PSI 44th Annual Fall Conference Miami Beach, Nov 8-11, 2005 Recovered Paper Indexes: Hedging Applications

1. PSI 44th Annual Fall ConferenceMiami Beach, Nov 8-11, 2005  Recovered Paper Indexes:Hedging Applications  Antoine Eustache, Ph.D.

2. 2 Goals for Presentation What is Hedging? Identifying and Evaluating if Hedging Works for You Hedging with the Dow Jones Indexes

3. 3 Precursors Does everyone share the same opinion on what OCC prices should be. Probably not. Well, some must agree to what direction OCC prices shall take in the near future? Couple this with expectations on what sellers are willing to sell at and what buyers are willing to buy at. Clearly, there is a mismatch. Hedging allows you to lock your competitive advantage or to take a position on your view.

4. 4 What is Hedging? Hedging is the ability to manage the exposure to price fluctuation. Level 1 - Lock in a margin or cap costs - don’t look back Level 2 - Take a market view, take a position, actively manage that position Mechanically this involves offsetting an existing position/commitment, by taking an opposing/different position. This could be taking a financial position to protect a physical position: Exchange-based Futures Over-the-Counter (OTC) Contracts - SWAPS, Options, and collars, etc.

5. 5 Hedging does not.... …remove market volatility. Hedging gives users a “tool” to manage market volatility with more options than typical contract or spot pricing. …provide “Regret-Free” Decisions Results of hedge programs are always clear with 20-20 hindsight. Users need to evaluate the change in the physical as well as the financial product. Evaluate if the hedge met the objectives at the time of the original decision. ...cost more than not hedging Hedging enables price certainty that allows users to focus on value added activities. Price of forward market determined by sum of all forward buyers & sellers

6. 6 What Benefits Can be Achieved from Hedging? Protect sales price on physical inventory, if the market price should decrease. Secure a set purchase price, if market price increases. Allows participants to take advantage of market movements Allows participants to focus on value-added (quality, service) components of the transaction. Ability to manage forward price risk. Lower the cost of capital.

7. 7 Identifying and Evaluating if Hedging Works for You

8. 8 Is Hedging for you? Education: Do you have price risk? Understand the mechanics, risks, and possible outcomes - How is a Swap different from a forward contract, etc?? Do other parts of your organization utilize hedging contracts (forex, energy, etc). Evaluate the relationship between an index and the product that you buy or sell. Develop a point of view. Can you act on that view? Management Approval: Ensure Management understands the risk and requirements. Procedures and oversight must be in place to monitor positions. Designate person (s) that can execute trades.

9. 9 Hedge Process Transaction: Know your business objectives Formulate a strategy that will help you eliminate the threats that could keep you from meeting your objectives Determine your ‘price level’, term and quantity of exposure to hedge. For OTC, identify counterparties, put agreements and credit provisions in place prior to transaction negotiations. Negotiate and agree to a price, quantity & term with counterparty. Monitor position over term of contract. Determine on timely basis settlement of position.

10. 10 Reliable Market Price Index – Crucial to a Successful Hedging Program Two broad categories of Indexes Informational Indexes Typically compiled based on informal market/industry surveys No paper trails Typically found in trade publications Good for analysis Sometimes used for trading for lack of more suitable alternatives Easily Manipulated (i.e. gas price indexes during ENRON scandal) Transactional Indexes Normally compiled by specialized publishers such as Dow Jones Specifically designed to reflect types of products characteristics Transparent methodology Underlying data can be verified trough audit mechanism Typically generates confidence and tends to drive liquidity

11. 11 Typical applications of a transactional index: Transactional indexes such as the ones published by Dow Jones are typically used to manage price risk or to settle exchange traded products or over-the-counter transactions. Typical Exchange Traded Settlements Dow Jones Electricity Indexes: Currently used as underlying for four electricity futures contracts Physical transactions Spot Transactions Fixed Price Transactions Forward Contracts Financial transactions Forward contracts Financial swaps Financial Options Reliable Market Price Index – Crucial to a Successful Hedging Program

12. 12 Assumptions Prices of recovered paper follow a log normal distribution OCC producers cannot lose more than the value of their product OCC Price will never fall below zero End-users and marketers are exposed to unlimited losses There is no limit to how far prices may rise in the event of supply/demand imbalance Neither buyers nor sellers of OCC want price instability Suppliers and end-users of recovered paper have or plan to have a risk management strategy/policy in place to protect themselves against price instability

13. 13 Forward Contracts based on the DJ Index

14. 14 Hedging with Swaps Using the DJ Index

15. 15 Hedging with Swaps Using the DJ Index

16. 16 Hedging with Options using the DJ Index

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