Creating Reliable and Effective Pricing System for Pulp Derivatives YOU MAY ENTER HERE A THEME TEXT FOR THE PRESENTATION Creating Reliable and Effective Pricing System for Pulp Derivatives Cutting Edge Derivatives ICM Conference 14-15 January, 1998; Stockholm by Timo Teräs

Contents Earlier attempts to create futures market for pulp Pulp derivatives from an industry point-of-view Volatility of the underlying market - reliable pricing of pulp derivatives Price fluctuations and their impact on the pricing of pulp derivatives Creating the Pulp Price Index (PIX) for cash-settled contracts Comparison of the price distribution of cash-settled and delivery-settled contracts Initials / code

Pulp Derivatives Problems with Earlier Attempts Volatility not high enough Industry not ripe to participate Bad PR from derivatives failures for other products Unlucky timing Physical delivery concept No reliable index for cash settlement Division of potential volume Initials / code

Pulp Derivatives Key Advantages to Industry Participant Less bottom-line volatility Risk reduction (insurance) Easier and more reliable budgeting Use as a financial tool Allows tender offers Increases co-op within company Allows focus in core business Optimization of down-time Possible reduction of volatility Use of index for other purposes Increased share values Initials / code

Pulp Derivatives Company Disadvantages Cost (product dependant) Costs (infrastructure, training etc.) Capital tied up Delivery requirement (if delivery settled) Quality problems (if delivery settled) Getting out of contract at unwanted time Potential increase in volatility Derivatives or index influencing underlying product price Inventory requirement (if delivery settled) Initials / code

Pulp Derivatives Company Risks Oversized exposure Lack of internal co-operation Low contract flexibility (volumes) Helping competitor Failure/problem with index (cash settled contracts) Technical squeeze (delivery settled contracts) Initials / code

Pulp Derivatives Volatility of Underlying Market Increased over time Marginality of market pulp Speculation Sales in different currencies Supply bursts Some market variations in pricing Delivery settled contracts follow spot prices Cash settled contracts follow list prices Correctness of changes between settlement dates decisive Laws of supply/demand and price expectations decisive Initials / code

Pulp Derivatives Price Fluctuations Prices quoted less and less misleading Increased competition and transparency At times common interest to show high/stable prices Still some reasons for misleading prices … varying rebates and payment terms … sales in different currencies - exchange rates … spot vs regular sales Initials / code

Pulp Derivatives Credible Index - Choosing Benchmark Grade Representing large part of physical trade Quotes from different producers close to one another Delivery destination with uniform terms of delivery Maximum public exposure Initials / code

Pulp Derivatives Creating the Index Closeness with the underlying market Reflecting normal trade of prime quality product Represented quality measurable in technical terms Both sellers and buyers views represented All main countries represented Big and small companies represented Defined shipment time for underlying product Impossible to manipulate Possible to audit and audited Acceptance of regulatory and anti-trust authorities Possible to copyright (sell/lease) Totally transparent Initials / code

Pulp Derivatives PIX index elements Participants report weekly 3 last sales/purchase prices NBSKP/CIF North Atlantic/North Sea port in USD Fully bleached ECF/TCF grade Equal number of sellers’ and buyers’ quotes Prices before customer-specific discounts Lowest and highest transactions (10% each) eliminated Expert panel as “trouble shooter” Auditing Initials / code

Pulp Derivatives Comparison: Cash Settled vs Delivery Settled Traded volumes still small - conclusions unclear Logical difference: discounts Other reasons for differences between contracts include … small volumes … insufficient number of industry participants … insufficient amount of warrants issued (delivery settled) … high portion of actual deliveries (delivery settled) … closeness of settlement date … increasing amount or geographical spreading of spot prices … trading between market makers/non-industry participants … different closing dates With growing volumes reliability increases Initials / code