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Proxy Hedging

The commodity market has the unique particularity to have both a physical and a financial side. The financial market will offer standardized tools and underlyings (benchmarks) to transfer the price risk from one market participant to another. 

That risk transfer enables each player to focus on his core business: producers or consumer on their industrial activities and financial institutions in pooling liquidity.

However standard products can hardly represent the entire commodity specificities linked to physical transactions. The price of a physical commodity includes a premium (basis) linked to its specific “grade” (density for oil, purity for base metals , type of crop etc.) and its location of delivery (in the field in Ukraine, at a port in south America , etc.).

Having reached the stage where the commodity exposure has been identified, documented and measured, there are the somewhat obvious questions of whether it is possible to hedge, and if so, whether it is wise to do so.