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Should processors use hedging strategies?

While the general raw materials outlook for '99 points to low, stable pricing, volatility remains an issue for processors working with tight margins. Few industries react as quickly through the pricin...


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January 1, 1999 by Canadian Plastics

While the general raw materials outlook for ’99 points to low, stable pricing, volatility remains an issue for processors working with tight margins. Few industries react as quickly through the pricing mechanism as does the raw materials segment, where a fire in Louisiana can make the difference between profit and loss to a processor half a continent away. Resin pricing and supply is increasingly global in character, while the majority of the Canadian processor community trades within our borders. Louis Dreyfus Petrochemicals’ John Hall notes that HDPE price volatility, for example, has averaged twenty two per cent annually in the ’90’s. While not all resin pricing is as volatile, the ability to quote a run based on realistic raw materials costs is essential. A useful financial tool to achieve this is the “swap”, where the processor agrees to pay a fixed price for resin, independent of the resin producer’s price. The swap “overlays” supply contracts without limiting processors supply options. Hall emphasizes what swaps are not: ” Swaps are not a profit centre, and they are not speculating.” Swaps can also be combined with caps, floors, and “collars” to fine tune the amount of risk the processor is willing to accept. A key advantage of risk management tools, such as swaps, is the ability to avoid the speculation inherent in buying forward and possibly contracting for product a processor can’t afford or inventory. Additional benefits include more accurate budgeting, lower cash-flow volatility, greater margin stability, and lower capital costs. And perhaps fewer sleepless nights.