Coal Price Risk Management

New Delhi, October 2009

*Regulated by The Financial Services Authority
1
Introduction
2

Page
What this presentation is about 3
Risk Management Methodology 4
Components of a Hedging Programme 5
Optimum Hedging Strategy 6
Key Aspects of a Risk Management Approach 7
Mitsui’s Role 8
Risk Management Products – Coal 11
Evolution of Coal Swaps Trading 11
Swaps and Options 13
What “Opportunities” emerge 17
Major Current Issues 14
Swaps 19
Contact Details 20
Attached Product Appendix 21-27
The Executive Summary! 3

! The Risk management discipline and process

!A clear methodology in place to support transaction decisions
! Identifying your exposure
!Full understanding of the business dynamic is essential
!Financial horizons must match market horizon
! Some contract examples
!A walk through some building blocks of derivatives
! Derivatives bring a new perspective, why “Opportunities” exist
!Taking a deeper look at the forward curve
! Some comments and conclusions on recent experience
!Economic shocks
!Supply and Demand shocks
!Credit and cash management
Risk Management Methodology

4
Components of a Hedging Programme 5

• In order to stabilise cash flow and

earnings volatility, IndiaCorp can
manage risk via “hedging”
• Hedging is an action of transferring
risk to energy prices to a counterparty Hedging Programme

• A well-designed hedging strategy can: Short-Term Long–Term Exposure

Exposure Management Management
– Facilitate earnings predictability
and stability and enable
management planning and
negotiation
– Reduce cost of capital or
release capital held against
commodity price shocks Flexible Application, Balance Sheet and
Timing, and Execution Revenue Management
• Hedging does not necessarily make
energy costs “cheaper” at any point in
time
• Hedging a particular exposure should
be considered as part of an overall
hedging strategy because currency
risk may remain
A well-designed hedging programme reduces the variability of costs
Optimum Hedging Strategy
6
Evaluate
Exposure
• The first step in any hedging
decision is to identify the risk(s)
that you are looking to mitigate. In Identify
Risk
the case of IndiaCorp the risk is
Coal costs will rise in the future
• The second step in a hedging Evaluate
policy is to evaluate acceptable risk Analyse Position Acceptable Risk
levels that the program can take (re- evaluate Levels
regularly) Hedging
• A number of diverse hedging Program*
instruments are available to
mitigate the risks of high prices
efficiently
• Hedging is an ongoing Determine
programme – regular Execute Best
adjustments to reflect forecasted Hedge Strategy
fuel oil expenditures and
anticipated market conditions
must be made
* A clear, written, hedging policy should be the foundation of
any hedging decision
Key Aspects of a Risk Management Approach
7

Risk Management Policy

To successfully manage a hedge Hedging fuel exposure consumed
portfolio on an international on the open market (outside of
market, while bearing in mind domestic market)
market economics Locking fuel costs out to 3 years
Looking at Swaps, Capped
Swaps, and other combinations
Execution
Risk Management
At any time prices are below
Policy
budget levels
Strategy
At any time structures are below
Timing
budget levels
Execution
Work orders to closely mirror the Strategy
movement in the markets by To take advantage of dips in the
taking advantage of dips in market by keeping abreast of
prices fundamentals and trading
activity
To fix a certain quantity
Timing
immediately after setting
Closely monitor the market on a budget and costs
regular basis
Take out protection soon after
budget is set
Identifying your exposure
8

•Start with the invoices at the purchasing department

•Floating or fixed price terms
•Taxation and duty calculations
•Price risk sharing in rebates or discounts

•Consider the flexible element of overhead or revenues

•Does this correlate to commodity prices?

•Work with CFO to understand shareholders’ outlook and expectation

•Consider capital requirements and credit facility capacity

•Look for regulatory support (RBI approval)

•Currency implications of settlements and collateral

A well-designed hedging programme reduces the variability of costs

Mitsui’s Role
9

To monitor targets and

‘stop’ levels and advise
To provide you with superior Financial Managers if
market analysis on an ongoing targets are close
basis including presentations at
regular hedge meetings To discuss adjustments to
min / max hedge levels that
we feel appropriate

To review portfolio of
hedges each month and
review effectiveness of To review hedges
policy taken over previous
month

To discuss targets and

If instructed, to enter ‘loss’ levels based on our
into hedge positions at perception of market
target / ‘stop’ levels outlook and hedge policy
set by IndiaCorp
 10
Our Capabilities and Services

Structures
! Swaps, Caps, Floors & Collars
! Straddle & Strangles
! Cracks
! Extendibles swaps & Collars
! Ratio strategies
! Full array of exotic OPTIONS
! 3-way collars
! Spread & compound option
! Call spreads
! Digital & barrier options
! Put spreads

Strategy Development and Support

Quantitative Analytics ! Tailored hedging strategies
! Historical price distribution ! Regular marked-to-market (MTM) reports
! Correlation
! Sensitivity
! Strategy identification

Research Products
! Daily Petroleum Price Reports
! Weekly Natural Gas Report
! Special Oil & Gas Impact Reports
! “Quick” technical & fundamental updates
! Client specific hedging presentations
Risk Management Products
Coal

11
Actively Quoted Coal Indices
12
• The index chosen as the underlying pricing reference for your hedge depends on the
particular exposure you have to physical fuel prices
• The following are the fuel oil indices that MERM is actively quoting and trading swaps on

Europe
API 2
US
NYMEX Coal
Arab Gulf / Asia
globalCoal Newcastle

South Africa
API 4
Swaps
13
• A swap is a financial instrument (no physical delivery) whereby one party (the buyer)
agrees to pay the other a fixed price for an underlying product (Fuel Oil, Crude Oil, or any
other commodity) in exchange for a floating price for the same underling.

• An example of which is a swap between MERM and IndiaCorp whereby IndiaCorp agrees to pay
MERM a fixed price for its fuel consumption and MERM agrees to pay IndiaCorp a floating price
for the same product – IndiaCorp thus fixes the price at which it buys its fuel (see below illustration)

• The swap protects against adverse movements in energy prices by fixing the price you
would pay for your fuel with a cash flow that compensates you should prices rise.

Physical Coal Supplier

Fixed Price Physical Fuel

IndiaCorp
Floating Price Floating Price

Financial Physical
Transaction Transaction
Swap Term Sheet
14

Swap Buyer: IndiaCorp

Swap Seller: Mitsui & Co. Energy Risk Management Ltd (“MERM”)
Reference: globalCoal Newcastle Index
Swap Price: 50 $/mt*
Start Date: 1st July 2010
End Date: 31st December 2011
Volume: 25,000 mt / month (450,000 mt total)
Settlement: Monthly ,5 business days after the end of the month
(Note that this settlement period can be adjusted to match the payment
patterns of the counterpart)

* Prices are constantly changing as markets move, we would be happy to show you firm offers via telephone, subject to credit and legal
requirements
Swap Mechanics
15

60.00
Swap Price $50/mt
Below the swap Above the swap
price, your price, Mitsui’s
40.00 payments to you
payments to
increases as the

Swap Payout ($/mt)

Mitsui increase
as the price of
20.00 price of coal rise
coal falls
0.00

-20.00

-40.00

-60.00
6.00

12.00

18.00

24.00

30.00

36.00

42.00

48.00

54.00

60.00

66.00

72.00

78.00

84.00

90.00

96.00
Average Settlem ent Price for NEWC ($/m t)

• To give you an idea of where the market is currently trading, the globalCoal Newcastle swap for
July 2010 – December 2011 is currently at $90/mt (5th October 2009)
• The vanilla swap fixes the maximum price you would have to pay for your fuel, offering you
immediate certainty of expenses
• As the upside is uncapped, you have unlimited up-side protection
• The swap has no entry costs
Call Option (also known as a Cap)
16

" A call option grants you the right but not the obligation to buy at an
agreed price in return for paying a premium.

" Options are effectively an insurance policy – once the premium is paid
there are no further outward payments.

" A number of factors affect how the premium of an option is

determined.
" These are: Strike Price / Price of Underlying Fuel / Duration of the
Option / Volatility of Underlying Fuel

" A Call for Apr 10 – Mar 11 NEWc with a strike at $85 costs $10/mt.

" A Call for Apr 10 – Mar 11 NEWc with a strike at $100 costs $5/mt.
Why opportunities exist
17
10-11-12 forward curve

Economic outlook improves sharply May 09

$110

Market low of $71 for Cal’12 March 2009

$100

$90

$80
100-110
90-100
$70 80-90
70-80
60-70
$60
50-60

$50

09 9
1 /20 /200 009
/0 1 09 09
02 22/0 2/2 3/20
/0
10 02/0 3 /20 /2009 09
/0 4 20 9
19 /0 4 / 200 09
07 /0 5 / 20 00
9
24 /0 / 09

Sep-12
13 0 6 /2
/ 20

Jan-12
6 9
02 0 / 00

May-11
/ 7 09
19 0 /2

Sep-10
/ 7 20 09
08

Jan-10
/0 /
27 3/08
9 /20 200
9
1 /0 /
01 /09
25
 -10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
19
82
Ja
n-
19 09

$50
$55
$60
$65
$70
$75
$80
$85
$90

84

19 Ja
n-
86 09

19 Ja
88 n-
09

19
90 F
eb
-0
9
19
92
F
eb
-0
19 9
94
M
19 ar
-0
96 9

19 M
98 ar
-0
9

Chinese coal consumption growth

20
00 A
pr
-0
9
20
02
A
pr
-0
20 9
04
M
ay
-0
9
20
06

BP Statistical Review
ay
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9
Why we are looking for opportunities

Ju
API4 CAL10 Swap

n-
09

Ju
n-

$0
$20
$40
$60
$80
$100
$120
$140
$160
$180
$200

0 Ju
Se 1 n-
p-
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De 1
c-
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M 1
ar
-0
Ju 2 Ju
n- l-0
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Se 2
p-
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De 2
c-
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M 2 l-0
ar
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Ju 3
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Se 3
p- Ju
03
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M 3
ar
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Ju 4
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0 ug
Se 4 -0
p- 9
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De 4
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-0 -0
Ju 5
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0
Se 5
p-
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Weekly RB

De 5 ep
c-
0 -0
M 5 9
ar
-0
Ju 6
n-
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Se 6 ep
p- -0
0 9
De 6
c-
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M 6
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Ju 7
n-
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ar
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Ju 8
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M
globalCoal

ar
-0
McCloskey/MERM

Ju 9
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0
Se 9
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09
The main issues of the day
• The Coal Market
– Dark Spreads in Europe
– Liquidity concentrations
– New Indices and Platforms
– Freight Market development
– Carbon Management
• Tax?
• Cap and Trade?
• Clean Coal
– 10 or 20 year hedges
19
• The Global Market
– V or W recession?
– Regulation of OTC markets
– Availablilty of Credit
• Cash Management
• Credit Default Risk
– Our Financial Horizon
– Technology
– Climate Change
– Role of Financial institutions
Contact Details 20
London Desk:
• Jack Kellett +44.20.7489.6748
» Jack.kellett@mitenergy.com

• We employ a team of 25 professionals in London dedicated to derivatives and are part

of a global trading organisation with offices throughout the world.

5th Floor
2 Shenton Way 31st Floor Mitsui & Co. Building
St. Martins Court
#08-03 SGX Centre 1 200 Park Avenue 2-1 Ohtemachi 1-Chome
10 Paternoster Row
068804 New York Chiyoda-ku
EC4M 7BB
Singapore NY 10166 Tokyo 100-0004
London
Singapore USA Japan
UK

This communication is for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial
instrument or as an official confirmation of any transaction. All market prices, data, and other information are not warranted as to completeness or
accuracy and are subject to change without notice. Any price information is not warranted as to completeness or accuracy and is subject to
change without notice. Any price statements made herein do not necessarily reflect those of Mitsui & Co., Ltd, its subsidiaries or affiliates.
Accordingly, Mitsui & Co., Ltd., its subsidiaries or affiliates shall have no liability to you whether such liability arises in contract, tort or statute for
any costs, losses, expenses, damages whether arising or incurred directly or indirectly by you placing reliance on any information contained within
this communication.
Risk Management Products
Appendix

21
 22
Capped Swap

Operates as a normal swap, with the upside limited to a specified

amount
If IndiaCorp buys the capped swap:
IndiaCorp pays Mitsui if the mean price for the relevant period falls below the
swap level (IndiaCorp pays Swap Price minus Mean Price)
Mitsui pays IndiaCorp if the mean price for the relevant period is greater than
the swap level (Mitsui pays Mean Price minus Swap Price)
The amount Mitsui will pay IndiaCorp will be limited to a specified
maximum amount
Because the upside is limited, the capped swap can be purchased at a
level lower than the normal swap
Therefore the structure is useful if you expect prices to increase, but
only up to certain levels
 23
Knock-out Structure

Operates in a similar way to a conventional swap, but if prices exceed

a specified level, the purchaser receives No payment
If IndiaCorp buys the knock-out swap:
IndiaCorp pays Mitsui if the mean price for the relevant period falls below the
swap level (IndiaCorp pays Swap Price minus Mean Price)
Mitsui pays IndiaCorp if the mean price for the relevant period is greater than
the swap level (Mitsui pays Mean Price minus Swap Price)
If the mean price exceeds a certain threshold, Mitsui pays Nothing to IndiaCorp

Because IndiaCorp has a risk of receiving nothing, if prices rise

beyond a certain threshold:
IndiaCorp will receive a very favourable swap level, lower than a
conventional swap
Such a structure would be suitable if you expect prices to rise, but are
confident they will not rise beyond a certain level
 24
Zero Cost Collar

Conventionally, IndiaCorp may purchase a call option by paying a

premium
The call may be purchased for zero cost, by selling a put
Thus IndiaCorp does not need to pay anything for this structure

If mean prices exceed the call strike level, IndiaCorp will receive an
amount equivalent to the excess from Mitsui
If mean prices fall below the put strike level, IndiaCorp must pay Mitsui
the amount by which the put strike level exceeds the mean price
If the mean price is between the call and put strike levels, there is no
payment between the parties
Such a structure would be suitable if you expect prices will stay above
the put strike level, and are likely to be higher than the call level
 25
Zero Cost Collar with a Knockout

Works as a conventional zero cost collar

If mean prices exceed the call strike level, by more than a specified
threshold, IndiaCorp receives No pay out
Therefore:
If mean price > knock out level, IndiaCorp receives No payment
If knock out level > mean price > call strike, IndiaCorp receives a payment
from Mitsui, equivalent to the Mean Price minus Call Strike Level
If mean prices < put strike, IndiaCorp must pay Mitsui an amount equivalent
to the Put Strike Level – Mean Price

The knock out allows us to offer lower price levels for the put and/or
the call
This structure would be suitable if you expect prices will stay above
the put level, and are likely to be higher than the call strike level
while also staying below the knock-out level
 26
3 Way Structure

IndiaCorp can get upside protection at zero cost

IndiaCorp buys a call, sells a call at a higher strike level and sells a put

The cost of the call purchased by IndiaCorp is subsidised by selling a

call and put

This gives upside protection which is limited to the difference between

the call strike levels

IndiaCorp will pay Mitsui if the mean price falls below the put level
 27
3 Way Extendible Structure

The 3 way structure may be extendible into the following period, at

Mitsui’s discretion

For Example, a structure for Q1 08 may be extended into Q2 08, at

Mitsui’s discretion

By giving Mitsui the choice of whether or not to extend the period:

IndiaCorp may be able to sell a lower put level

IndiaCorp may purchase a more attractive call level

IndiaCorp may purchase a wider call spread

The 3 Way and 3 Way Extendible may be suitable if you expect

prices will remain above the put level, and are likely to be within the
range outlined by the call spread for the full term of the transaction