Rising commodity prices and price volatility have many treasurers concerned about their exposures.
Commodity risk has become a growing concern in recent years with rising prices and spikes in price volatility. At a recent summit for The NeuGroup’s FX Managers’ Peer Groups 1 and 2, sponsored by BNP Paribas, members shared their challenges and insights.
One remark illustrated the magnitude of the concern to corporates and their ability to manage the cost of their inputs was: “Everyone looks at FX and goes crazy over it, but commodities are a much bigger problem.” The panel discussion and the pre-meeting survey yielded several insights, including:
- Who manages commodity risk? Treasury is often involved in managing this risk: of those of who responded to the commodity section (about half of the 32 who completed all or part of the survey), 43 percent said treasury manages it, while 29 percent said treasury manages it jointly with another group (typically procurement).
- Exposure classes are hedged separately. Very few – 13 percent of respondents – say that FX and commodities are hedged jointly. But typically, whether hedged jointly with FX or not, the commodity hedge decision rests with treasury, as does the execution of the hedge, a possible indicator of a desire to concentrate such decisions and actions to a center of excellence or expertise. The few that take a portfolio look at all FX, interest-rate and commodity exposure combined rely heavily on VaR analysis to determine what ultimately gets hedged and how much exposure is within acceptable bounds.
- Assured supply and predictability of pricing are the main goals. Assured supply to the business is of utmost importance for business continuity, and the way to get it is to provide fair and predictable prices to suppliers.
- Can a price hike be passed on to customers? Depending on the industry, there are accepted ways of passing on the risk to consumers and end-users, for example fuel surcharges in the airline and delivery business. In businesses like consumer goods, price elasticity is higher and those who are not price leaders need to carefully manage costs by hedging.
- How is commodity risk hedged? When not hedging a particular commodity using financial instruments (futures or OTC contracts) – which many members said they would prefer – agreeing on fixed-price contracts for a certain period of time is a common tool to assure supply (especially if it is a commodity that is hard to get) and satisfied suppliers.
- Hedge accounting. Many commodities are only a component of a compound or supply purchased (e.g., iron ore as an input of steel), which makes it hard to hedge in a manner consistent with qualifying for hedge accounting. This is another reason fixed-price contracts have gained so much ground.
Commodity risk is not going away and will perhaps get more integrated into risk-management programs as companies get more sophisticated in their analysis of all their risks on a portfolio or global basis. This however does require a firm understanding at the senior-management level of this measurement of risk to the company (e.g., earnings at risk) and a decision on how much risk the company is willing to take. Budgets to manage risk, as well as the list of permitted ways to manage commodity risk, will both likely grow as prices continue to rise and remain volatile.