Quantifying Sourcing Risk: Building Commodity Risk Ratings to Mitigate Geopolitical Uncertainty,...

Quantifying Sourcing Risk: Building Commodity Risk Ratings to Mitigate Geopolitical Uncertainty, Commodity Volatility, and Conflict Minerals Risk

June 27, 2013

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Today’s Speakers

Rory KingDirector, Global Product Marketing, IHS

Rory King is Director, Global Product Marketing at IHS. In this role, King is responsible for go-to-market strategy and product marketing for IHS offerings that address market initiatives in Product Lifecycle and Supply Chain Management, as well as Environmental Health & Safety and Sustainability. Prior to IHS, King held positions at information management and supply chain technology providers i2 Technologies, Aspect Development, and Requisite Technology. Most recently, King’s efforts have earned more than ten individual and team-based awards in areas relating to supply chain excellence, environmental compliance and sustainability. These include receipt of company-based Excellence and Leadership Team awards, industry recognition as a Supply Chain Pro to Know, and key contributions among teams winning the Green Supply Chain Award and Supply Chain Top 100 award honors.


Today’s Speakers

Paul RobinsonSenior Economist, Pricing & Purchasing, IHS

Senior Economist, Pricing and Purchasing Group, IHS Global InsightPaul Robinson is an economist in the IHS Global Insight Pricing and Purchasing group. He is a graduate of the George Washington University, where he earned a BA in economics and international affairs with a concentration in international economics. He currently works in the ferrous metals division, specializing in raw materials and assisting on the Steel Monthly, Steel Industry Review and Weekly Pricing Pulse publications.

Paul has spoken about commodities at a number of conferences, including IHS conferences in Monterrey, Mexico (Commodities Outlook: Will Renewed Economic Growth Bring Higher Costs? ) and Mexico City, Mexico (Commodities Outlook: Purchasing Strategies for 2011), as well as the Association for the Advancement of Cost Engineering (AACE) conference in Anaheim, CA (Economic Risks To Consider Before Bidding Your Next Contract).

Conflict Minerals RegulationA Look At Geopolitical Disruption to Supply & Demand EquilibriumRory KingDirector, IHS Supply Chain27 June 2013

© 2013 IHS

Four conflict mineral commodities are regulated

• “Conflict minerals” are pervasively-used commodities• Tin

• Tungsten

• Tantalum

• Gold

• In the DRC, conflict minerals finance armed groups who control population with rape and violence

• They are regulated in U.S. Dodd-Frank with SEC Final Rule

• 2013 is the first reporting period with filings due May 31, 2014

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© 2013 IHS

Regulations are contested… will that matter?

• Unrelenting social pressure• NGO and consumers

• Ongoing regulatory debate• Legal challenges to SEC• Will regulation curb violence?• Activity in other jurisdictions

• U.S. States• Canada• EU• Australia

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Slavery is Not a Game: 430,558 have emailed Nintendo asking them to take credible steps to ensure slave-mined minerals are not in their gaming consoles -- and Nintendo has not responded with action.

Source: Walk Free Organization, June 2013

© 2013 IHS

Where is industry at? Roughly 25% of electronic components have conflict-free disclosures today

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Source: IHS Electronics & Media Conflict Minerals Service, June 2013

Available Conflict-Free Disclosures/DeclarationsComponent Manufacturers as of June 3, 2013

While a step in the right direction, progress and position statements are not disclosures.

© 2013 IHS

You care because such regulations are disruptive to supply-demand equilibrium

Innovators

Early Adopters

Early Majority

Laggards

Late Majority

time (years)

IHS has shown that organizations approach adoption to environmental, social,

and sustainability regulations at rates consistent with innovation adoption theory.

Companies tend to approach regulations in groups of similar behavior, including:

innovators, early adopters, early majority, late majority, and laggards

© 2013 IHS

This means a (long) period of instability due to bifurcation of traditional behaviors

Supply Demand

Product

S1 D1

P1

S2 D3

P2

Innovators

Early Adopters

Early Majority

Laggards

Late Majority

time (years)

“compliant” supply chains

“non-compliant” supply chains

© 2013 IHS

EU RoHS illustrates how regulations disrupt component price and availability

Purchase Price: Price variation factor as of May 30, 2008

Availability: Total RoHS-related EOL vs. RoHS-compliant NPI as of January 1, 2010

Source: IHS Parts Intelligence, June 2013

EU RoHS 6 in this context are lead, mercury, cadmium; hexavalent chromium, PBB and PBDE

© 2013 IHS

You really care because price and availability impact your ability to meet KPI

• Your top-five most important key performance indicators*

1. Total Cost Savings Achieved

2. Attainment of Cost Savings Target

3. Purchase Price Variance (PPV)

4. On-Time Delivery

5. Continuity of Supply

• Regulations impose change to equilibrium that undermines KPI*Source: IHS Pricing & Purchasing Audience Survey, April 24, 2013

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© 2013 IHS

Beyond regulation, geopolitical risk at the source correlates with price volatility

15Source: IHS Economic & Country Risk, June 2013

© 2013 IHS

In addition to price volatility, geopolitical issues threaten to disrupt supply chains

Country Risk Forecast: Mineral Producing Regions (e.g. Gold)

What is the risk?

Source: IHS Economic & Country Risk, June 2013

© 2013 IHS

For instance, turmoil in Mali poses a threat to mining operations and infrastructure

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Risk forecast

Property risk

Source: IHS Economic & Country Risk, June 2013

Country Risk Forecast: Mineral Producing Regions (e.g. Gold)

© 2013 IHS

So, what about conflict minerals regulation?

Here’s what our audience had to say…

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Source: Quantifying Risk Audience Poll, June 27 2013

What’s your company’s typical adoption of environmental or social regulations?

© 2013 IHS

Conflict minerals are great leadership opportunity for you and your organizationCommodity influence… What you can do about it…

Social Pressure Get engaged with industry and peers

►Get ahead of the herd on the public relations front

Early adoption = competitive advantage

Late adoption = market failure/restriction

Regulatory Compliance Track regulations and embrace inevitability of outcomes

►Use supply chain benefits to justify early action

Competitive advantage

Improve supplier collaboration

Gain multi-tier visibility

Identify supply chain vulnerabilities

Establish resiliency / risk & security monitoring

Price Volatility Get religious about price monitoring and drivers of cost

►Become proficient at timing buys strategically

Geopolitical Risk Correlate your key commodities with associated regions

►Institutionalize economic & country risk monitoring

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My perspective: You cannot change nor ignore the behaviors of a globally-integrated

supply chain in transformation – only monitor and manage the implications thereof

Quantifying RiskA Look At Commodity Risk and Country Risk InteractionPaul RobinsonSenior Economist, Pricing & Purchasing, IHS27 June 2013

© 2013 IHS 21

About IHS Pricing & Purchasing

The IHS Pricing & Purchasing Service enables supply chain cost savings by providing timely, accurate cost and price analysis. Armed with a better understanding of suppliers' cost structures and market dynamics, organizations can effectively negotiate prices, strategically time buys, and boost the bottom line. With a database of more than 80,000 historic prices and thousands of price, wage and input cost forecasts, IHS offers more coverage than any other provider in the market. IHS has been providing forecasts of key commodity, labor, and input costs since 1970 -- helping define the purchasing advice industry.

Learn more, visit ihs.com/PricingPurchasing

© 2013 IHS 22

Agenda

• Volatility explained: What is it and why does it matter?

• Where have we been: A recent history of volatility

• Building commodity risk ratings: A way to quantify the interaction of country risk and commodity risk

© 2013 IHS 23

Agenda




© 2013 IHS

Volatility Explained

•What is it?• Variation in price

over time

•How is it measured?• Standard deviation• CBOE’s VIX (equities)• Implied volatility in S&P

500 index options – risk compensation

•Why does volatility matter to you?• Timing buys• Coping with changing

inventory values• Makes planning more

difficult

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© 2013 IHS 25

Agenda




© 2013 IHS

Recent History of Volatility

Standard Deviation of MPI (52-Week Moving Average)

Chicago Board of Options Exchange VIX Index

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© 2013 IHS

Volatility Drivers – Micro

• Just in time inventory (JIT)

• Lengthening supply chains• Example: Japan earthquake

• Supply boom/bust cycles• Example: Shipping

Inventory/Shipments Ratio

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© 2013 IHS

Volatility Drivers – Macro

• Monetary policy – liquidity

• Exchange rates - dollarization

• Exchanges (ETFs)/High frequency traders

• Country risk

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© 2013 IHS 29

Agenda




© 2013 IHS 30

Premise

• A key part of the risks associated with buying a given commodity is the risk of the country you are sourcing from

• Items such as “Conflict Minerals” have gotten a lot of attention, but the truth is that the operating environment in many countries is subject to high levels of risk

• We can develop a quantitative method for capturing country risk as a way of better understanding commodity price volatility

© 2013 IHS

Selected Commodities…

Energy•Oil •Coal •Natural Gas

Ferrous Metals• Iron Ore

Non-Ferrous Metals•Aluminum•Chromium•Copper• Lead•Manganese•Molybdenum •Nickel•Tin•Zinc

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© 2013 IHS

1. Gather the (Production) Data

Energy•Oil (IEA)•Coal (World Coal Association)•Natural Gas (IEA)

Ferrous Metals• Iron Ore (USGS)

Non-Ferrous Metals•Aluminum (WBMS)•Chromium (WBMS)•Copper (WBMS)• Lead (WBMS)•Manganese (WBMS)•Molybdenum (WBMS)•Nickel (WBMS)•Tin (WBMS)•Zinc (WBMS)

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© 2013 IHS

2. Ranking the Largest Producers

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© 2013 IHS

3. Calculating the Concentration Ratios

• Highly concentrated production is risky in any country• Capture difficult risks like weather (Australian floods) and

geography (Straits of Hormuz)

• Calculate share of top 4 producers

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Iron Ore Millions of Metric TonnesChina 1300Australia 525Brazil 375India 245

Top 4 Total 2445

Global Production 3000

Top 4 Concentration Ratio 0.82

© 2013 IHS

4. Developing Country Risk Scores

•Calculate scores for additional country specific risks

• IHS Exclusive Analysis• Intra-national location

specific risk

• IHS Global Risk Service

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© 2013 IHS

5. Weight Country Risk Ratings by Production

• Simple weighted average of the individual country risk ratings to create a commodity risk rating

• Multiply by the concentration ratio from step 3 to take into account additional risks

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Commodity Top 4 Producing Countries Production IHS Country Risk Rating Top 4 Weighted Average Risk RatingIron Ore Total 3000

China 1300 14.35 7.63Australia 525 3.19 0.68Brazil 375 6.68 1.02India 245 6.77 0.68

10.02

© 2013 IHS

6. Gather the (Price) Data

Energy•Oil (IMF)•Coal (IMF)•Natural Gas (IMF)

Ferrous Metals• Iron Ore (IMF)

Non-Ferrous Metals•Aluminum (LME)•Chromium (AMM)•Copper (LME)• Lead (LME)•Manganese (AMM)•Molybdenum (AMM)•Nickel (LME)•Tin (LME)•Zinc (LME)

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© 2013 IHS

7. Calculate Standard Deviations

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…

...Or just let a computer do it for you

3 Year standard deviation of the monthly percent changes of each variable

© 2013 IHS

8. Interpreting the Results

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© 2013 IHS

Assessing the Outliers – Natural Gas

Why is natural gas more volatile than its scores show?•Seasonality•Difficult to store/move•Artificially low score (United States)

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© 2013 IHS

Assessing the Outliers – Tin

Why is tin less volatile than its scores show?•Hedging (LME)•Long history operating in elevated risk countries•Mines close to ports or even offshore

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© 2013 IHS

SURPRISE!

Oil and Copper Low Risk/Low Volatility?•Still volatile, just not as volatile as some•Growing production in United States; Growing stability in Chile

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© 2013 IHS

Conclusion – This is just the beginning

Improvements:• Build commodity

risk scores based on exports, not production• Group oil

producers locked within the Straits of Hormuz with Iran’s score

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Go build commodity risk scores!


Thank you!

Paul RobinsonSenior Economist, Pricing & Purchasing [email protected]

Copyright © 2013 IHS Inc. All Rights Reserved.45

IHS Global Commodity Risk Scorecard

*Offer limited to qualified entities until July 30th, 2013.

Limited time offer to all attendees…

© 2012, IHS Inc. All Rights Reserved.

Best Practices in Strategic Sourcing & Procurement

Resilient Supply Chains: How to Dynamically Manage Risk, Opportunity, and Business Continuity July 11, 2013 | 8 AM PT /11 AM ET / 4 PM BST

•Who is at risk from supply chain disruption? •What does it mean to be resilient? •Where do traditional approaches to risk fail? •Why are leaders re-tooling their super-lean supply chains? •How can your organization sense and respond to change?


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For More Information

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