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Becoming a navigator of commodity risk

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High interest rates and erratic economic fortunes have sent commodity prices on a perilous roller coaster ride over the last year.

Energy, metals and agricultural goods have all experienced major spikes and collapses creating precarious risks for corporations dependent on their predictable pricing. Too often companies have taken passive stances, simply accepting exposure or imperfectly reacting as commodity uncertainty unfolds.

But for forward-thinking CFOs and treasury teams, turbulent commodities offer upside if risk is approached proactively rather than reactively.

The fundamentals driving commodities volatility remain mostly macroeconomic and geopolitical forces beyond corporate control. This leads many executives to throw up their hands under the presumption risk mitigation avenues remain limited so exposure is inevitable.

But innovative treasury groups understand powerful options still exist to modulate exposure, acting as navigators who actively steer their enterprises based on risk mentality not just price movements alone.

Being proactive

This proactivity starts by comprehensively cataloguing all direct and indirect commodity dependencies across the enterprise. For example, a food manufacturer may realize it holds not just ingredients risks but also outsized packaging or transport fuel exposures.

Holistically quantifying usage then allows selective targeting of mitigation efforts towards risks that could truly move the needle while letting incidental exposures self-correct through natural hedges. A manufacturer might hedge aluminium but not minor cardboard inputs as a discretionary place to start.

With core exposures understood, navigators could take a portfolio approach, deliberately balancing exposure. Some is fixed via long term supply contracts, providing certainty even at some premium.

Additional exposure gets externally hedged through derivatives that allow capitalizing on short term price declines without forgoing long run averages. Any residual exposure can be retained to leave upside in case of trends like broad material inflation where input costs rise relative to output prices, protecting margins. Balancing tools creates resilience.

Importantly proactive commodity risk managers build tight connections between physical supply teams and financial treasury teams. This prevents over-hedging by recognizing that procurement flexibility on vendor, grade or specification changes moderates financial derivatives needs.


Building connections

  1. Cross-functional Teams: Establishing cross-functional teams involving members from both physical supply and financial treasury teams can enhance communication and collaboration. These teams can work together on risk assessment, strategy development, and execution, ensuring that both operational and financial perspectives are considered in decision-making processes.
  2. Integrated Risk Management Systems: Implementing integrated risk management systems that can track and analyze both physical and financial risks in real-time. Such systems allow for a unified view of commodity positions, financial exposures, and market movements, facilitating more informed and coordinated responses to market changes.
  3. Regular Joint Meetings: Holding regular meetings between the physical supply and financial treasury teams can ensure that both sides are aware of the current market conditions, operational challenges, and financial strategies. These meetings can be used for sharing insights, forecasting market trends, and aligning on risk management strategies.
  4. Joint Training Programs: Developing joint training programs for members of both teams on topics such as market analysis, financial instruments (e.g., futures, options, swaps), and risk management techniques. This shared knowledge base fosters a common language and understanding, making it easier for teams to work together effectively.
  5. Collaborative Decision-making Processes: Ensuring that key decisions regarding commodity purchasing, hedging strategies, and financial risk management are made collaboratively between the physical supply and financial teams. This approach ensures that operational realities inform financial decisions and vice versa.
  6. Technology Integration: Leveraging technology to integrate data sources and analytics tools used by both teams. This could involve the use of commodity management software, ERP systems, and financial modeling tools that provide both teams with access to shared data and analyses.
  7. Performance Metrics and Incentives: Aligning performance metrics and incentives for both teams to encourage collaboration and joint achievement of risk management objectives. This alignment can motivate teams to work together towards reducing commodity price risks and optimizing financial performance.

But it also avoids risk spikes from contract coverage gaps or substitutions made without treasury visibility. Tight commodity alignment insulates both supply assurance and pricing outcomes.

These efforts require investments – in data transparency, analytics and people. But the payoffs warrant attention from senior executives.

Mitigating commodities uncertainty not only prevents profit shortfalls but allows smarter decisions from contract negotiation through to competitive pricing and margin expansion when competitors struggle with volatility.

It’s why navigators with strategic risk programs ultimately sail ahead of passenger peers at the mercy of external commodity price winds. Now is the time for CFOs to take stock of commodity risk resilience. Of all the uncertain seas companies face, this is one worth charting proactively.

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