Commodity Risk

Commodity risk is the threat to financial performance from adverse price, supply, or cost movements in raw materials. For treasurers in industries like energy, manufacturing, or agriculture, managing this risk is central to protecting cash flow, margins, and strategic plans.

A structured approach is essential. Effective commodity risk management moves from identifying exposures, to selecting tools, and finally to ongoing execution and review.

A Treasurer’s Framework for Commodity Risks

Treasury action depends on the specific nature of the exposure. The primary risks and corresponding management strategies are:

Implementing a Control Framework: Centralization and Technology

Managing these risks effectively requires a strong organizational and technological setup.

• Centralized Risk Management: A centralized treasury function, often through an in-house trading desk or “procurement hub,” provides full visibility of group-wide exposure. This allows for netting of positions, achieves better pricing from banks due to larger volumes, and ensures consistent policy application.

• Technology as an Enabler: Advanced Treasury Management Systems (TMS) or specialized Commodity Trading and Risk Management (CTRM) software are critical. They automate exposure aggregation, track hedge effectiveness in real time, manage complex hedge accounting, and generate necessary reports.

• Cross-Functional Collaboration: Treasury cannot manage this in isolation. A close partnership with procurement (for physical contract terms), supply chain (for logistics risks), and risk management (for overall policy) is mandatory for a unified strategy.

Critical Challenges for Treasury

• Basis Risk: The risk that the standardized derivative contract (e.g., Brent Crude futures) does not move perfectly in line with your specific exposure (e.g., regional jet fuel costs). Managing this requires careful instrument selection and ongoing correlation analysis.

• Hedge Accounting: Applying IFRS 9 or ASC 815 hedge accounting rules for commodities is complex but vital. Done correctly, it prevents earnings volatility by matching the hedge’s financial impact with the exposure it covers. This is a key technical requirement for the treasury team.

In essence, treasury’s role in commodity risk is to provide financial certainty. By establishing clear frameworks, leveraging technology, and enabling cross-departmental coordination, treasury transforms commodity risk management from a reactive cost center into a function that actively supports strategic business objectives and stable financial performance.