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To Hedge or Not To Hedge

- Raw material price management and added value from treasury

by Wolfgang Frontzek,  Director of Group Treasury/Corporate Finance, Wilo

In recent years, commodities buyers have had to cope with extreme price increases and price fluctuations. Where it was not possible to cushion or pass on the effects of the price rises, they often had a negative impact on company profits. Rising raw material prices are not the only problem that buyers have, as the buyer is responsible not only for a fixed calculation or price basis but also for ensuring continuity of the production process, certainly over the medium term and thus over a planning period of 12-24 months. Price volatility presents the same problem, as it makes commodity prices genuinely unpredictable.

An active financial risk management process is necessary, to answer the following questions:

  • How high is the exposure?
  • What percentage of the production costs do raw material costs account for?
  • What effect does the price fluctuation of raw materials have on total profits?
  • Can price fluctuations be passed on?
  • What is the competition doing?

Only when these analyses have been made and the links clearly understood is it recommended to evaluate risk strategies and make use of derivative instruments.

This is where the experience of the treasury division is of benefit to the purchasing function. Long before there was much discussion of high volatility and unpredictable price fluctuations this was a common scenario for the treasurer. For years, treasurers have been tackling the problems of interest and exchange rates in an analytical and structured manner, in order to get to grips with the effect on overall profits and interest expenditure.

For years treasurers have been tackling the problems of interest and exchange rates in an analytical and structured manner.