After 15 years in the energy industry, I have come to expect extreme price volatility in our oil, natural gas and petrochemical markets. Macroeconomic pressures, geopolitical issues, capital flows, currency fluctuations and extreme weather patterns will frequently cause dramatic swings in underlying values. But I don’t think anyone has been quite prepared for the price suppression we have seen over the last year.
In the 2015 Ernst & Young Global Capital Confidence Barometer, a global survey of over 1,600 executives across 18 sectors, 35% of respondents believed increased volatility in commodities and currencies is the greatest economic risk to their business.
If you are a risk manager, supply chain manager or a CFO, you have many responsibilities – managing commodity price risk is just one of those. But it’s a critical one. Especially when the prices you are managing are in volatile energy markets.
When managing energy price risk, start by carefully assessing which hedging strategies you can handle on your own and when you will need a partner. And be sure to ask questions: How do you buy or sell inputs? What currency risk do you face? Are you considering all of the costs that impact margins?
For some, hedging strategies put in place two or three years ago are causing pain in today’s low price market. Over one year, oil prices fell from $50 a barrel to less than $35; two years ago they were $103.40 a barrel. It is likely that hedges put in place in 2013 were done so at prices significantly higher than today’s market price. While hedging strategies provide insurance to create more predictable pricing and protection from market moves, in a downturn like this, these strategies are realized as losses.
But these losses should not encourage complacency or inaction on the part of a financial risk manager or CFO. By not utilizing hedging strategies and locking-in these historical low prices today, you could be missing the opportunity to gain more profitability for your business. Are you willing to risk that these market prices will remain this low one, two or three years from now? If not, putting strategies in place utilizing a diversified and structured approach, can help secure more predictable pricing and mitigate any sudden shifts in pricing.
You may not have control of the markets, but you can confidently construct a diversified risk management strategy which minimizes uncertainty and maximizes opportunity.