Do you face commodity price risk in your business? The answer is presumably “yes”, which is why you’re reading this right now. To be great at managing price risk, there are a few areas you need to get absolutely spot on. Get them right, and you’ll improve long term performance. Get them wrong, and we guarantee that you will fail.
At Flow&Ebb we’ve put our heads together to come up with this guide to the top 5 key areas you can’t afford to get wrong.
- Clear lines of responsibility. Your traders (i.e. the people who change the quantity of risk you face) must be totally separate from the people who track measure and report on your risk position. The reason why is simple – you don’t want the people who are incentivised to take risk marking their own homework.
- Remove the emotion. The decision to hedge should be made for one of 3 reasons. 1. Something unexpected has happened operationally and you need to react, 2. You have a reasoned view of what’s going to happen in the market, 3. You have an unacceptable amount of risk and want to reduce it. Whatever your reason, be very clear about why you are making the decision. Eliminate decisions that are made for other reasons (especially the “I’m below my budget so I’m going to lock in the price” reason, when it’s a falling market and there’s a lot further to go…)
- The Three G’s: Governance, Governance and Governance. Be under no illusion, this one is very, very important. If you’re giving your traders the freedom to trade, you want to be safe in the knowledge that they are doing so within the safety of a controlled framework.
- Doing nothing is doing something. People in your business are frequently making the decision to not trade. Probably daily. You need to recognise that the decision to not trade is just as important as the decision to trade, and give it the same rigour and scrutiny as the decision to trade.
- Transparency, clarity, accuracy and great communication. You need to quantify your risk positions constantly. It changes constantly. Knowing where you are is critical. And you can’t wait a week or so for the information. You need it now. It points to the need for a system – and frankly Excel is not up to the job.