Commodity EDGE Day 1: How to Hedge, Use Advanced Sourcing Technologies and Price Forecasting for Commodities

Hedging Strategies for Commodities

We all know what it’s like to hear the word “hedging” thrown around — but do we know what it means for our sourcing organizations?

Damon Pavlatos and Tom Hronis from Future Path Trading break it all down for manufacturers, and what it really means to effectively hedge your commodity spend. The good news: “You don’t need 10 or 15 million dollars to get involved in the futures market,” according to Hronis.

As my colleague (and Big Kahuna over at Spend Matters) Jason Busch put it in his dispatch:

“One of the benefits (and challenges) associated with hedging using the futures markets…is that procurement organizations must get their head into a mindset in which not everyone in the market wants to actually take physical delivery of a commodity. Which is why, in part, there is so much potential leverage one can have over a futures contract (i.e., low dollar amounts can theoretically control large volumes of materials/commodities for future delivery).

For example, for a 25,000-pound contract for “High Grade Copper” if the current price per pound is $3.87, hedgers, with only a $5K performance bond, can control the entire contract worth $96,750.

However, as Tom and Damon caution, if you’re on the wrong side of the agreement and the price falls, you are responsible for any margin calls and new margin requirements generated. And on the other side of the coin, the counter position would be as “the price rises, you also are responsible for any margin calls and new margin requirements generated.” In other words, small dollar amounts can control very significant future obligations in the futures markets. But as such, spend can be “locked” with relative ease, provided companies maintain enough margin on reserve to cover the future obligation and the moving price targets in the meantime.

Unlike futures contracts that come with an obligation to take delivery (i.e., you’re buying or selling “it” at settlement based on the underlying contract terms), call options provide the “option to buy something by a certain time at a certain price by a certain date” and represent a “a cheaper alternative in lieu of a full blown futures contract” and can also be “used to provide upside protection for short positions.” For procurement organizations, a short position could simply be an un-hedged demand.”

Advanced Sourcing Technologies

Several stars in the sourcing technologies world — Jim Wetekamp of BravoSolution, Sean Timmins of Triple Point Technology, and Trevor Stansbury of Supply Dynamics — took the stage at our second session, Advanced Sourcing Technologies.

One of the speakers, Trevor Stansbury, has a close hand on the metals world, as his primary focus is material demand aggregation. “Companies don’t just compete with companies anymore — now supply chains compete against supply chains,” he said. In order to provide visibility across supply chains, Trevor maintains that you need a very “robust platform to connect the dots between the players.” When asked how demand aggregation helps, Trevor stressed that standardization (just one of many important facets) is key.

For example, when collecting the data across suppliers, you get to see that they’re not matching up the types or forms of products they need with the mills that produce those exact specifications (e.g. targeting and buying from mills that specialize in producing plate, rather than a more specific shape). “Harnessing the information to do very simple things that don’t require much engineering change or large investment” is the goal, Trevor said.

Forecasting, Statistical Modeling, and Building Internal Competencies

You may already be familiar with Omer Abdullah’s leading-edge work with The Smart Cube, Inc. — watch a video interview with Omer here and here — but Commodity EDGE attendees got an hour-long session featuring Omer’s winning persona (not to mention killer insights).

Omer’s mantra comes down to this: you must understand the fundamentals of a commodity’s manufacturing process, from inputs to end uses, to be able to build forecasting models. After you understand fundamentals, make sure you check essential steps off your list in forecasting accurately — including, but not limited to, building in evaluations for alternative scenarios, continually refreshing and evaluating your model to keep it dynamic, and understanding your hedging options (natural, physical or financial hedging).

And that brings us full circle. Themes weaving through the three sessions became apparent — one, namely, standing out above the rest: volatility, and, indeed, uncertainty, is the New Normal.

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