1

Merchant Trade Capital: Unlimited, Costless Capital?

A. How much does it take? Identifying Capital Components

B. What’s the cost? Pricing Trade Capital Components

C. Will market bear the cost?Structural Mitigants (Capital Management)

2

A. How Much (Capital) Does it Take?Identifying Capital Components

• “Lending” (Deploying) Capital – Credit Assets– Sales Payment cycle (net/25)

– PRMAs (MTM Assets): Probabilistic Capital Deployed

• “Borrowing” (Sourcing) Capital– Credit Liabilities– Purchases: (same payment cycle)

– PRMLs (MTM Liabilities): Probabilistic Capital Sourced

– Why/how is this a bad thing?

3

[A/R slide]

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000

$4,500,000

$5,000,000

1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 91 96 101

106

111

116

P50 (Expected)

P95 (Potential)

Days

Credit Asset (A/R Exposure)

4

-$5,000,000

-$4,500,000

-$4,000,000

-$3,500,000

-$3,000,000

-$2,500,000

-$2,000,000

-$1,500,000

-$1,000,000

-$500,000

$0

1 7 13 19 25 31 37 43 49 55 61 67 73 79 85 91 97 103

109

115

P50 (Expected)

P95 (Potential)

Days

Credit Liability (A/P Exposure)

5

[MTM +/- slides]

-$800,000

-$600,000

-$400,000

-$200,000

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37

months

Credit Asset (MTM+ Exposure)

Credit Liability (MTM- Exposure)

6

B. What’s the Cost?Pricing Trade Capital

• ‘Lending’ Commodity / Position (Credit Assets)– Market Price of Credit (Credit Spreads and Default Probability)

– Portfolio Diversification

– Term Structure Sensitivity (credit theta)

– Subordination (contractual and structural)

• ‘Borrowing’ Commodity / Position (Credit Liabilities)– Uncommitted Capital / Incomplete Capital

– BalanceSheet Liquidity Stress/Tax

– Missing Piece: Contingent Capital (Backstop)

– Cost of Contingent Capital?

7

[CS term slide]

0 bps

50 bps

100 bps

150 bps

200 bps

250 bps

300 bps

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

A

BBB

BB

B

Credit Spread Term Structure by Rating Class

0 bps

50 bps

100 bps

150 bps

200 bps

250 bps

A BBB BB B

30-d

365-d

ComPaper vs Near-term Spreads

8

“Fully-loaded” Capital Cost: Example #1 A/Rs & A/Ps

• Example: Purchase at GasDaily; 10,000 MMBtu/d; and

Sale at GasDaily; 10,000 MMBtu/d

– How Much Capital?• Lend Capital (Sale): A/R Credit Risk Assumed

• Borrow Capital (Purchase): A/P BalanceSheet Liquidity Consumption

– Cost of Capital?• Counterparty Default Risk

• BalanceSheet Stress

– Incremental increase in committed capital revolver

9

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58

0 - 31 dys 32 - 60 dys

Days

One-Month Sale (10,000MMBt/d @ index)

($2,500,000)

($2,000,000)

($1,500,000)

($1,000,000)

($500,000)

$0

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58

0 - 31 dys 32 - 60 dys

Days

One-Month Buy (10,000MMBt/d @ index)

10

"Fully-Loaded" Capital Cost-to-Carry: A/Rs & A/Ps

Notional Throughput:10,000 MMBtu/d x $6.45 /MMBtu x 31 days = $2,000,000

Credit Cost of Carry:period cost

1 31 days : x 80 bps x 1/12 th = 667

31 - 60 days : x 80 bps x 1/12 th = 1,333

2,000

$.006 /MMBtu

Liquidity Cost of Carry:period cost

1 31 days : x 40 bps x 1/12 th = 333

31 - 60 days : x 40 bps x 1/12 th = 667

1,000

$.003 /MMBtu

Fully "Loaded" Capital Cost: $.010 /MMBtu

average exposure revolver capacity cost

$1,000,000

$2,000,000

average exposure

$1,000,000

$2,000,000

credit spread

11

“Fully-loaded” Capital Cost: Example #2 PRMAs & PRMLs

• Example: BUY: 1-Year Fixed-Price Swap; 10,000 MMBtu/d

SELL: 1-Year Fixed-Price Swap; 10,000 MMBtu/d

– Capital Identified• Capital Deployed (Sale): Potential MTM Credit Risk Assumed

• Capital Sourced (Purchase): Potential MTM Liability/Liquidity Assumed

– Cost of Capital• Counterparty Default Risk

– Credit Spreads (or Default Probability and Recovery)

– Term Structure: One-Year; delcining volume

• BalanceSheet Stress– Incremental increase in committed capital revolver?

12

PRMA / PRML Capital Probablility Distribution

-6,000,000

-5,000,000

-4,000,000

-3,000,000

-2,000,000

-1,000,000

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14

13

1 2 3 4 5 6 7 8 9 10 11 12P 95 5,270,998 7,117,949 8,180,281 8,733,384 8,889,395 8,708,106 8,226,119 7,467,817 6,450,384 5,186,418 3,685,420 1,954,708

P 90 4,019,165 5,377,352 6,135,226 6,509,512 6,589,193 6,422,208 6,038,275 5,457,489 4,694,263 3,759,386 2,661,194 1,406,288

P 80 2,571,937 3,403,288 3,849,725 4,054,776 4,077,762 3,950,891 3,694,316 3,321,808 2,843,361 2,266,560 1,597,350 840,518

P 75 2,041,114 2,689,730 3,032,820 3,185,663 3,195,983 3,089,742 2,883,220 2,587,567 2,210,900 1,759,395 1,237,908 650,364

P 70 1,573,070 2,065,320 2,322,126 2,433,253 2,435,904 2,350,344 2,189,298 1,961,498 1,673,310 1,329,586 934,152 490,103

P 65 1,146,540 1,500,215 1,682,337 1,758,934 1,757,392 1,692,642 1,574,069 1,408,119 1,199,496 951,793 667,844 349,945

P 60 748,090 975,724 1,091,477 1,138,791 1,135,694 1,092,022 1,013,959 905,755 770,517 610,617 427,927 223,968

P 55 368,321 478,919 534,466 556,519 554,026 531,869 493,121 439,894 373,730 295,810 207,066 108,253

P 50 - - - - - - - - - - - (0)

P 45 (363,015) (469,191) (521,201) (540,601) (536,338) (513,297) (474,549) (422,206) (357,811) (282,544) (197,337) (102,947)

P 40 (726,522) (936,180) (1,037,550) (1,074,074) (1,063,782) (1,016,508) (938,440) (833,827) (705,778) (556,663) (388,358) (202,384)

P 35 (1,096,646) (1,408,726) (1,557,559) (1,609,176) (1,590,966) (1,517,866) (1,399,264) (1,241,610) (1,049,614) (826,871) (576,219) (299,960)

P 30 (1,480,644) (1,895,819) (2,090,918) (2,155,718) (2,127,437) (2,026,355) (1,865,211) (1,652,749) (1,395,351) (1,097,883) (764,184) (397,365)

P 25 (1,888,178) (2,409,205) (2,650,093) (2,726,159) (2,685,165) (2,553,112) (2,346,319) (2,075,974) (1,750,234) (1,375,313) (956,105) (496,576)

P 20 (2,333,752) (2,966,271) (3,253,325) (3,338,533) (3,281,309) (3,113,958) (2,856,725) (2,523,475) (2,124,297) (1,666,868) (1,157,230) (600,264)

P 15 (2,842,385) (3,596,699) (3,931,481) (4,023,127) (3,944,485) (3,735,093) (3,419,688) (3,015,176) (2,533,838) (1,984,999) (1,375,982) (712,694)

P 10 (3,466,319) (4,361,952) (4,748,063) (4,841,879) (4,732,888) (4,469,536) (4,082,045) (3,591,018) (3,011,381) (2,354,431) (1,629,019) (842,260)

P 5 (4,359,199) (5,441,290) (5,887,054) (5,973,244) (5,813,365) (5,468,582) (4,976,880) (4,364,029) (3,648,608) (2,844,615) (1,962,960) (1,012,376)

1 2 3 4 5 6 7 8 9 10 11 12P 95 3,514 4,745 5,454 5,822 5,926 5,805 5,484 4,979 4,300 3,458 2,457 1,303

P 90 2,679 3,585 4,090 4,340 4,393 4,281 4,026 3,638 3,130 2,506 1,774 938

P 80 1,715 2,269 2,566 2,703 2,719 2,634 2,463 2,215 1,896 1,511 1,065 560

P 75 1,361 1,793 2,022 2,124 2,131 2,060 1,922 1,725 1,474 1,173 825 434

P 70 1,049 1,377 1,548 1,622 1,624 1,567 1,460 1,308 1,116 886 623 327

P 65 764 1,000 1,122 1,173 1,172 1,128 1,049 939 800 635 445 233

P 60 499 650 728 759 757 728 676 604 514 407 285 149

P 55 246 319 356 371 369 355 329 293 249 197 138 72

P 50 - - - - - - - - - - - (0)

P 45 121 156 174 180 179 171 158 141 119 94 66 34

P 40 242 312 346 358 355 339 313 278 235 186 129 67

P 35 366 470 519 536 530 506 466 414 350 276 192 100

P 30 494 632 697 719 709 675 622 551 465 366 255 132

P 25 629 803 883 909 895 851 782 692 583 458 319 166

P 20 778 989 1,084 1,113 1,094 1,038 952 841 708 556 386 200

P 15 947 1,199 1,310 1,341 1,315 1,245 1,140 1,005 845 662 459 238

P 10 1,155 1,454 1,583 1,614 1,578 1,490 1,361 1,197 1,004 785 543 281

P 5 1,453 1,814 1,962 1,991 1,938 1,823 1,659 1,455 1,216 948 654 337

Probabilistic Capital (Assets and Liabilities)

Distribution of Cost of Capital

14

"Fully-Loaded" Capital Cost-to-Carry: PRMAs & PRMLsNotional Throughput: 10,000 MMBtu/d x 12 month Swap BUY and SELL

Credit Cost of Carry:period Average Exposure cost

month 1 : $110,870 x 80 bps x 1/12 th = $739month 2 : $147,553 x 80 bps x 1/12 th = 984month 3 : $167,678 x 80 bps x 1/12 th = 1,118month 4 : $177,318 x 80 bps x 1/12 th = 1,182month 5 : $178,971 x 80 bps x 1/12 th = 1,193month 6 : $173,986 x 80 bps x 1/12 th = 1,160month 7 : $163,202 x 80 bps x 1/12 th = 1,088month 8 : $147,187 x 80 bps x 1/12 th = 981month 9 : $126,350 x 80 bps x 1/12 th = 842

month 10 : $100,997 x 80 bps x 1/12 th = 673month 11 : $71,368 x 80 bps x 1/12 th = 476month 12 : $37,651 x 80 bps x 1/12 th = 251

$10,688$.0030 /MMBtu

Liquidity Cost of Carry:period Average Exposure cost

month 1 : $103,093 x 40 bps x 1/12 th = 344month 2 : $130,474 x 40 bps x 1/12 th = 435month 3 : $142,651 x 40 bps x 1/12 th = 476month 4 : $146,014 x 40 bps x 1/12 th = 487month 5 : $143,199 x 40 bps x 1/12 th = 477month 6 : $135,635 x 40 bps x 1/12 th = 452month 7 : $124,217 x 40 bps x 1/12 th = 414month 8 : $109,556 x 40 bps x 1/12 th = 365month 9 : $92,094 x 40 bps x 1/12 th = 307

month 10 : $72,168 x 40 bps x 1/12 th = 241month 11 : $50,041 x 40 bps x 1/12 th = 167month 12 : $25,927 x 40 bps x 1/12 th = 86

4,250$.0012 /MMBtu

Fully "Loaded" Capital Cost:

credit spread

$.0041 /MMBtu

revolver capacity cost

$.0083 /MMBtux2

15

C. Will Market Bear the Cost? Structural Mitigants & Capital

Management

• Position Consolidation– Consolidation Factor (gross vs. net throughput )– Cleared Products– Capital Management Opportunity

• Market Structure– Price Discrimination despite Counterparty Anonymity?– Example: best available price (price stack ‘depth’)– Credit risk premium embedded?

• Capital Advantages?

16

Objective: Buy 50,000 MMBtu/d, prompt month

"AA" bid price stack view

"BBB" bid price

stack view

"B" bid price stack view

Counterparty Stack

A 10,000 MMBtu/d 7.250 7.250 7.250

B 10,000 MMBtu/d 7.272 7.272 7.272

C 10,000 MMBtu/d 7.294 7.294 7.294

D 10,000 MMBtu/d 7.315 7.315 7.315

E 10,000 MMBtu/d 7.337 7.337 7.337

F 10,000 MMBtu/d 7.359 7.359 7.359

G 10,000 MMBtu/d 7.381 7.381 7.381

H 10,000 MMBtu/d 7.404 7.404 7.404

I 10,000 MMBtu/d 7.426 7.426 7.426

J 10,000 MMBtu/d 7.448 7.448 7.448

K 10,000 MMBtu/d 7.470 7.470 7.470

L 10,000 MMBtu/d 7.493 7.493 7.493

Average Purchase Price 7.294 7.342 7.386Credit Premium -0.048 -0.093