Risk Management

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A Bespoke Approach to Commoditised Products For corporation, the reliance on commodities either as inputs or outputs is often fundamental to the business. Over recent years, we have seen unprecedented volatility in the price of all kinds of commodities, and in this article the Editor considers what developments we might witness in the future, and how the corporate community is responding.

A Bespoke Approach to Commoditised Products

by Helen Sanders, Editor

As I sit here with my morning cup of tea and toast, with the radio on, while the rest of the country seems to be out on the beach eating chocolate ice cream and/or drinking flasks of lukewarm coffee, depending on where in the world you happen to be, it occurs to me just how reliant we are on commodities. Energy, metals, grain, rice, tea, coffee, cocoa are all essential features of our lives, virtually every day of the year (or in the case of precious metals, they don’t feature quite enough for my liking). For corporations, the reliance on commodities either as inputs or outputs is often fundamental to the business. Over recent years, we have seen unprecedented volatility in the price of commodities of all sorts, fuelled by supply peaks, a decline in demand, currency fluctuations, ongoing economic uncertainty and growing demand for commodities by the investment community. So as it is often said that opinions are the cheapest commodities in the world, what could we witness in the future, and how is the corporate community responding?

A little crystal ball gazing

According to the IMF’s World Economic Outlook (WEO) in July 2010, world growth is projected at 4.6% in 2010 and 4.3% in 2011. This forecast is around 0.5% higher for 2010 than previously stated in April 2010, reflecting stronger than anticipated activity during the first half of the year and enhanced by attractive prospects in Asia, particularly China,

“Overall, macroeconomic developments during much of the spring confirmed expectations of a modest but steady recovery in most advanced economies and strong growth in many emerging and developing economies.” (WEO, July 2010)

However, the IMF also comments that in parallel with steady growth, downside risks have risen sharply amid renewed financial turbulence, in countries such as Greece and Spain,

“Nevertheless, recent turbulence in financial markets — reflecting a drop in confidence about fiscal sustainability, policy responses, and future growth prospects — has cast a cloud over the outlook.” (WEO, July 2010)

Concerns over both sovereign and banking sector risk stemming from the European crisis have been yet another storm that has buffeted equity, commodity and currency prices. Looking at commodity prices, many of which seemed to have steadied following unprecedented volatility in recent years, the IMF commented,

“Prices of many commodities fell during the financial market shocks in May and early June, reflecting in part expectations for weakened global demand. Prices recovered some ground more recently, as concern about the real spillovers of the financial turbulence has eased. At the same time, waning appetite for risk prompted gold prices to settle higher. In line with futures market developments, the IMF’s baseline petroleum price projection has been revised down to $75.3 a barrel for 2010 and $77.5 a barrel for 2011 (from $80 and $83, respectively, in the April 2010 World Economic Outlook). (WEO, July 2010)

Commodity hedging is in many cases, a relatively new activity for treasurers.

A new task for treasurers

When we consider the heady post-$100 a barrel oil prices of relatively recent years, it might seem that large users of fuel can heave a sigh of relief and start browsing for a last minute holiday package. Not so. If the past few years have taught us anything, it is not only that the unexpected should be expected, but that something no-one has thought of might just happen too. So where does this situation leave treasurers? Firstly, commodity hedging is, in many cases, a relatively new activity for treasurers, as Jiro Okochi, Chief Executive Officer, Reval explains,

“Treasurers are taking more ownership over the commodities hedging process, an activity which would historically have been undertaken by procurement. In the past, hedging was typically more seasonal, based on historic trends; treasury tends to be more methodical in assessing the potential impact of current and future market risks.

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