7/27/2019 Hedging Bets and Insulating Budgets Against Fluctuating Commodity Prices

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Bank o America Merrill Lynch Article May 2013

Hedging Bets and Insulating

Budgets Against FluctuatingCommodity Prices

A trend among fnancial managersWild swings in commodity prices in recent years have

a ected public sector organizations, whose xed budgetshave also taken hits rom uncertain global markets, decliningrevenues and government cuts. But theyve also impactedprivate-sector companies, even those that began trimmingtheir work orces and budgets in 2008 in response to theeconomic downturn.

To most nancial managers, a 5% variation in an annualbudget is signi cant, to say the least. Not so in commoditieslike energy and metals, where sharp daily price swings havebecome part o the landscape. As a result, nancial o cersat many public-sector agencies and private-sector companies

are increasingly turning to risk management tools to stabilizebudgets, o set commodity price swings and manageuture expenses.

Risk is inherent in doing business,

especially in a global economy.

Risky businessAccording to a McKinsey & Company workingpaper on risk, it is more perilous or public-sector

organizations than their counterparts in the private sector.The role o most government institutions is implicitly orexplicitly rooted in managing risks that the private sectoris either not equipped or not willing to take, the papernotes, citing massive oil spills, Homeland Security threats,the housing and mortgage crisis, and the raud andinsider trading cases that have made ront-page newsin recent years.

On the other hand, private-sector companies have risks otheir own. For multinational ood and beverage corporations,or example, a host o issues rom heat waves and ooding

to lower crop yields and rising oil prices have mademanaging commodity prices critical. Adding to the volatilityare emerging market demands, geopolitical uncertainties,unstable oreign monetary policies and speculation.

A per ect stormIn the summer o 2011, a London-based hedge und boughta substantial percentage o the worlds cocoa bean supply,causing prices to jump to a 33-year high, according to A.T.Kearney, a global management consulting rm. The ood andbeverage industries were in the eye o a per ect storm oprice increases and volatility in the agriculture commoditymarkets, noted Dave Donnan, a partner in KearneysChicago o ce.

Risks o this kind are beyond the control o managementin either sector. Yet while most businesses have su eredthe e ects o economic turmoil here and abroad in thepast ve years, job losses and budget cuts in public-sectororganizations have been especially widespread and deep,leaving no wiggle room when the cost o doing businessrises against reduced budgets.

Take, or example, energy costs. From January 2011 to January 2013, prices ranged rom -3% to +30% or dieseluel, -4% to +43% or unleaded gas, and -9% to +4% or

natural gas. In the same period, public-sector budgetsremained static.

Fluctuations in the prices o raw materials also greatlyin uence how suppliers, manu acturers, retailers and otherprivate enterprises do business, and, consequently, how theymanage nances.

Commodity uctuations o this kind signal the need orlong-term thinking and strong risk management measureswithin public- and private-sector organizations.

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