Hedging Alone Can’t Save Manufacturers from Risk
July 20, 2018
Volatility is back – if it ever left – in commodity markets. Geopolitical risks have exploded in the past few weeks and months with the threat and reality of trade tariffs and trade wars, sanctions and political instability, adding to both price and supply uncertainty. Among those impacted – potentially severely – are CPG and manufacturing companies that rely on basic commodities for their products, packaging, and transportation. Often unable to pass on price increases to consumers as a result of competitive retail markets, these businesses stand exposed to greater risk than ever before.
Over the last decade, a fair proportion of such businesses have seen hedging base commodity exposure as a potential answer to price risk and volatility. However, in some instances, the hedging strategies have had a negative impact on financial performance as hedging can actually increase risks around earnings, at least in the short term under certain circumstances. Additionally, there are often imperfect correlations between an underlying financial commodity and the actual raw materials being utilized by the business. Others may see hedging as an undesirable speculative activity.
In reality, CPG/Manufacturers require an overall more sophisticated approach that involves significant data analysis, planning, forecasting, and risk management. They need the tools and the expertise to perform such analysis, especially in very volatile and complex commodity markets. They have many choices on how to manage their exposures, but making the right choice and managing that effectively requires more than just a hedging strategy. By performing analysis on an ongoing basis, decisions can be made ranging from ingredient substitution to doing nothing at all, from hedging to negotiating longer-term supply contracts that share the price risk with the suppliers, or even acquiring that supply directly via acquisition, for example.
A key aspect of the data analysis is always going to be having a comprehensive and up to date view of position and exposure through the deployment of risk analytics that have access to the underlying data from multiple sources. Ideally, not only will this provide insights into exposure and risks, but it will also allow stress testing and scenario testing to allow different strategies and market conditions to be better understood. Active risk management may well be the key between profit or loss, success or failure, but again, this requires the skills, tools, and mindset to succeed.
These days, comprehensive risk management strategies for CPG/Manufacturers are even more complex as the supply chain has come increasingly into focus. As larger, global entities have more control over producers via farm to fork type strategies, origination has become more important and harder than ever before. It is not just the basic raw materials that are impacted here, but also logistics, and the management of expenses related to origination and logistics. As trade tariffs bite and sanctions take hold, supply chains can be negatively impacted and impacted abruptly – for example, the Russian sanctions and Rusal. Aluminum prices skyrocketed as supply chains were thrown into complete chaos, meaning that other suppliers – rather than being able to take advantage of higher prices – found they faced difficulties just keeping supply chains active.
Again, this emphasizes the need for comprehensive and active risk management – not just a hedging strategy. It must factor in supply chain risks and exposures as well as market risks. This requires access to data, planning and forecasting tools and that data needs to be integrated into a broad view of risks and exposures. In an increasingly protectionist and unpredictable world, this is now an essential part of operating a CPG/Manufacturing business.