risk management in the pulp and paper context
TRANSCRIPT
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Risk Management in the Pulp and Paper ContextRISI European Conference
March 7, 2017Gary Helik
Risk Management ConsultantINTL FCStone Financial Inc.
FCM Division
The trading of derivatives such as futures, options, and over‐the‐counter (“OTC”) products or “swaps” may not be suitable for all investors. Derivatives trading involves substantial risk of loss, and you should fully understand those risks prior to trading. Past financial results are not necessarily indicative of future performance. All references to futures and options on futures trading are made solely on behalf of the FCM Division of INTL FCStone Financial Inc. (“INTL FCStone Financial”), a member of the National Futures Association (“NFA”) and registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a futures commission merchant. All references to and discussion of OTC products or swaps are made solely on behalf of INTL FCStone Markets, LLC (“IFM”), a member of the NFA and provisionally registered with the CFTC as a swap dealer. IFM’s productsare designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and whohave been accepted as customers of IFM.
This material should be construed as the solicitation of trading strategies and/or services provided by INTL FCStone Financial, or IFM, as noted in this presentation.
Neither INTL FCStone Financial nor IFM is responsible for any redistribution of this material by third parties or any tradingdecisions taken by persons not intended to view this material. Information contained herein was obtained from sources believed to be reliable, but is not guaranteed. These materials represent the opinions and viewpoints of the author, and do notnecessarily reflect the opinions or viewpoints INTL FCStone Financial or IFM.
All forecasting statements made within this material represent the opinions of the author unless otherwise noted. Factual information believed to reliable, was used to formulate these statements of opinion; but we cannot guarantee the accuracy andcompleteness of the information being relied upon. Accordingly, these statements do not necessarily reflect the viewpoints employed by INTL FCStone Financial or IFM. All forecasts of market conditions are inherently subjective and speculative, and actual results and subsequent forecasts may vary significantly from these forecasts. No assurance or guarantee is made that these forecasts will be achieved. Any examples given are provided for illustrative purposes only, and no representation is being made that any person will or is likely to achieve profits or losses similar to those examples.
Reproduction or use in any format without authorization is forbidden. © Copyright 2017. All rights reserved. 2
Disclaimer
INTL FCStone Global Commodity Profile
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Number of Offices## Number of Exchanges
Provides hedging solutions in nearly every major commodity producing country
Significant presence in key emerging markets
U.S. and U.K platforms provide broad suite of financial services
Global payments provider in over 130 countries
Access to 36 global exchanges
Global Exchange Membership
Serving more than 11,000 Clients Globally with 1,200 Professionals Located in 12 Countries on 6 ContinentsServing more than 11,000 Clients Globally with 1,200 Professionals Located in 12 Countries on 6 Continents
NORTH AMERICAUS
SOUTH AMERICABrazilArgentinaParaguayColombia
EUROPEEngland Ireland ASIA
ChinaSingaporeSouth Korea
AUSTRALIA / NZ
1912
112
211
58
12
AFRICA 1
EMEAUAE
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Role of Futures Exchanges
Futures exchanges provide two vital economic functions:‐ PRICE DISCOVERY‐ PRICE RISK TRANSFER
Futures exchanges help manage price risk shifting from HEDGERS on the production side to HEDGERS on the consuming side
SPECULATORS assist by providing constant buying / selling activity
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Futures Exchanges Are Regulated Markets
Government Oversight: FSA (Norway), FCA (UK), CFTC (USA)
Industry Oversight: NFA (USA)
Contract performance guaranteed by clearing house
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Price Discovery RevealedCrude Oil – Forward Month Contracts
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RESULT : BUYERS know how much they will have to pay; SELLERS know how much they will be paid;INVESTORS and ANALYSTS can estimate futures earnings.
Futures Exchanges Price Physical Commodities
– Futures price commercial business:“I will sell you my oil at the average daily exchange price plus a $2 basis premium for quality and delivery”
– Transparent transactions on exchange determine market price– Producer and customer only negotiate basis to market;
market price debates eliminated…a constructive relationship!
– Futures prices move reflecting changing expectations– Volatility is managed by hedging on exchange
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EXCHANGEBids & Offers
PHYSICAL TRADEBasis reference exchange price
Pulp and Paper Pricing is ‘Unusual’
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Leading producers announce ‘list’ price increase for upcoming month• $20/$30/$50/ton• Secret negotiations follow between buyers & sellers• Indices estimate ‘market’ price• Transaction price is substantially discounted • Month to month pricing only
– What is the result?• NO market price transparency• NO market price beyond 1 month• Questionable investment and operating decisions
BUYERS DON’T know how much they will have to pay; SELLERS DON’T know how much they will be paid;INVESTORS and ANALYSTS STRUGGLE to estimate futures earnings.
P&P Industry Results Are Among Worst
10Source: Suzano Pulp and Paper, Walter Schalka, CEO, London Pulp Week 2016
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Without Futures Market Prices to Induce Discipline Investment Decisions Rely on Forecasts: Excess Supply, Low Prices
The history of the pulp industry has beento add capacity in an undisciplined manner, often in excess of demand, thereby depressing price. In the absence of a liquid futures market, forecasts have played a major role in these decisions. Futures adjust to new supply through lower bids, thereby discouraging even more new supply. Forecasts are static and tend to reused giving the illusion of a satisfactory return to other investors considering the same new capacity.
What is Pulp Volatility in Local Currency/Ton?*
13*Low & high range of PIX volatility from 2010 to 2016 against 2016 closing price at 95% confidence level
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$1.65 billion - 6 %market cap loss over 4
days;6X earnings
miss
• Failing to pass through monthly cost increases onto finished goods prices in a timely fashion has serious consequences when margins are crippled and shareholder expectations are not met.
• If consumers have no market to manage forward exposure they will resist monthly increases, especially sequential increases. This strains seller / buyer relationships!
• Futures markets ease the process of passing through higher costs to the ultimate consumer.
How Do Consumers Fare in Current Pricing System?
What Do Investors Want?
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It depends…
– Some want consistent earnings and growth• Expectation is that management will do everything in its power to deliver consistently
– Product, customer mix, organic and strategic growth– And…manage risk to floating market exposures– This firm is an ‘investment’
– Some want exposure to cyclicality• Buy equity low, sell high
– This firm is a ‘trade’
The Need to Manage Price Risk Varies by Pulp & Paper Sector
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LOWER
LOWER
HIGHER
HIGHERSector Consolidation
Price VolatilityExposure
Pulp
Printing & Writing
US Corrugated
US Tissue
SpecialtyPaper
Hedging is NOT about speculating and beating the market:
Hedging is about profit stability
Pricing stability
Promotional planning
Business efficiency
Cash flow consistency
Budget consistency
Effective strategic decision making
Customer loyalty
Futures Hedging is Misconceived in the Pulp and Paper Industry
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Hedging Should Allow You To:
Anticipate profit margins
Improve fiscal development
Develop a comprehensive business plan
CREATE CERTAINTY
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What is the Holdback on Participationin Futures Markets for Pulp & Paper?
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• Industry culture of secrecy surrounding transactions
• Misconception that hedging is speculating
• A lack of expertise across the organization concerning hedging and tools
• Focus on consolidation or capital investment
• Lack of mandate from BOD
• ‘We are conservative’ = reluctance to change behavior
• Market volatility creates uncertainty: • Supply/demand + currency + China
• Financial hedging creates certainty mitigates risk, allows for better planning, deliverable results …predictable shareholder value
Final Thoughts
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What Does Your Firm Want to Be?
…An Investment or a Trade?