Risk Management

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Commodity Hedging - the advent of a new paradigm The events of 2008 have shaken up the risk management approach of multinational corporations (MNCs) and have given renewed emphasis to the way they handle a range of financial risks, such as commodity purchasing, liquidity, FX and funding. These issues have come to the fore for heavy users of commodities following the rollercoaster ride in the prices of oil, metals, and soft commodities.

Though the high prices of 2008 have now subsided, today’s situation remains woefully uncertain for the MNCs. Consequently, many firms have experienced hedging outcomes that are as unexpected as they have been painful, with the end result that they have seen significant M-t-M losses on their books. This has increased scrutiny from the board, and made ever greater calls on the expertise of the treasury function in general and on the treasurer in particular. In such conditions, complacency is not an option.

This article details the manner in which companies must respond to a new reality in order to achieve more reliable, predictable raw material costs and similarly predictable earnings in both primary business and in the capital markets.

Commodity Hedging – the advent of a new paradigm

by Hans-Kristian Bryn and Mark Robson, Partners, Oliver Wyman’s Corporate Risk practice

The events of 2008 have shaken up the risk management approach of multinational corporations (MNCs) and have given renewed emphasis to the way they handle a range of financial risks, such as commodity purchasing, liquidity, FX and funding. These issues have come to the fore for heavy users of commodities following the rollercoaster ride in the prices of oil, metals, and soft commodities. Though the high prices of 2008 have now subsided, today’s situation remains woefully uncertain for the MNCs:

  • Though price levels have in general dropped from their peak, volatility remains high and, in some cases, even higher than in 2008
  • The consumption rate of most commodities is now lower than in most of the previous decade as a consequence of the economic downturn
  • In consequence, the present hedge positions have a market value which is far below the levels at which they were entered into.

As a result of this situation, many firms have experienced hedging outcomes that are as unexpected as they have been painful, with the end result that they have seen significant M-t-M losses on their books. This has increased scrutiny from the board, and made ever greater calls on the expertise of the treasury function in general and on the treasurer in particular. In such conditions, as one treasurer told us, “Complacency is not an option”.  

Faced with higher levels of earnings volatility, organizations need to quickly develop an approach to effectively manage this uncertainty. Companies that are able to achieve more reliable, predictable raw materials costs – and similarly predictable earnings – will have a clear competitive edge, both in their primary business, where customers can be confident that their own costs are not going to be volatile, and in the capital markets, where debt and equity investors will reward stability.

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