Risk Management

A Treasury Twist on Commodity Hedging: Overseeing Price Locks

By October 6, 2022No Comments

Having a physical price lock team report to treasury instead of procurement made perfect sense for one company.

Breaking down boundaries and extending the reach and influence of treasury teams can help businesses succeed and may enhance the strategic value of finance in the eyes of a corporation’s senior executives.

  • That takeaway and others emerged during a presentation by the director of risk management at a mega-cap company who now oversees a team dedicated to setting physical price locks for commodities in contracts with suppliers—a team that previously reported to the corporate’s purchasing group.
  • The member described the reasoning behind the move and the company’s approach to commodity hedging, including its use of derivatives, at a meeting of NeuGroup for Foreign Exchange sponsored by Wells Fargo.
  • The discussion comes amid high volatility in commodity prices that’s prompting more NeuGroup member companies to consider hedging energy and other costs where liquid derivative markets exist.

Propose a win-win change, get buy-in. When the member became head of risk management, the physical price lock team interacted with treasury but reported to procurement. He took initiative and asked the treasurer, “Why aren’t they in our treasury team?” He believed there could be additional value for both groups if “we were all reporting through treasury.” His reasoning:

  • Combining the teams in treasury would allow increased collaboration, improved alignment on market views and team strategies, cross-training opportunities, increased connectivity with other treasury teams and growth in finance team talent for current and future positions.
  • The company’s procurement leaders liked the idea because they would still get the support of the price lock team to help buyers reduce costs by deciding when to lock in prices with suppliers and when to keep commodity surcharges in contracts. It was seen as a “win-win,” the member said.
  • There have been other benefits to the change. The company has made multiple process improvements within the physical price lock team to simplify the internal approval processes and reporting “that are clear advantages from having the team located within our treasury group,” the member said.

Price locks or surcharges? Treasury first tries to hedge commodity exposures through its supplier contracts using price locks—if that makes sense for both the corporate and the supplier. Physical price locks are legal contracts that lock in a forward price for a set quantity of a certain commodity for an estimated time period. Locks are used with suppliers with whom the company has good relationships that are financially sound and provide a high volume of a target commodity.

  • Suppliers, who are used to assessing a surcharge that fluctuates with the price of a given commodity, may not agree to lock a price, the member explained. Therefore, onboarding suppliers requires close collaboration with the buyers and the treasury price lock team.
  • “We’re considered the internal foreign exchange and commodity market experts,” he said. So part of the value of treasury’s knowledge of markets is deciding when the company will benefit from a price lock versus taking a surcharge.

Where derivatives enter the picture. The company hedges commodity exposures that exceed what can be offset through price locks with derivatives in those areas where there are active and liquid markets.

  • The same traders at the company are responsible for FX and commodity derivative hedging. The company’s policies, systems, processes, controls and reporting are generally consistent across both types of exposures.
  • Treasury has the authority to hedge on a rolling 12-month period into the future but can extend that up to five years with CFO approval. However, multiyear hedges are normally limited to only a portion of the company’s exposure.
  • “We evaluate the multiyear hedging opportunities when currencies or commodities are significantly overvalued or undervalued,” the member said. “We believe we have a strong chance of succeeding when markets are extended because they normally revert to their long-term trend over time.”
Justin Jones

Author Justin Jones

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