Transcript None - PwC

Treasury Hot Topics Seminar
Record price and volatility levels > need to
start hedging your commodity exposures?
19 February 2009
PwC
Agenda
Audience perspective
A view on the markets
Evolution of Commodity Markets
Where philosophy meets strategy
CRM related issues
Wrap up and conclusion
Agenda
Audience perspective
A view on the markets
Evolution of Commodity Markets
Where philosophy meets strategy
CRM related issues
Wrap up and conclusion
Audience perspective
Audience perspective
Share your point of view
Question n°1 – Treasurer’s viewpoint
How would you rank your company’s exposure to commodity risk
compared to other financial risks?
PricewaterhouseCoopers
Slide 4
Audience perspective
Audience perspective
Share your point of view
Question n°2 – Management awareness
How would you qualify your company’s top management level of
awareness to commodity price risk issues?
PricewaterhouseCoopers
Slide 5
Audience perspective
Audience perspective
Share your point of view
Question n°3 – Identification and quantification
Does a centralised view of your company’s commodity exposures exist
and are these exposures quantified?
PricewaterhouseCoopers
Slide 6
Audience perspective
Audience perspective
Share your point of view
Question n°4 – Where is the exposure managed
Where is the commodity price risk managed within your company?
PricewaterhouseCoopers
Slide 7
Audience perspective
Audience perspective
Share your point of view
Question n°5 – How is the exposure managed
What type of instrument do you use to manage the commodity price risk?
PricewaterhouseCoopers
Slide 8
Audience perspective
Audience perspective
Share your point of view
Question n°6 – Financial instruments type
What type of financial instrument do you use or would you consider using
to manage the commodity price risk (multiple answers possible)?
PricewaterhouseCoopers
Slide 9
Agenda
Audience perspective
A view on the markets
Evolution of Commodity Markets
Where philosophy meets strategy
CRM related issues
Wrap up and conclusion
PricewaterhouseCoopers
ICE Brent
Chinese imports
04/01/09
04/10/08
04/07/08
04/04/08
04/01/08
04/10/07
04/07/07
04/04/07
04/01/07
04/10/06
04/07/06
04/04/06
04/01/06
04/10/05
04/07/05
04/04/05
04/01/05
04/10/04
04/07/04
04/04/04
04/01/04
04/10/03
04/07/03
04/04/03
04/01/03
04/10/02
04/07/02
04/04/02
04/01/02
04/10/01
04/07/01
04/04/01
100 = 04/04/2001
A view on the markets
Chinese Imports – ICE Brent – LME Copper
700,00
600,00
500,00
400,00
300,00
200,00
100,00
0,00
Source: Bloomberg data and PwC analysis
Time
LME Copper Cash price
Slide 11
PricewaterhouseCoopers
04/01/2009
04/10/2008
04/07/2008
04/04/2008
04/01/2008
04/10/2007
04/07/2007
04/04/2007
04/01/2007
04/10/2006
04/07/2006
40
04/04/2006
04/01/2006
US Airways
04/10/2005
04/07/2005
ICE Brent & Airlines Filings
04/04/2005
80
04/01/2005
100
04/10/2004
04/07/2004
04/04/2004
04/01/2004
04/10/2003
04/07/2003
04/04/2003
120
04/01/2003
20
04/10/2002
04/07/2002
04/04/2002
04/01/2002
04/10/2001
04/07/2001
04/04/2001
USD/Bbl
A view on the markets
Brent
160
Northwest & Delta Airlines
140
United Airlines
Air Canada
US Airways
Aloha Airlines
Brent
60
Maxjet Airways
Aloha – ATA – Skybus – Frontier – EOS Airlines
0
Dates
Source: Recession.org and PwC analysis
Slide 12
-10
PricewaterhouseCoopers
01/01/2009
01/10/2008
ICE Brent 36 Months – ICE Brent Spot
01/07/2008
40
01/04/2008
01/01/2008
01/10/2007
01/07/2007
01/04/2007
01/01/2007
01/10/2006
Backwardation
01/07/2006
01/04/2006
01/01/2006
01/10/2005
01/07/2005
01/04/2005
01/01/2005
01/10/2004
01/07/2004
01/04/2004
01/01/2004
01/10/2003
01/07/2003
01/04/2003
20
01/01/2003
01/10/2002
01/07/2002
01/04/2002
01/01/2002
01/10/2001
01/07/2001
01/04/2001
01/01/2001
USD/Bbl
A view on the markets
Brent - From a backwardation to a contango market (1/2)
Contango (+) / Backwardation (-)
Contango
30
Contango Back
10
0
-20
-30
Time
Source: Bloomberg data and PwC analysis
Contango (+) Backwardation (-)
Slide 13
PricewaterhouseCoopers
31/01/2007
30/11/2006
30/09/2006
31/07/2006
31/05/2006
Time
31/01/2009
30/11/2008
30/09/2008
31/07/2008
31/05/2008
31/03/2008
31/01/2008
30/11/2007
30/09/2007
31/07/2007
31/05/2007
31/03/2007
Source: Bloomberg data and PwC analysis
31/03/2006
31/01/2006
30/11/2005
30/09/2005
31/07/2005
31/05/2005
31/03/2005
31/01/2005
30/11/2004
30/09/2004
31/07/2004
31/05/2004
USD/Bbl
31/03/2004
31/01/2004
A view on the markets
Brent - From a backwardation to a contango market (2/2)
160
140
120
100
80
60
40
20
140-160
120-140
100-120
80-100
60-80
40-60
20-40
0-20
0
24-M
Spot
Slide 14
A view on the markets
Commodity Markets Volatilities (cont’d)
Volatility Drivers
• Political Risk (e.g. oil and gas)
• Weather (e.g. temperature levels, hurricanes in the U.S impact electricity
and gas prices)
• Storage capacity and availability of Supply help reduce the volatility
(i.e. electricity cannot be stored and is consequently the most volatile
commodity).
• Shortage expectations or bottlenecks in production / refining process
• Short-end of the price curve is significantly more volatile than the Longend.
PricewaterhouseCoopers
Slide 15
A view on the markets
100-days historical Vol – ICE Brent – LME Copper – LME Zinc
80,00%
70,00%
60,00%
50,00%
40,00%
30,00%
20,00%
10,00%
Source: Bloomberg data and PwC analysis
0,00%
01
01
02
02
03
03
03
04
04
04
05
05
05
06
06
06
07
07
07
08
08
08
8/
2/
5/
9/
1/
5/
9/
1/
5/
9/
2/
6/
0/
2/
6/
0/
2/
7/
1/
3/
7/
1/
0
1
0
0
0
0
0
0
0
0
0
0
1
0
0
1
0
0
1
0
0
1
/
/
/
/
/
/
/
/
/
/
/
/
/
/
/
/
/
/
/
/
/
/
22
26
01
04
08
14
17
21
26
29
02
08
12
15
21
25
28
04
07
12
16
19
ICE Brent
PricewaterhouseCoopers
LME Zinc Cash price
LME Copper Cash price
Slide 16
PricewaterhouseCoopers
21/11/2008
21/08/2008
21/05/2008
21/02/2008
21/11/2007
21/08/2007
21/05/2007
21/02/2007
21/11/2006
21/08/2006
21/05/2006
21/02/2006
21/11/2005
21/08/2005
21/05/2005
21/02/2005
21/11/2004
21/08/2004
21/05/2004
21/02/2004
21/11/2003
21/08/2003
21/05/2003
21/02/2003
21/11/2002
21/08/2002
21/05/2002
21/02/2002
21/11/2001
21/08/2001
21/05/2001
100-days historical Vol
A view on the markets
Volatility and contracts maturity
80,00%
ICE Brent 100-days historical Volatilities
70,00%
60,00%
50,00%
40,00%
Spot
3-M
12-M
24-M
30,00%
20,00%
10,00%
0,00%
Source: Bloomberg data and PwC analysis
Time
Slide 17
Agenda
Audience perspective
A view on the markets
Evolution of Commodity Markets
Where philosophy meets strategy
CRM related issues
Wrap up and conclusion
Evolution of Commodity Markets
A Bit of History
From Butter and Cheese…
The Butter and Cheese Exchange of New York was founded in 1872..
You may better know its today’s name: NYMEX. Today, the Exchange is the
world's leading energy and precious metals market.
PricewaterhouseCoopers
Slide 19
Evolution of Commodity Markets
A Bit of History… (cont’d)
… to a wide range of commodities: from oil, gas, electricity and metals to…
Vegetable Oil, Cheese, Eggs, Pork Bellies… CO2 and Weather…
Today, a high number of market places exist and can be used for hedging or
speculating on Commodity Risk
PricewaterhouseCoopers
Slide 20
Evolution of Commodity Markets
From physical to financial markets (1/2)
Zeebrugge Hub daily average traded volumes and
daily average physical throughput
2000,0
an
-0
M 1
ay
-0
Se 1
p01
Ja
n0
M 2
ay
-0
Se 2
p02
Ja
n0
M 3
ay
-0
Se 3
p03
Ja
n0
M 4
ay
-0
Se 4
p04
Ja
n0
M 5
ay
-0
Se 5
p05
Ja
n0
M 6
ay
-0
Se 6
p06
Ja
n0
M 7
a
1800,0
1600,0
1400,0
Month
1200,0
GWh 1000,0
800,0
600,0
400,0
200,0
Ja
n0
M 0
ay
-0
Se 0
p00
Ja
n0
M 1
ay
-0
Se 1
p01
Ja
n0
M 2
ay
-0
Se 2
p02
Ja
n0
M 3
ay
-0
Se 3
p03
Ja
n0
M 4
ay
-0
Se 4
p04
Ja
n0
M 5
ay
-0
Se 5
p05
Ja
n0
M 6
ay
-0
Se 6
p06
Ja
n0
M 7
ay
-0
Se 7
p07
Ja
n0
M 8
ay
-0
Se 8
p08
Ja
n09
0,0
Month
Physical Throughput daily average
Net Traded daily Average
Source: huberator.com
PricewaterhouseCoopers
Physical Throughput daily average
Net Traded daily Average
Slide 21
Evolution of Commodity Markets
From physical to financial markets (2/2)
Average
daily World Oil production and Brent traded
Average daily Oil production and Brent Futures traded (Thousand Bbl)
(Thousand barrels)
350.000
300.000
Thousand Bbl
250.000
200.000
150.000
100.000
50.000
2008-10
2008-7
2008-4
2008-1
2007-10
2007-7
2007-4
2007-1
2006-10
2006-7
2006-4
2006-1
2005-10
2005-7
2005-4
2005-1
2004-10
2004-7
2004-4
2004-1
2003-10
2003-7
2003-4
2003-1
2002-10
2002-7
2002-4
2002-1
2001-10
2001-7
2001-4
2001-1
0
Month
Wold oil production (Average KBbl / day)
PricewaterhouseCoopers
Average of FUT_AGGTE_VOL (KBbl)
Source: Bloomberg data and PwC analysis
Slide 22
Evolution of Commodity Markets
Development of New Markets – Weather Derivatives
• Correlation between their business and climate:
- Hot summer of 2003, hot winter 2006-2007, rainy summer 2007…
- Concerns regarding global climate change and its impact
• Weather fluctuations is a risk against which companies may wish to be
hedged
• Slow to take-off of hedging products due to:
- Complex relationship between weather and business performance
- “Uniqueness” of the relationship between the business and the weather
(creation of basis risk and sub-optimal hedges)
- No medium-long term valuation method (due to uncertainty of weather
forecast) and lack of speculators who could add liquidity in the market
PricewaterhouseCoopers
Slide 23
Evolution of Commodity Markets
Development of New Markets – Weather Derivatives (cont’d)
Example 1: Correlation between
temperature and electricity demand
in Spain in 1983 and in 1998
Source: Journal of applied meteorology,
August 2001, Volume 40, p 1418
PricewaterhouseCoopers
Example 2: Influence of T° and
rainfalls on the corn yield
Source: WRMA lesson 1a Weather effects
on Crop yields, December 2004
Slide 24
Agenda
Audience perspective
A view on the markets
Evolution of Commodity Markets
Where philosophy meets strategy
CRM related issues
Wrap up and conclusion
PricewaterhouseCoopers
Slide 25
Where philosophy meets strategy
Would you be Winnie the Pooh or the Tigger
"Don't underestimate the
value of Doing Nothing, of
just going along, listening
to all the things you can't
hear, and not bothering.“
~ Winnie the Pooh
"True mastery can be
gained by letting things go
their own way. It can't be
gained by interfering."
~ Lao Tseu
Source:http://financialphilosopher.typepad.com/
PricewaterhouseCoopers
Slide 26
Where philosophy meets strategy
The call for action
“The market can remain irrational longer than you can remain solvent”
~ Keynes
The basic 4 steps approach:
3. Manage
1. Identify
4. Control
2. Measure
PricewaterhouseCoopers
Slide 27
Where philosophy meets strategy
The 4 steps approach (1/5)
1. Identify what the exposure is?
• Locate the exposure:
- In which subsidiaries, for which products?
- Within purchases, sales, transformation process?
• Identify physical contracts (firm commitments, forecasts) and indexed
contracts creating exposure
2. Measure the exposure and your sensitivity
• Quantify the exposure (consider netting of exposures, natural hedges,…)
• How much does the commodity price represents within my cost structure?
• Assess earnings sensitivity to commodity price taking into account
- Commodity price volatility
- Volume risk (demand elasticity)
PricewaterhouseCoopers
Slide 28
Where philosophy meets strategy
The 4 steps approach (2/5)
3. Manage the exposure in line with the company’ strategy and
objectives (1/4)
• Key input from management:
- CFO, Treasurer, Sales Director, Purchase Director, Production Director,
Country Managers
• Objectives should be aligned with:
- Company business model
- Company risk appetite
- Shareholders expectations
• Typical objectives:
- Zero exposure
- Reduce earnings volatility
- Lock-in margins and ensure medium term visibility for the business
PricewaterhouseCoopers
Slide 29
Where philosophy meets strategy
The 4 steps approach (3/5)
3. Manage the exposure in line with the company’ strategy and
objectives (2/4)
How can we manage the risks?
• Choice of methodology and instruments:
- Financial hedges
- Purchase / sales contracts re-negotiation
- Find natural hedges
- Process re-organisation
• Centralised V.S. decentralised processes:
- Identification of exposures
- Reporting process to Group Treasury
- Follow-up of forecasts versus actuals
- Hedging decision and execution process
PricewaterhouseCoopers
Slide 30
Where philosophy meets strategy
The 4 steps approach (4/5)
3. Manage the exposure in line with the company’ strategy and
objectives (3/4)
What are the economic and accounting impact of selected strategy?
• What are competitors doing? Which are the accounting implications of the
economic choice made,…
How to implement?
• Provide training to key stakeholders:
- In which subsidiaries, for which products?
- Within purchases, sales, transformation process?
• Customise and automate exposure reporting
- Tools, reports,...
PricewaterhouseCoopers
Slide 31
Where philosophy meets strategy
The 4 steps approach (5/5)
3. Manage the exposure in line with the company’ strategy and
objectives (4/4)
4. Control the achieved performance
• Benchmarking versus
- “No hedge” scenario
- Alternative hedging scenario
• Consider whether we achieved our primary objectives
- From an economical standpoint (cost effectiveness, competitiveness,…)
- Accounting (do we reflect the economic reality in the accounting?)
PricewaterhouseCoopers
Slide 32
Where philosophy meets strategy
The quantification exercise (1/3)
Measuring the exposure
• Across the Group
- Netting opportunities
- Local monopolistic markets / legal constraints / non-market driven
prices
• Natural hedges / price pass-through mechanism
- Working in both ways
• Competitive environment / market practice
• Client acceptance for price increase in bull market
• Client acceptance for no price decrease in bear market
- Time lags between purchases and sales
• How does the commodity volatility impact
- Cost structure
- EBIT
- Other (covenants working capital requirements,…)
PricewaterhouseCoopers
Slide 33
Where philosophy meets strategy
The quantification exercise (2/3)
Base case
Measuring the sensitivity of the cost structure: Air France – Base case HY08
Source: AirfranceKLM website
14.000
12.000
2.972
10.000
8.000
12.983
EUR Mio
6.000
4.000
639
2.000
0
Costs
Employees
commercial & distribution costs
Fuel costs
PricewaterhouseCoopers
Revenues
Aicraft costs
Handling charges
Revenues
Margin
Landing fees and end route charges
Other
Margin
Slide 34
Where philosophy meets strategy
The quantification exercise (3/3)
Measuring the sensitivity of the cost structure: Air France simulated costs:
•
No hedge – 60% jet fuel increase – 50% pass through via fuel surcharge
Source: AirfranceKLM website
and PwC simulations
Simulation - No hedge; 50% pass through
16.000
892
14.000
4.755
12.000
10.000
8.000
12.983
EUR Mio
6.000
4.000
2.000
0
-253
-2.000
Costs
Employees
Handling charges
Fuel surcharge revenues
PricewaterhouseCoopers
Revenues
Aicraft costs
Other
Margin
Landing fees and end route charges
Fuel costs
Margin
commercial & distribution costs
Base Revenues
Slide 35
Where philosophy meets strategy
The need for adequate CRM policies
"Only in quiet waters things mirror themselves
undistorted.
Only in a quiet mind is adequate perception of the world.“
~ Hans Margolius
•
•
PricewaterhouseCoopers
Avoid bad timing for decision taking. E.g.
- Hedging jet fuel price in July
- Clearly sets the rules of the game, the
expectations of the stakeholders
Policies should cover
- Goal
- High level strategy
- Rationale
- Roles & responsibilities
- Reporting requirements – KPIs
Slide 36
Where philosophy meets strategy
Choosing the right strategy upfront (1/2)
"When the mind is in a state of uncertainty the smallest impulse directs it to
either side.“
~ Terence (195/185 - 159 BC)
Avoid asking yourself the right questions at the wrong moment
•
•
•
•
•
Historical comparison of potential strategies
Building simulation tool
Running what-if analysis
Using stress testing
…
Knowing upfront potential impact of Commodity prices should enable you to
react more quickly and more appropriately
PricewaterhouseCoopers
Slide 37
Where philosophy meets strategy
Choosing the right strategy upfront (2/2)
Weighted average quarterly Jet fuel pruchase price
Historical simulation of jet fuel hedging strategies
1.000
Source: Bloombreg data and
PwC analysis
900
Jet fuel price (USD / Ton)
800
700
600
500
400
300
200
Hedge build-up period
100
Comparability period
0
Q1
2003
Q2
2003
Q3
2003
Q4
2003
Q1
2004
Q2
2004
Q3
2004
Q4
2004
Q1
2005
Q2
2005
Q3
2005
Q4
2005
Q1
2006
Q2
2006
Q3
2006
Q4
2006
Q1
2007
Q2
2007
Q3
2007
Q4
2007
Quarters
Scenario 1 - No Hedge
PricewaterhouseCoopers
Scenario 2 - Systematic Hedge
Scenario 3 - Hedge Ratio Cube
Slide 38
Where philosophy meets strategy
Finding the Best Hedge
Do financial instruments exist for the commodities I am exposed to?
• Yes
- Are these OTC or exchange traded derivatives?
- Is the price transparent?
- Is there enough liquidity? And for which maturity?
- What would be the cost / benefit of hedging?
•
No => Proxy hedging
- Do other financial instruments exist for highly correlated commodities?
(Proxy hedging)
- How stable is the correlation across time?
- How effective is the hedge relationship?
=> Proxy hedging may be the only efficient solution for hedging but
may create additional complexities on the accounting side.
PricewaterhouseCoopers
Slide 39
Where philosophy meets strategy
CRM and the Treasurer
•
Commodity Risk Management tends to be placed under the
responsibility of the Treasurer when the exposures remain
acceptable.
- This allows to benefit from the Expertise and the infrastructure of
Treasury.
•
This is untrue for companies where Commodity Risk is at the core of
the Business (e.g. Utilities, Metal Refining, etc)
- Commodity Risk tends to be managed by a distinctive function from
Treasury (need for expert skills and specific systems).
•
In the latter case, interaction between Commodity Risk Management
and Treasury remains important in order to integrate :
- The FX risk dimension (commodities are often USD denominated)
- Funding of CRM activities (e.g. margin calls)
- Counterparty risk generated by CRM activities (OTC derivatives)
PricewaterhouseCoopers
Slide 40
Section five
Audience perspective
A view on the markets
Evolution of Commodity Markets
Where philosophy meets strategy
CRM related issues
Wrap up and conclusion
PricewaterhouseCoopers
Slide 41
CRM related issues
Managing CRM related issues
Managing commodity risk comes along with other “side duties”:
Liquidity
Commodity Risk
Management
Counterparty
Crack spread swaps
Foreign Currency
Brent swaps
Operational
Accounting
PricewaterhouseCoopers
Slide 42
CRM related issues
Accounting for Commodity Hedges (1/2)
Specificities for commodities:
• Cannot isolate a component of a pricing formula: only the entire change in fair value
of the hedged commodity contract can be hedged
- Hedging one component of a price formula would most likely not qualify for
hedge accounting
Proxy hedging - Basis risk
• When no exact pricing is available to hedge an exposure, a correlated pricing can
be used which may lead to difference in pricing movement from the hedge item and
hedge instrument
Proxy hedging - Quality premium
• The quality premium in a pricing formula of a physical contract may not be included
in the pricing formula/index of a financial contract.
Hedge accounting and effectiveness testing may be difficult to achieve but
solutions do exist.
PricewaterhouseCoopers
Slide 43
CRM related issues
Accounting for Commodity Hedges (2/2)
Application of hedge accounting to stack-up strategy
• De-designation and Re-designation may need to take place if various derivatives
are packaged to synthetically hedge the exact exposure
Synthetic jet fuel build-up
14.000
Volume (Bbl)
12.000
Diffs
10.000
8.000
6.000
Crack spread swaps
4.000
2.000
Brent swaps
0
Q1
Q2
Q3
Q4
Q5
Q6
Q7
Q8
Quarter ahead
PricewaterhouseCoopers
Slide 44
CRM related issues
FX and Operational risks
Majority of commodities are quoted in USD – FX risk
• Chosen policy should incorporate a strategic analysis of interdependency of these
two risks
- Managed at the same time?
- Manage separately (leave room to benefit from potentially favourable market
movements)
Type of operations – Operational risk
•
Need to have adequate structure to manage CRM instruments (derivatives)
- FO / MO / BO segregation
- Set-up risk committee to monitor CRM activities and take strategic orientations
- Follow-up of physically VS financially settled transactions
- Adequate systems and tools
- Knowledgeable teams / training
=> Treasury is the adequate environment to develop this activity
PricewaterhouseCoopers
Slide 45
CRM related issues
Liquidity and Counterparty risks
High volatility implies important changes in market values – Liquidity risk
• Exchange traded derivatives often require the set-up of margining arrangements
- Daily exchange of the Mark-to-Market (MtM) of open contracts
• Limited credit risk
• Creates additional administrative burden
• Creates additional liquidity requirements that may be significant (asymmetric
margining between physical and financial contracts)
Important market values of derivatives can increase the credit risk
•
Positive fair value of OTC derivatives not subject to margining create additional
credit risk
- Requirement for adequate follow-up of trading counterparties
- Need to incorporate credit risk within the CRM policies
PricewaterhouseCoopers
Slide 46
Agenda
Audience perspective
A view on the markets
Evolution of Commodity Markets
Where philosophy meets strategy
CRM related issues
Wrap up and conclusion
PricewaterhouseCoopers
Slide 47
Wrap up and conclusion
The best moment to fix the roof is when the sun is shining
•
•
Is it the right time to hedge the Commodity price risks?
In any case it is the right time to
- Define your CRM strategy
- Start managing your commodity risks
700,00
Back to the future!
• Brent: Dec 2004
• Zinc: Dec 2004
• Aluminium: Oct
2002
• Copper: May 2005
Between 4 and 7
years of price rise
have disappeared!
600,00
400,00
300,00
200,00
100,00
04/01/2009
04/10/2008
04/07/2008
04/04/2008
04/01/2008
04/10/2007
04/07/2007
04/04/2007
04/01/2007
04/10/2006
04/07/2006
04/04/2006
04/01/2006
04/10/2005
04/07/2005
04/04/2005
04/01/2005
04/10/2004
04/07/2004
04/04/2004
04/01/2004
04/10/2003
04/07/2003
04/04/2003
04/01/2003
04/10/2002
04/07/2002
04/04/2002
04/01/2002
04/10/2001
Source: Bloomberg data and PwC analysis
04/07/2001
0,00
04/04/2001
100 = 04/04/2001
500,00
Time
ICE Brent
PricewaterhouseCoopers
LME Zinc Cash price
LME Copper Cash price
Aluminium Cash price
Slide 48
Thank you!
Olivier Cattoor
[email protected]
+32 2 710 4118
Olivier Kaczmarek
[email protected]
+32 2 710 9624
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