risk management techniques beyond price risk management

United for a Better Trade Syed Abdul AzeezSenior Vice PresidentNatural Fibers Team

Risk Management TechniquesBeyond Price Risk Management

Olam operates across the value chain and is a market leader in many of its businessesCo

ffee,

pal

m

Origination/trading Logistics

Midstream

Primary processing

Downstream

Secondary processing

Distribution/retail

Upstream

Farming/plantation

Rice

, rub

ber,

cott

on,

dairy

, alm

onds

Suga

r &

grai

ns

Creating value is our business


Price Volatility: Is It Only about Cotton S&D?

Spec and fund activity

Government farm programs

Cross commodity relative values

Import and export policies

Ethanol policy

Chinese reserve stock

Government interventions

Federal reserve actions

Exchange rates

Deflation and inflation

Macro economic environment

Polyester prices / capacity

We all know it goes way beyond cotton and agricultural trading!

Source: World Economic Forum 2013

Impa

ctif

the

risk

wer

e to

occ

ur

Likelihood to occur in next ten years


Water Supply CrisisFailure of Climate Change Adaption

Extreme volatility to Energy and Ag pricesFood Shortage Crisis

Risk, Resilience and Rewards!


Frequent, Extreme Weather Events Play HavocOn Global Agricultural Supply!


Every Populated Continent On Earth Endured Significant Natural Disaster during 2011


Government Intervention To Support Local Industry Distorts Global Markets!World cotton support and subsidies expanding:- $1.4 US billion in ‘10/11- $4.8 US billion dollars in ‘11/12

Crop share receiving direct support- Average 55% from ‘97 to ‘08 - Average 48% from ’09 to ’12

Delivered in multiple ways- Direct crop/input support- Mill support- Crop insurance - Border protection - Minimum support prices- Transportation subsidies- Financing Assistance

Source: ICAC, October 2012

331

320302

277

1502010/11

3,077819

428266

180

2011/12ChinaUSATurkey GreeceOther

Level of Direct Assistance


China’s Strategic Reserve RequirementsDirectly Related To Their Consumption !!

Source: IMF/Working Paper - China’s Impact on World Commodity Markets - Prepared by Shaun K. Roache

China’s share of global consumption accounts for about 20% of nonrenewable energy resources, 23% of major agricultural crops, and 40% of base metals.

World Population Growing and Aging!

012345678

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

Billi

on s

of In

divi

dual

s

China India US Indonesia Brazil Pakistan World Projected Population Growth

Region 2011 2050 Change %

World 6,987 9,587 +2,600 38

High Income 1,242 1,333 + 91 7

Low Income 5,745 8,254 +2,509 44

East & S.E. Asia 2,183 2,308 + 125 6

South Central Asia 1,795 2,574 + 779 43

Sub-Saharan Africa 883 2,069 +1,186 134

Lat. America/Carib 596 746 + 150 25

N. Africa & W. Asia 451 725 + 274 61Source: Population Reference Bureau.

October ‘11 the world surpasses the 7th billionth in habitant1.4 billion individuals live on less than $1.25/day (poverty)

2.6 billion individuals live on less than $2.00/day (most hunger problems)Projected growth in Low Income, and Sub-Saharan Africa and South Central Asia.


Declining Per Capita Arable Land

Source: PotashCorp, DB, FAO

Population growth has outpaced Arable Acres per Capita

60% of arable land concentrated in 8 geographies

0.5x


Burgeoning world food demand will cause high and volatile prices!

World food demand expected to grow 70-80% by 2050- 40% from population growth- 40% from economic expansion in low income countriesPer Capita Meat consumption on the rise- China CAGR at 4.2% over 50 years to reach 52 kgs per capita- US per captia meat consumption is 110 kgsDietary preferences changes with incomes- First, transitions to more meat, dairy products, and fresh fruit and vegetables- Second, to processing, services and packaged products (more luxury forms)Source: World Bank

0.100.150.200.250.300.350.40

1960

1966

1972

1978

1984

1990

1996

2002

2008

Hectares per Person

Declines from .37 in 1960 to

.20 in 2008



Instability in Global MarketsIMF World Economic Outlook; January 2013Gradual Upturn in Global Growth During 2013

Global growth is projected to increase during 2013, as the factorsunderlying soft global activity are expected to subside. However, thisupturn is projected to be more gradual then in October 2012.

Down side risk remain significant, including renewed setbacks in theeuro area and risks of excessive near-term fiscal consolidation in theUnites States.

Global financial conditions improved further in the 4th quarter of 2012;however, a broad set of indicators for global industrial production andtrade suggests that global growth did not strengthen further……..it waspartly due to temporary factors, including increased inventoryaccumulation.

Expansion in emerging and developing economies are affected by theweakness in advanced economies, weighing on external demand, andon the terms of trade of commodity exporters, given the assumptionof lower commodity prices in 2013.

GDP Percent Change

2013 ‘1990 to 2007 avg.

Year return

World 3.5 3.57 2013

Advanced 1.4 2.68

US 2.0 2.92 2014

Euro -0.2 2.08

Emerging 5.5 4.94 2010

China 8.2 10.22

India 5.9 6.27 2014


Increasing demand for “Sustainability” to become a common practice built into all of our business process and decisions

“Development which meets the needs of thepresent without compromising the ability offuture generations to meet their ownneeds.”United Nations

What is Risk?


Webster Dictionary: A chance or possibility of danger, loss, injury or other adverse consequences.

Warren Buffet: “Risk comes from not knowing what you are doing”

From a firm’s perspective: it is any internal or external actionsand events that may adversely affect the possibility of a lossof equity capital.

…There is no business in the world which offers nil risk……No risk entails no returns…

Recent Cotton Risk Events


2011 Floods in Pakistan,

Thailand and Australia

2012Drought

across the US

CurrentChina’s Strategic

Reserve Policy

2008 Financial Crisis

loss of consumer disposable incomes

http://www.google.com/imgres?imgurl=http://kstp.com/kstpImages/repository/2012-10/cash_register_sales.jpeg&imgrefurl=http://kstp.com/article/stories/s2877684.shtml&usg=__oKbGOlGjEKXfDzwlxYGj0E21nIc=&h=341&w=455&sz=107&hl=en&start=42&zoom=1&tbnid=TvgTi0Q-CagR5M:&tbnh=96&tbnw=128&ei=HI5HUbauEMj2iQL03IHoDg&prev=/search?q=retail+us&start=40&hl=en&sa=N&rlz=1T4ADRA_enSG397SG397&tbm=isch&prmd=ivnsu&itbs=1&sa=X&ved=0CCwQrQMwATgo

Cotton Risk - Event Impacts


2008 Financial CrisisFinancing across the supply chainCotton lint prices highly volatileSourcing patterns shortened Blend shifts from cotton to polyesterConsumer disposable income eroding; weak retail demandRetail stocking patterns changeFlight to liquidity in the supply chain (destocking)

2011 Floods in Pakistan, Thailand and AustraliaYield and quality Timing of crop harvest and delivery of cottonShifting of textile capacityLogistics disruptionShift in global trade environmentSignificant price and basis volatility in cotton

http://www.google.com/imgres?imgurl=http://kstp.com/kstpImages/repository/2012-10/cash_register_sales.jpeg&imgrefurl=http://kstp.com/article/stories/s2877684.shtml&usg=__oKbGOlGjEKXfDzwlxYGj0E21nIc=&h=341&w=455&sz=107&hl=en&start=42&zoom=1&tbnid=TvgTi0Q-CagR5M:&tbnh=96&tbnw=128&ei=HI5HUbauEMj2iQL03IHoDg&prev=/search?q=retail+us&start=40&hl=en&sa=N&rlz=1T4ADRA_enSG397SG397&tbm=isch&prmd=ivnsu&itbs=1&sa=X&ved=0CCwQrQMwATgo

Cotton Risk - Event Impacts


2012 Drought across the USCotton fiber price volatility Cotton prices supportive at relatively high level versus polyesterLogistics, contractsYields, quality and timing of crop availabilityLimits cotton for the ICE certification processCreates inversion in the cotton price spreadsCross commodity demand for food products

China’s Strategic Reserve and India Support PricesLimiting consumptionHolding prices above the natural cotton vs polyester blend ratiosMaintain large carryout which distorts perceptions of the marketTiming of reserve and import cotton quota releaseMinimum support price encouraging additional global surplusesLack of transparency of government implementations and policies

China Cotton Stocks

0%

20%

40%

60%

80%

100%

120%

140%

0

2

4

6

8

10

12

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

Stoc

k to

Use

Rat

io

Mil

lion

Met

ric

Ton

s

Residual Reserve Stock to Use


Source: USDA/March WASDE

Even more than price increases, price volatility has been the realkiller of budgets and procurement schedules, inventories and logisticscost; while putting pressure on counterparty relationships.

Cotton Price Trends


?

Price Volatility is Here to Stay


Risk Management Beyond Price …

Source: McKinsey Quarterly Summer 2010

Immediate affects are usuallyobvious, but need to identifyfuture risks that could destabilizeyour environment…

An effective risk plan shouldinclude a combination of bothfinancial (price) hedges andnonfinancial levers to alleviate risk.

Must look beyond direct risk andidentify indirect high risk.

“THE MARKET CANREMAIN IRRATIONAL MUCH

LONGER THAN YOU CANSTAY SOLVENT”

John Maynard Keynes



Un

cert

ain

ty

Complexity

Risk Prioritization MonitoringHigh

LowHighLow

Global Macro Economic Policies

Supply Chain Modifications

Industry Alignment

High-magnitude and low-frequency

Operational Functions


Cascading Risk

Source: McKinsey Quarterly October 2009

“Executives who systematically examine the way risks propagate across the whole value supply chain including competitors, suppliers, distribution channels, and customers, can foresee and prepare for second-order effects more successfully.”

Risk Triggers

CompanySupply Chain

Distribution

Customer

Competition


Risk Categories

Outright Risk:Exposure of the portfolioto adverse changes in theValue of the underlying Commodity price

Basis risk:Exposure of the portfolioto adverse changes in thedifferential value betweencash and future hedge

Cash Flow Risk:Risk of not being able to service margin calls due to sudden changes in futuresprices

Currency Risk:Exposure arising due totransactions in non-functional currency

Credit Risk:Risk of loss due to paymentdefault.Counter-party Risk:

Risk of counterparty notperforming on a contractual obligation

Various Operational & Sovereign Risks


Risk Management …it has to be on-going

EventProbability

ImpactMitigation

ContingencyExposure

The concepts of risk management usually invokes negative impacts; However, it can also include seizing opportunities as they arise.

Risk management should be embedded into the organization!

It does not work as a stand alone process.

It is best to incorporate it into mangers

performance practices.

Mitigation Approaches to Alleviate Risk


Organizational Set Risk Capital limit’s appropriate to firm’s equity capital

Proactively use hedging tools for prices, basis and currencies

Maintain a balanced risk portfolio; limit potential of over leveraging

Clear trading boundaries laid out across the corporation

Fina

ncia

l Hed

ges


Biggest Risk Being PriceAre Our Price Risk Mitigation Tools Working?

Fundamental Basis Moves

United States only Certificated Market

Liquidity only in Front Month

US share of global trade declining

ICE contract - increasing or decreasing Risk?

We all know that ICE can detach itself from the

fundamentals.

There is a general consensus for the need of

a global contract.


World Cotton Contract“Price Discovery & Hedging Tool”

Key Structured Items

Defining cotton in a fashion that spinners/merchants know what they are receiving: Quality, Grades and Contamination free

Integrity during the delivery and tendering process

Destination versus origin

Liquidity in the contract

Assurance in contract



Non

-Fin

anci

al L

ever

s

Focus on core competence, reducing complexity

Counter Party Risk

Forging partnerships

Flexible logistics, warehousing and documentation

Track government regulations and policies

Model cotton supply and demand situation

Build a well balanced supplier & customer portfolio

Implement synergistic approaches for quick dispute resolution

Use precise contract agreements and arbitration rules



Non

-Fin

anci

al L

ever

s

Design industry wide tools ( World Contract, default lists) Identify choke points that affect the industry Network across the industry to identifying potential issuesWork in unison to tackle government policy issues Proactive reviewing up and down stream dynamics Build strong and effective industry associations & strengthen the arbitration body

Balanced Approach is Key


Non

-Fin

anci

alFi

nanc

ial

“There is never a favorable wind for those who do not

know where to go”Socrates

Common Factors That Lead To Risk Events? FACTORS LEADING TO RISK EVENTS• Losses directly caused by the actions of a

single individual• Lack or failure of controls • Lack of understanding of the trades

and/or position by senior management• Unclear reporting lines, inadequate

segregation of duties between Back Office and Front Office, noncompliance with procedures

• Top management overriding internal controls

• Models in ‘Blind Faith’• Intersection of quantitative/qualitative

approach

LESSONS LEARNT• Management should ensure that

incentive systems don’t encourage excessive risk

• Senior managers must understand the complexities of the products traded

• Clear segregation of front office and back office duties with strong supervision & control

• Top Management to encourage a culture of responsible risk taking

• Mathematical models cannot always quantify risk?

• Art-judgment, experience, intuition, common

Creating value is our businessCreating value is our business

Key Lessons Learnt Management should ensure that incentive systems don’t encourage excessive risk

Senior managers must understand the complexities of the products traded

Clear segregation of front office and back office duties with strong supervision & control

Top Management to encourage a culture of responsible risk taking

Mathematical models cannot always quantify risk?

Art- judgment, experience, intuition, common

Creating value is our businessCreating value is our business

“The greatest mistake you can make in life is continually fearing you will make one”

Elbert Hubbard, 1927

Beyond Price Risk Management Syed AzeezSenior Vice PresidentNatural Fibers Team

THANK YOU


I hope you all see this as a sunrise, and as a sign of positive growth for the cotton industry!

DISCLAIMER

This presentation has been prepared and given to you in strictconfidence. No part of the presentation may bedisclosed, distributed or reproduced to any third party withoutthe consent of Olam International Limited. The copyright in thispresentation resides and shall remain in Olam InternationalLimited, and all rights are reserved.

Olam International Limited does not warrant theaccuracy, adequacy or completeness of the information andmaterials and expressly disclaims liability for any loss or damagewhich may be suffered by any person as a consequence of anyinformation in this presentation or any error or omission therefrom.


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