I am a part of the team which is responsible for management and hedging of commodities exposures. Some say corporates are good only in following advice from banks or brokerages. I do agree corporates do not have market insight of a bank. But here is a problem. It is not bank or broker or a hedge fund that has biggest risk that markets will go against them. These guys always have an option to do nothing and wait for a better trading opportunity where as we don't. We have to continue to purchase commodities, spend currencies for daily business. Such company is always exposed to changes to market price even if it decides not to hedge. In fact my company has probably one of the biggest short commodities portfolio in the world. Managing such risk effectively is a challenge. It is like being between a rock and a hard place. You get your behind kicked all the time be senior management, whether it was a missed opportunity to hedge or hedge that turned to be out of the money. Critics will say if you lost money on your hedge then you probably bought it cheaper on physical market. let's face it, nobody wants to loose money, full-stop.

So I do not have an option to do nothing as I am always in the position (short in this case). I think people like me have higher motivation to earn positive return on their portfolio then other players. In fact my intention is to bring hedging to a performance benchmark of proprietary trading.

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The basics of hedging policies

I have seen various commodity hedging policies. I assume that any company is buying commodities, transforms them into final product and sells to a customer. obviously there are exceptions, such as bulk commodity producers. These guys only sell e.g. iron ore at certain price. Or you are a car producer that buys galvanised steel, but you cannot transfer 100% of price changes of steel and zinc onto final customer. such exceptions in fact pose the biggest risk of operational margin squeeze or negative p&l. In general consumer or producer have the following choices:

- do not hedge at all. it is also a decision. Now there is a trick... can you pass most of your risks onto your customers? if yes, from risk management perspective it is the best hedge, however you rarely find one on consumer side. Bulk commodities producers like it very much. It also makes sense from investors view: I am buying shares of such company to be exposed to commodity price fluctuations. If you cannot pass the risks and do not hedge them, then you are in trouble from my point of view. so you have a choice to adopt following hedging policies:

- fixed percentage hedging policy. It is very common for airlines who have minimum required hedge percentage of jet fuel for any period in time. Some policies require hedges that go up to 5 years in the future. well, such strategy reduces volatility of your input costs and if markets are rising (look at 2000-mid2008) your hedges have a good chance to end up in the money. but I doubt these hedges added any value when markets crashed in the middle of 2008. and moreover you cannot unwind these hedges as most probably you were applying hedge accounting rules. and that sucks!

- opportunistic hedging. the purpose of such strategy is simple - hedges should bring money. This is the only way to mitigate market risk - risk from that arises from adverse price movements. I think this is the future of any corporate that decides to engage into hedging its risks. This however makes things more difficult as the requirements for market expertise increase greatly. This puts hedging on the same level with proprietary trading. this puts a corporate on the same level with bank and hedge fund or any other entity whose sole purpose is to provide return for their investors.

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