Indian Commodity Exchange Limited

Presentation : Iron Ore Derivatives

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What are Derivatives
Derivative is a financial instrument (or, more simply, an agreement between two parties) that has a value, based on the expected future price movements of the asset to which it is linked—called the underlying asset — as a share or a currency or a commodity Most common derivatives are swaps, futures, and options Derivatives are usually broadly categorized by: 1. the type of underlying asset (e.g., equity derivatives, foreign exchange derivatives, interest rate derivatives, commodity derivatives or credit derivatives); 2. the relationship between the underlying asset and the derivative (e.g., forward, option, swap); 3. the market in which they trade (e.g., exchange-traded or over-thecounter); 4. their pay-off profile.
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Why Commodity Derivatives…
1. 2. 3. 4. 5. 6. 7. Dynamic Price Discovery Transparency – Information Dissemination Hedging Tool Even smaller players reap same advantage as big ones Takes care of counter party default Easy to sell / buy in liquid market Leverage

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Iron Ore Derivatives

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Iron Ore Derivatives
Anticipating the Needs of a Changing Market…
• The iron ore and related ferrous market is the second largest commodity market by volume after crude oil. • The mining and transport of this raw material is capital intensive, which leads to supply constraints not readily filled by other materials. • These factors thus expose the steel mills not only to supply constraints, but also to transport uncertainties, which can lead to volatile price fluctuations. • • Demand is expected to rise with the continual growth of emerging markets. China produces nearly one-half of the world’s finished steel, making it the premier destination for seaborne iron ore shipments.

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What Impacts Iron Ore Prices?
Steel-making Demand for Iron Ore

Quality and Grade Specifications

Available Supply

Seaborne Freight
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World Steel Scenario
Global Crude Steel Production (Mt)
Country China Japan USA Russia India Rest of World Global 2009 574.00 87.50 58.20 60.00 58.44 390.86 1,229.00 2010 627.00 109.60 80.60 67.00 64.88 463.92 1,413.00 Growth (%) 9.23 25.26 38.49 11.67 11.02 18.69 14.97

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World Iron Ore Scenario
• The three largest iron ore companies Vale (Brazil), Rio Tinto (UK), BHP Billiton (Australia), together control 35% of total iron ore production and 61% of total seaborne Iron ore trade. Output increased mainly in four major producing countriesBrazil, Australia, China & India. China’s Iron Ore import was 628 million tons – 70% of seaborne trade.

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World Iron Ore Scenario….contd
It is anticipated that around 685-million tons of new production capacity may come on stream between 2010 and 2012. It is predicted that the world iron-ore market would be characterized by tight conditions over the short term, but that supply would gradually catch up with demand and that prices would decline from current levels, although they would stay higher than in the period before 2008.

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Global: Production, Consumption & Trade
1800 1600 1400 1200 1000 800 600 400
2004 2005 2006 2007 2008

Production

Consumptipn

Export

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Iron Ore : World Scenario

Top 5 Iron Ore Producing Countries 1. China 2. Brazil 3. Australia 4. India 5. South Africa Top 5 Iron Ore Consuming Countries 1. China 2. Japan 3. India 4. Russia 5. USA Top 5 Iron Ore Exporting Countries 1. Australia 2. Brazil 3. India 4. South Africa 5. Canada Top 5 Iron Ore Importing Countries 1. China 2. Japan 3. South Korea 4. Germany 5. Taiwan
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Iron Ore : Indian Scenario

Reserves: 25 Billion Tons (6% of Global), ranked 5th - High quality reserves 4th largest producing country–218 Mt (FY 2009-10) 3rd Largest exporting country–117 Mt (FY 2009-10)

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Major & Intermediate ports for Iron Ore Exports

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Iron Ore : Indian Scenario
250

200 Mn tonnes

150

100

50

0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10
Export
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Production

Consumptipn

Direction Of Trade

Country China Japan S. Korea Europe Others Total

2007-08 91.98 7.70 1.76 1.62 1.20 104.27

2008-09 97.85 5.43 0.99 0.75 0.85 105.87

2009-10 109.30 5.87 1.32 0.72 0.17 117.37

2010-11
(Apr-Jan)

71.50 2.51 0.43 0.51 0.16 75.11

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Volatility & Changing Pricing Landscape

• • • •

Stable and longer price cycles are history. After decades, annual benchmark pricing is dismantled. Quarterly; Monthly; Spot; Index- A new era has started. Prices have moved from US$ 17 to US$ 170 in 7 years: Higher returns = Greater risks Price risk management no longer optional.

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US$/DMT 200 180 140 150 120 130 170 190 160 100 110 1-Apr-10 5-May-10 4-Jun-10 5-Jul-10 3-Aug-10 Weekly 2-Sep-10 1-Oct-10 1-Nov-10 30-Nov-10 Yearly 31-Dec-10 1-Feb-11 2-Mar-11 31-Mar-11
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Volatility & Changing Pricing Landscape..

TSI 62%Fe Monthly

…. Iron Ore is moving in the direction of setting prices as Copper, Nickel or other base metals are on a completely transparent Exchange under the full control against any type of manipulations ….
Source: Iron Ore Market 2009-2011 (UNCTAD)
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200

150

125

100 175 01-Apr-10 21-Apr-10 11-May-10 31-May-10 20-Jun-10 10-Jul-10 30-Jul-10 19-Aug-10 08-Sep-10 28-Sep-10 18-Oct-10 07-Nov-10 27-Nov-10 17-Dec-10 06-Jan-11 26-Jan-11 15-Feb-11 07-Mar-11 27-Mar-11 4.00 2.00 0.00 6.00 -2.00 -4.00 -6.00 Movement (%) Price (US$/dmt)

Daily Price Volatility (IO-TSI62%Fe)

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Example - Hedging
It is January 2011 and the price for iron ore CFR China 62% Fe fines currently stands at $ 174.60/dmt. Buyer (Steel mill) A steel mill in China expects to import iron ore 62% Fe fines of a Cape size shipload of 75,000 metric tons (mt) in March 2011 and wishes to fix this cost as they have just clinched a major deal to supply flat steel products in 2011. To hedge this position, this steel mill will bid at $169.00/dmt for March 2011 Iron Ore Swap on CFR China 62% Fe Fines. Seller (Iron ore trader) At the same time, an iron ore trader with an inventory of iron ore wishes to hedge against a possible decline in stock value from drop in iron ore rates. The trader would like to lock-in the iron ore price of $169.00/dmt.
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Example - Hedging
Buyer: Seller: Product: Quantity: Contract Price: Settlement Date: Settlement Basis: Steel mill Iron ore trader Iron Ore CFR China 62% Fe Fines 75,000mt (750 lots) $169.00/dmt 31st March 2011 Average of the spot price assessments of the contract month

Due to natural calamity in Japan, the price of iron ore CFR China 62% Fe fines falls from $174.60/dmt to $169.36/dmt in March 2011. As a result, the steel mill doesn’t suffer an increase in input cost.

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Hedge Result

Buyer Steel Miller Physical Ease in cost = $2,62,000 [(174.6-169.36)*500*100] Futures Payoffs = $ 18,000 [(169.36-169.00)*500*100] Net P/L = $ 2,80,000 [262000+18000]

Seller – Iron Ore Trader Physical Rise in Value = $2,25,000 [(109-106)*500*100] Futures Payoffs = -$2,62,000 [(105.5-109)*500*100] Net P/L = -$ 37,500 [225000-262000]
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Benefits of Hedging
Hedging is the process of offsetting risk (by locking effective price), owing to adverse price movements, by taking opposite position in the derivatives market against the position in the spot market. Any gain or loss in the spot market offset (partially if not fully)with the loss or gain respectively in the derivatives market. For a stable and manageable balance sheet of a company, hedging in indispensible.

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Us$/DMT 175.00 200.00 150.00 125.00 100.00 01-Apr-10 26-Apr-10 21-May-10 15-Jun-10 10-Jul-10 04-Aug-10 TSI 29-Aug-10 23-Sep-10 18-Oct-10 SHFE 12-Nov-10 07-Dec-10 01-Jan-11 26-Jan-11 20-Feb-11 17-Mar-11 4000 3500 5500 4500 5000 SGX

Iron ore impacting steel margin

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Yuan/Tonne

Iron ore impacting steel margin

• • • •

Volatile Iron Ore prices are impacting steel mills ability to secure stable prices –eventually it will off load on the consumer (you and I) Steel buyers can access the iron Ore swaps market to hedge (with basis risk) a portion of their price risk … this is similar to airlines hedging jet fuel exposure using crude oil contracts … or steel contracts which meets the needs of buyers in different parts of the world There are several steel contracts available at Exchanges (LME, DGCX etc). Volumes are increasing.

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Iron ore and steel 3-4 years from now

Iron Ore Miners

Spot Iron Ore

Steel Mills

Spot Steel

Steel Users

Locked in Price (Margin)

Locked in Margin

Locked in Price (Margin)

Iron Ore Swaps and others
Buyers and sellers of Iron Ore use Iron Ore swaps and FFAs (Freight swaps) to lock in forward prices, effectively hedging against adverse movements in the price of Iron Ore and ocean freight. This achieves predictable pricing and allows P+L planning in a spot trading environment.

Iron ore & Steel Swaps and Futures
Buyers and sellers of Steel products use Iron Ore swaps and different steel swaps and steel futures contracts to lock in the forward price of Steel, which will fluctuate according to the cost of delivered Iron Ore (Ore/Freight combination) supply/demand pressure of steel and the marginal operating environment of steel mills.
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INDIAN st Exchange to World’s 1 launch an Iron Ore Future Contract…

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About ICEX

Recognition granted by Govt. of India on 9th October 2009

Operations Commenced on 27th November 2009

Currently Trading in 11 Commodities

Over 450 memberships with more than 1000 TWS spread across India
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Key Stakeholders

26% 10% 5%

14% Others 5% 14%

26%

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Key Stakeholders
Reliance Exchange Next Ltd - A wholly owned subsidiary of Reliance Capital, represents Reliance entry into Exchange vertical. R Next aims to be present across asset classes in the Exchange space MMTC Ltd - Leading exporter of Minerals, largest buyer of Fertilizers, biggest importer of Bullion & Non- Ferrous Metals in India and active player in agro-products Indiabulls - Top ranked business houses in India with business interests in Real Estate, Infrastructure, Financial Services, Retail, Multiplex and Power KRIBHCO - World’s premier fertilizer producing Cooperative Society IDFC - Specialized financial intermediary for infrastructure development IPL - Biggest canalizing agency for import of Urea and other fertilizers on behalf of GOI
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Indian Commodity Exchange Iron Ore Future Contracts
Iron Ore – Contract Specifications
Contract Symbol Underlying Commodity Trading Unit Quotation Price Quote Tick Size Trading Hours (IST) Monday to Friday Saturday IRONORE62FDDMMMYY IRONORE62FINES 100 MT Rs. per DMT (Dry Metric Ton) CFR- -Tianjin port (China) Inclusive of all duties, taxes and other levies as applicable in India. Rs. 0.50 per 1 DMT 10.00 a.m. to 7.30 p.m. 10.00 a.m. to 2.00 p.m. Monthly contracts, Expiring on the last day of the month
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Contract Month

Indian Commodity Exchange Iron Ore Future Contracts
Iron Ore – Contract Specifications
Delivery Logic Delivery Size Initial Margin Main Delivery Centres Both Options 5000 MT 8% Ennore Port / Vizag / Haldia / Paradip Due Date Rate (DDR) shall be calculated by taking simple average of International Spot Price of TSI for contract expiring month and converted at the Rupee – US Dollar reference rate as notified by RBI on the contract expiry date. Note: In case, the RBI reference rate is not available on the contract expiry day then the reference rate of RBI on previous day shall be taken in to consideration.

Due Date Rate

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Our Associations – Our Strengths

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Factors Effecting Prices
• • • • • • • Grade of Iron Ore Export Demand for Iron Ore Steel industry growth Sea Freight rates Govt. Regulations (EXIM and Mining) Big Players (Big – Trio) Decision in Pricing Mechanism Growth of BRICI

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Benefits of Future Trading in Iron Ore
• • • • • • • Measure of hedging the price volatility of Iron ore as prices are very volatile Price stabilization-in times of violent price fluctuation Easy to own/sell iron-ore Standardized contracts guarantee the quality and quantity of iron. The exchange guarantees performance of the contract irrespective of buyer and/or seller The Exchange has set up a SGF-Settlement guaranteed Daily MTM Settlement

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Thank You

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