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Finance in the Global Iron Ore Industry

November 2013

Phillip Killicoat +44 207 888 0893

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Finance in the Global Iron Ore Industry

Financing for iron ore producers

Then and now

Capital

markets

Mitigating

risks

Hedging in mine financing

Iron ore market developments

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Trade-offs in raising capital for mining projects

Equity

Cost of capital

Mezz

Bank loan

Bonds

Flexibility

What

motivates

each type

of mining

investor?

4

Equity investors and mining

Then

Growth focus

Bubble charts

Blue sky optionality

„Leverage to the cycle‟

Now

„Cash is king‟, capex discipline

Investor demands for yield

Pressure for project curtailments, concerns of excess

supply

Credit ratings matter

5

Fixed income investors and mining

Then

Small equity buffers

Demand for higher yielding instruments

High prices masked production/construction

underperformance

Active bank loan market

Now

50% equity buffers

Basel III reg cap restrictions

Volatile prices expose

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Mining is a risky business

Source: AP

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The rise of China has increased real price levels and volatility

Historic iron ore prices (Real terms 2010 USD)

Source: IMF, Credit Suisse

0

20

40

60

80

100

120

140

160

180

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Why hedge?

A modest hedge protects profit margins for the volume hedged

Improves loan-carrying capacity by withstanding market shocks

Provides a cash flow buffer to achieve target run rate

production plans in all market conditions

Protecting [25]% of 2 year cash flows meaningfully reduces equity

dilution risk if prices were to fall again

If prices never fall, equity investors still have full upside exposure

on [75]% of production over the hedged period

If prices fall at any point you have the option to unwind the swaps

and monetise the hedge mark-to-market as cash

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Iron ore hedging process

Set up Execution Settlement Scenarios

Security

ISDA

Unmargined

Select strategy

Volume

Price

Tenor

Low case

Mid case

High case

Monthly

Cash settled

Hedge settlement – separate physical and financial flows

* Swap level determined at time of execution

Settlement Diagram

If realised price <$125*

CS pays Miner $125

minus realised price

Financial

swap

Off-taker pays

market price

(net of freight,

quality and

agency

adjustments)

Physical

IO

delivered

to off-taker

Physical

If realised price >$125

Miner pays CS the

realised price minus $125

Miner

Customer

10

or

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Payoff scenarios – the hedge pays the miner needs it most

0

50

100

150

200

250

Physical Financial Net

High realised price = $150/t

Operating profit

US$mm

0

50

100

150

200

250

Physical Financial Net

Low realised price = $90/t

Operating profit

US$mm

0

50

100

150

200

250

Physical Financial Net

Par realised price = $125/t

Operating profit

US$mm

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Iron ore swaps and options volume averaged >360Mt since April

Source: SGX; LCH; CME, SMX, Credit Suisse

Iron ore swaps volume (Mt annualised)

Annualised Mt

0

50

100

150

200

250

300

350

400

450

abr/09 out/09 abr/10 out/10 abr/11 out/11 abr/12 out/12 abr/13 out/13

OTC SGX LCH CME SMX

Oct 2013:

* 30 Mt

* 1.4 Mt/day

* 361 Mtpa

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Iron ore swaps and options volume averaged >360Mt since April

Source: SGX; LCH; CME, SMX, Credit Suisse

Iron ore swaps volume (Mt annualised)

Annualised Mt

Oct 2013:

* 30 Mt

* 1.4 Mt/day

* 361 Mtpa

0

200

400

600

800

1000

1200

abr/09 out/09 abr/10 out/10 abr/11 out/11 abr/12 out/12 abr/13 out/13

OTC SGX LCH CME SMX Dalian

Adding Dalian

* 67Mt

* 6.7 Mt/day

* 808Mtpa

Sources of liquidity across the ferrous market

Share of swaps activity by industry segment (% total volume)

Merchants,

30%

Miners,

30%

Mills, 5%

Investors,

25%

Consumer,

10%

More frequent price adjustment is passed down the value chain

Raw materials

Steel mills

Steel consumers

Iron ore

Coking coal

Alloys

Now indexed Monthly or Quarterly

From: Arbitrary adjustments in steel list price

To: raw material formula steel sales contracts

Autos / machinery

Appliances

Construction

Steel pricing basis:

Fixed conversion margin with floating IO+CC formula

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Disclaimer

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