It is no surprise that we have seen big shifts in commodity prices for oil, iron ore, base metals and steel over the last few years. After all, markets are volatile, right? What IS a little surprising, though, is that steel price volatility has been particularly sharp (see below) recently.
In fact, steel prices spiked recently, reaching nearly $600 and giving many risk managers heartburn. So, how can you help mitigate that risk? By using steel price risk management tools (i.e., derivatives), risk managers can reduce earnings volatility AND deliver fixed prices to their customers. These financially settled contracts can be used to manage price risk up to 24 months in the future. That means that near-term inventory price risk, as well as longer- term customer commitments, can be prudently managed by using these steel price risk management tools.
The chart below shows how you can lock in margins by using these kinds of “hedging” tools. When you buy a physical commodity (steel) and the price rises, your profit falls. You can offset that risk by “hedging” and purchasing a paper contract for the steel. As the price rises, your profit rises. The “hedge” (or contract, in this case), effectively removes your exposure by offsetting the loss of the physical purchase with the futures contract.
What does this all mean for your company? Less financial risk, for one. But, all things equal, companies with lower earnings volatility should be more valuable in the marketplace when compared to companies with a high level of volatility. In the end, prudent use of hedging tools like steel derivatives can help lower swings in earnings due to commodity price movements and help you focus on what’s most important – serving your customers.