Insight & Analysis

Companies reassess hedging programmes

Published: Sep 2023

While natural gas volatility has declined from last year’s highs, corporates are aware of the potential risks of not protecting themselves from price movements in other key commodities.

Person on laptop doing an assessment survey

Corporates have found themselves under less pressure to implement commodity hedging programmes since the start of this year.

“We are far away from the panic and lack of liquidity experienced during the worst periods of 2022,” observes Kristoffer Dale, Head of Commodities at DNB Markets. “However, we have seen a material uptick in activity from energy consumer clients who are rebuilding hedging programmes that were put on hold during the pandemic and have taken time to normalise due to the energy crisis,” he says.

Luke Roberts, Director, Head of Commodity Sales at Lloyds refers to strong demand from sectors perhaps assumed to be less exposed to commodity prices – such as hospitality and business services – as well as familiar industries such as aviation.

Hungarian low-cost airline Wizz Air rebuilt its commodities hedging policy during the last financial year in the face of rising energy costs, accumulating coverage of 60% of its jet fuel needs for the current financial year.

“In reinstating our commodity risk management policies we have neutralised any advantage our competitors have had on some of our largest cost drivers, which allows us to focus on those aspects of our cost base we can and will control,” says József Váradi, Wizz Air Group CEO.

Multinational oil and gas exploration company Tullow Oil recently implemented new hedges and now has downside protection in place for around 60% of forecast sales volumes through to the end of 2023, with legacy uncapped upside exposure for approximately 45% for the same period.

At 30th June 2023, the group’s derivative instruments had a net negative fair value of US$79m compared to negative US$573m for the same period last year.

However, commodity hedging is not always a positive contributor to the bottom line. Reporting his company’s first quarter results, Volkswagen Group CFO Arno Antlitz referred to strong growth in revenues and operating profit before the non-cash valuation effects from commodity hedging were taken into account.

Having recorded a positive non-cash effect from commodity hedging of €3.2bn in the previous quarter, the German carmaker was down €1.3bn in Q1 2023.

“Fuel and natural gas are most frequently the focus of attention with the exception of consumer packaged goods companies where there is always an emphasis on agricultural products, particularly soybean oil, wheat and corn,” explains Amol Dhargalkar, Managing Partner and Global Head of Corporates at Chatham Financial.

Volatility remains elevated in domestic natural gas even though it is much lower than it was at this time last year. Steel prices are less volatile than in 2021 and 2022 but more volatile than the long-term trend.

Another factor that can temporarily cause an increase in demand for hedging services is the transfer of assets from public to private equity-backed companies, which are more risk averse than public entities.

“I see increased demand for commodity hedging when the market moves against an entity and they can see the negative impact on their capital plan,” says Mohit Arora, VP, Head of Risk Analytics and Decision Sciences at Mobius Risk Group. “Unfortunately, those are the wrong times to hedge. It would be far more advantageous to have a proactive hedge plan that meets their objectives in all price environments.” Additional hedging demand can come from asset purchases and sales when there is an urgent need for a sizeable one-off hedge or unwind transactions.

According to Arora there is sufficient capacity in financial markets to meet demand. “However, the bid/offer can move materially depending on hedge flow and urgency,” he adds. “Market volatility also has an impact since higher volatility means higher risk for the counterparty while they work to neutralise the hedged risk.”

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