Commodity price management

Commodity price management and best ways for companies to hedge their commodity risks

Unrest in the Arabic world, inclement weather, droughts in wheat-growing regions and trade wars between the world’s greatest economies: global events have an immense impact on commodity prices and cause volatility. Consequently, companies should actively manage their commodity price risks. Our experts at Commerzbank have the know-how and solutions that enable companies to safely hedge their commodity risks.

Adequate hedging of commodity risks

The ongoing tensions between Iran and the USA show that geopolitical events may cause significant price volatility, in this case concerning the price of crude oil. Other potential reasons for price fluctuations are changes in economic forecasts, strikes and supply shortages. And then there is a rather simple, everyday reason why price development is often extremely volatile: the weather. As a result, securely calculating offers poses a great challenge to companies that make extensive use of commodities. A sudden increase in commodity prices may quickly turn into a cost trap. Thus companies should give priority to the active management of commodity price risks. This is the only way to achieve planning security, reduce exposure to price fluctuations and guarantee stable prices for their customers.

Specific risk analysis as the first step

At Commerzbank, we support our customers in analysing their commodity risks and in quantifying their relevant areas of exposure. Transparency with regard to one’s own value chain is a prerequisite for the identification and hedging of risks. And any adequate hedging of commodity risks also involves paying attention to so-called secondary risks, such as foreign exchange rates, the cost of energy, transport, logistics and relevant packaging materials. There’s no uniform solution in commodity risk management as every corporate segment and every individual company has its own specific requirements. For example, a sudden increase in fuel prices can pose an existential threat to a logistics company because for them fuel is a crucial cost factor. Meanwhile, the same increase in fuel prices would probably constitute a secondary, indirect risk for other corporate segments. Companies should pay attention to these differences and hedge their risks in a specific, tailored manner.

Information is fundamental for effective and professional risk management

Our customers’ information about their specific requirements is crucial to devising and implementing a tailored commodity risk management strategy. Commerzbank Research provides transparency and information on market development with an abundance of relevant publications. Our customers* benefit from the “Commodities Daily” newsletter as well as “Commodity Spotlights” , a regular publication focusing on current topics. In addition, there is the quarterly newsletter “Commodity Radar“, which provides an overview onf the historical volatility of selected commodities.

Basic ways for companies to hedge their commodity risks

Many companies are already actively hedging their interest and foreign exchange risks. Identical financial instruments exist for the management of commodity price risks. However, the extent of volatility and the direct exposure of companies are much greater when it comes to commodities. At Commerzbank, we offer a multitude of instruments for hedging commodity risks. For example, it may be possible to hedge a fixed price for a certain commodity. A company might also choose to pay a premium for a kind of insurance, a warrant, which assures compensation in the event of a strong increase or decline in the price of a commodity. By combining these basic instruments, we can achieve specific payment profiles tailored to our customers’ requirements. These financial hedging instruments separate the price risk from the physical transaction allowing the client to be much more flexible at procuring commodities.

In addition, most companies have already acquired some experience and knowledge of their own, which can be meaningfully combined with our instruments. As a rule, a company’s finance department already uses similar instruments to hedge interest and foreign exchange risks. The corporate procurement unit contributes know-how with regard to commodities, supply and value chains. If this knowledge is paired with Commerzbank’s expertise, companies may hedge their commodity price risks in the best way possible.

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Crude oil hedging

Interview: Why hedging of commodities such as crude oil is so important