transaction intended to protect or reduce risk from subsequent adverse price movements of a physical position already bought or sold
19 Battery Makers HEDGED position A Simple Transaction (from above) now with LME Hedge Cost Revenue Buy Physical Lead @3500 /mt3500 Sell LME 2 mths Forward3500 Conversion 200 8weeeks later Sell BatteriesPb2700 Buy LME at time of battery sale2700 +Conversion cost200 Total64006400 LOSSzero/mt
20 What are options….(put simply) CALLS … set a ceiling, The right to buy at the strike price but not the obligation PUTS …set a floor, The right to sell at the strike price but not the obligation
21 Battery Makers HEDGED position A Simple Transaction (from above) now with LME Hedge Cost Revenue Buy Physical Lead @3500 /mt3500 BUY A PUT 100 Prem3500 Conversion 200 8weeeks later Sell BatteriesPb2700 Buy LME at time of battery sale2700 +Conversion cost200 Total64006400 LOSS100 The PUT has the same effect as selling at 3500 but should the LME rise you sell the battery at the higher Pb price and keep the profit (net of the cost of the PUT)
22 Basis 3m close on PB at 2075 here’s some ideas on FEB10 strikes. …Feb is also 2075. Calls: STRIKE/Premium 2100: 260/280 2200: 220 2300: 190 2500: 140 2600: 115 Puts STRIKE/Premium : 2000: 220 1900: 190 1800: 140 1750: 140 1700: 110
23 Effective risk management – A word of warning Hedging frightens some companies. The anecdotes do have great deal of truth in them. History has its disasters and all could have been avoided had careful consideration been given to the trading structure and policy. Specifically: – The policy to be employed using it – The choice of instrument – The directives covering authority and accountability, and – Adequate controls to ensure these considerations were adhered to – this includes reports to the hedge committee on all trades compared to the trading authorization and policy
24 Summary and Conclusions Base Metals are experiencing more volatility than ever before The London Metal Exchange is an important part of Base Metals Pricing Don’t be afraid to identify your price risks and hedge them Hedging goals might include – Protecting margins, covering cash costs, and preserving upside potential Choose relevant strategy Coordinate physicals and futures positions Talk to your friendly Broker about your risks. Monitor and review performance – You must report all gains and losses
25 Mitsui Bussan Commodities Contacts New York – Mo Ahmadzadeh & Abe Ulusal – +1 212 878 4192 London – Micki Waite – +44 207 489 6700 Sydney – Rick Holmes – +61 2 9256 9599