In today’s volatile and changing global economy, corporate interest in commodity price risk management is increasing. Almost every commodity has seen price increases, and many corporations want to protect themselves from these volatile price movements. However, the decision to hedge can be dependent upon factors beyond the economics of the transaction. The difficulties lie in the qualification for hedge accounting treatment of the derivative. Many factors need to be considered, but the fact that commodity hedgers can only hedge the overall price risk (of the physical purchase or sale to the delivered location) is by far the largest hurdle. An often consideration in the testing is the “likeness” of the pool of transactions hedged, if delivered to/from varying locations. The corporation must have access to historical data in order to establish the effectiveness of the hedging relationship.
For those who are thinking of getting started: Kick things off by talking to procurement, understand how many suppliers are used and how the prices are determined under suchsupplier agreements. The next hurdle is finding the derivative instrument that will best match the exposure you need to hedge.
Is your price determined based on spot, average or prior month average index pricing? You may need to look beyond what is obvious and ensure that your derivativeinstrument is the best match, possibly considering a combination of derivatives to get thebest price match (for instance, a combination of an indexed future contract with a location basis swap). While getting started might seem daunting, there are opportunities to qualify for special hedge accounting when hedging commodity price risk.
A little extra effort and data capture may be required, but you can protect the economics and achieve the accounting presentation that matches the transaction timing.