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August 19, 1996 02:00 AM

PROPER TOOLS LESSEN RISKS OF BUYING RESIN

Bruce Vernyi
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    HOUSTON - Timothy O'Neal, director of Capital & Trade Resources for Enron Corp., thinks paying for resin is a risky business. For example, a hopper car of linear low density polyethylene liner film resin that cost $65,000 in January costs $92,500 today. A hopper car of PET bottle resin that cost $140,600 in January costs $99,990 today.

    O'Neal believes Enron has financial tools that can flatten such hills and spills to provide processors and suppliers with predict-able costs for specified periods.

    Enron of Houston is an integrated producer of natural gas, and has interests in gas pipelines, electrical power plants, oil and gas exploration and finance.

    O'Neal has been charged with adopting for the plastics industry financial tools the company developed for the exploration and development of gas and oil production.

    Many of the hazards and benefits are similar, he said, explaining that in oil and gas explora-tion, the large initial investments often are paid for with products whose prices fluctuate widely over the debt-payment period.

    The solution, O'Neal said in a recent interview at his office, is to establish a forward market, in which risks are spread out over the entire period of production.

    A forward market is an over-the-counter exchange of risks that differs from a futures market, where contracts are traded on an exchange, O'Neal said.

    Such markets use established risk-management tools that may not be well-known in the plastics industry, but are common in other businesses.

    Classic risk-management tools have been used in agriculture for years. We developed those tools for the exploration and development of petrochemicals, and we are adopting them for the plastics industry,'' he said.

    Enron is looking to adapt these financial tools for both resin suppliers and purchasers, O'Neal said. Enron makes its profit from assuming that risk and spreading it out over several contracts and a long period of time, he said.

    Enron's toolbox contains several complex formulas for managing risks, O'Neal said. Here is a brief explanation of the primary tools:

    Swaps, by which Enron would agree with another party to exchange or ``swap'' price risks over a predetermined period of time. This tool protects a company from market price fluctuations by locking in a specific price for a commodity, giving the company control over variable revenues and costs in its business for the period specified in the contract.

    Caps and Floors, which are similar to swaps. With caps and floors both parties gain the right but not the obligation-to hold a long or short position in a product over a specified period.

    While they provide price protection in a way similar to swaps, they also allow the parties that buy them to benefit from favorable price changes.

    However, caps and floors require an initial cash premium from buyers, and that premium always will be the maximum loss or cost. In plastics, caps may be more attractive to processors, while floors may be more attractive to resin suppliers. The best-known pricing caps are price insurance programs that other companies offer, O'Neal said.

    Collars, which are similar to caps and floors, while not requiring the initial cash premium.

    collars offer price protection within a specified range of prices, and are paid for by giving up portions of favorable price changes, O'Neal said.

    O'Neal said the tools can be combined in a variety of ways to provide custom financial packages to plastic processors and suppliers of any size. Also, he said they can be used to provide pricing protection to portions of a company's purchases.

    With these risk-management tools, both Enron and its clients agreed to use a common index of pricing as the basis for their contracts.

    These tools are most applicable to people who have long-term, fixed-price contracts.

    You could guarantee your prices to your customers for a long period of time. There are thousands of variations that we could put together for these tools, and customers like them because they are clean,'' he said.

    His company's financial contracts provide assurance to customers, he said, by spelling out how prices and costs - which otherwise might be guessed at - will be accounted for.

    Don Black, a vice president for Enron Capital & Trade Resources, O'Neal and Eric Paulsen, who, like O'Neal, is a director of Enron Capital & Trade Resources, make up the team devoted to adopting Enron's tools to plastics. They acknowledge that they face a difficult marketing effort: No other financial company could be found that provides similar services to the plastics industry.

    No one wants to be the first to do this,'' Black said.

    However, they are considering using educational seminars in strategic cities to break down the barriers.

    The world has changed: five-and-dime stores have become Wal-Marts. Resin producers are consolidating their production lines. Competitors who used to be down the street now are in China,'' Black said. ``This is a new competitive edge,'' he added.

    Enron now is trading in polyethylene, polypropylene, styrene monomer and benzene, and is considering moving into ethylene and propylene, O'Neal said.

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