Crude oil hedging
Interview: Why hedging of commodities such as crude oil is so important
Crude oil is one of those commodities that are subject to the greatest price fluctuations. In the period from sqummer 2020 to summer 2021 alone, price volatility amounted to more than 32 per cent. Our experts at Commerzbank are professional partners for corporations that want to hedge these large price fluctuations and other commodity risks. In this interview, Michael Alt, head of Commerzbank’s Commodities Advisory & Distribution Team, outlines the crucial points of a successful commodity risk management for crude oil and mineral oil products.
Mr Alt, how would you rate the significance of crude oil and the products derived from it for the German corporate sector?
Michael Alt: They are of immense significance. Take the transport sector as an example: according to the German Environment Agency (Umweltbundesamt) (only available in German), mineral oil products accounted for more than 90 per cent of energy consumption in the transport sector alone. This includes fuel for trucks, ships, planes, trains and public transport units. By comparison, the industrial sector on average relied on mineral oil products for just 3.8 per cent of its total energy consumption. However, for some individual companies, this share may certainly be a lot greater.
Transport and logistics companies are the most vulnerable. For them, fuel costs amount to between 30 and 35 per cent of total expenses. Large price fluctuations have significant effects here and directly affect a company’s economic success. This is also true for companies with large vehicle fleets or major logistics expenditures. A good example of such a company would be an industrial bakery that supplies its 200 retail outlets with fresh baked goods on a daily basis – or a supermarket that also has to supply multiple subsidiaries in a timely fashion.
Currently, rising oil prices are the result of increased demand due to a more relaxed Covid-19 situation and the reawakening global economy. In 2014, fracking oil from the USA was still able to compensate for the supply shortage. However, the number of US oil wells is only slowly increasing. Instead, investors are calling for more investments in renewable energies. How can companies keep an overview?
At Commerzbank, our analysts provide our clients with comprehensive information. By the way, this applies to the entire commodities sector. For instance, our daily briefing “Commodities Daily” contains current information on developments regarding the energy sector, precious and industrial metals as well as agricultural commodities. Our weekly analysis “Commodity Spotlight” provides more in-depth information on current focal topics. And every three months, we publish “Commodities Radar”, a newsletter that provides companies with information on the volatilities of many commodities.
Are there any other factors that companies should take into consideration with regard to this area of risk management?
As a rule there is a potential additional risk pertaining to foreign exchange rates, since many commodities, including mineral oil products, are traded in US dollars. At Commerzbank, we offer our clients the possibility to directly close their hedging deals with us in euros or the relevant local currency. Alternatively, they may decide to hedge foreign exchange risks separately. On top of that, emissions trading may constitute another additional risk.
Under European law, enterprises whose business is particularly energy-intensive, such as utility companies and airlines, are obliged to participate in EU emissions trading. This means that they have to compensate their annual CO2 emissions by purchasing emission certificates. The price for these certificates has risen enormously, increasing by more than 75 percent in 2021 alone. One interesting development we are witnessing in this area is also a growing number of companies that purchase emission certificates from emission-reduction projects on a voluntary basis in order to be able to offer their customers climate-neutral services or products, or even develop a totally climate-neutral business.
Price volatility of mineral oil products – how we at Commerzbank support our corporate clients in their risk management:
Mineral oil products are elementary to the value chains of many companies as a basis for their products or as fuel for their vehicle fleet. The greater their contribution to the value chain, the greater the company’s exposure to major commodity price fluctuations. Consequently, it is advisable to proactively manage this risk.
Strategic procurement and proactive risk management also increase planning security. Compared to volatile interest and foreign exchange rates, volatile commodity prices pose a much greater direct risk to companies. Apart from planning security, professional risk management supported by our experts at Commerzbank also lets you reap the following benefits:
- A marked decline in your exposure to commodity price fluctuations.
- Your costs remain stable, even if market prices fluctuate significantly.
- You may more accurately project your medium to long-term operating profits.
- You are able to offer your customers fixed prices and avoid price escalation clauses.
- You can focus fully on your core competencies.
- You not only benefit from increased planning security but, depending on your hedging strategy, you might even be able to profit from favourable market developments.
Exemplified by crude oil and mineral oil products: an analysis of requirements is the basis for any successful risk management
Any successful risk management is based on an analysis of your specific requirements. We at Commerzbank support you in this. When quantifying the relevant commodity position, for example crude oil, we have to answer a set of concrete questions such as:
- Which mineral oil products are important for your business?
- Which quantities does your business require?
- What currency do you want to use for hedging?
- Which periods are relevant for you?
- What are your hedging priorities: having a fixed price or maybe even profiting from price declines?
We at Commerzbank offer you current expert information on markets, leveraging off our renowned and comprehensive research. Our daily publication “Commodities Daily” extensively covers the energy sector. The analysis “Commodity Spotlight” regularly presents in-depth information from our analysts including but not limited to the sectors crude oil and emissions trading while our quarterly report “Commodities Radar” contains information on the volatilities of many commodities.
Flexible and bespoke hedging solutions for price risks
At Commerzbank, we offer bespoke hedging solutions for your individual commodity price risks. Your risk management is always determined by your special requirements and you benefit from our flexibility. For instance, you can choose whether you want to close your hedging deals in the regular trading currency for mineral oil products, i.e. US dollars or euros. Of course we have other common currencies on offer should you require them. Some of the other advantages we offer include:
- no binding to standardised exchange contracts
- no margin obligations
- free choice of notional size
- free choice of due dates and calculation periods.
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