Merchant Trade Capital Unlimited Costless Capital A How

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) 1

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? 2

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[MTM +/- slides] 5

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 Balance. Sheet Liquidity Stress/Tax Missing Piece: Contingent Capital (Backstop) Cost of Contingent Capital? 6

[CS term slide] 7

“Fully-loaded” Capital Cost: Example #1 A/Rs & A/Ps • Example: Purchase at Gas. Daily; 10, 000 MMBtu/d; and Sale at Gas. Daily; 10, 000 MMBtu/d – How Much Capital? • Lend Capital (Sale): A/R Credit Risk Assumed • Borrow Capital (Purchase): A/P Balance. Sheet Liquidity Consumption – Cost of Capital? • Counterparty Default Risk • Balance. Sheet Stress – Incremental increase in committed capital revolver 8

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“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 • Balance. Sheet Stress – Incremental increase in committed capital revolver? 11

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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? 15

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