Hedging Your Bets – can procurement beat the markets?

We're delighted to welcome a guest post from Andrew F Smith, a  guest poster and senior procurement leader from a large UK organisation

As the gardeners among you will no doubt testify, it is hard to keep your hedge in order.  The same can be true in procurement.  The UK budget announcement recently brought the spotlight back onto oil pricing and helped remind me of an apparent ‘branching out’ (sorry) taking place within our profession.  Partly to help deal with escalating prices and future uncertainty, many procurement functions are seemingly becoming increasingly involved in advanced planning and forward hedging strategies for fuel and energy.  So what can these deliver?

Hedge programmes can provide spectacular benefits for Procurement functions keen to deliver savings for the business.  This can help both with achieving targets and with improving our reputation around the business.  The rewards can be great.

Additionally Hedge programmes are often popular with FD’s and other senior business stakeholders given their ability to deliver budget certainty and help achieve cost targets over the coming year (or longer).  This can help Procurement influence at the most senior levels.  I know of one major airline that holds a daily (yes daily) conference call between the CEO, FD and CPO to discuss their positions on jet fuel, given that a good programme can make the difference between a good and a terrible year (and most likely their ability to hold on to their jobs).

More often FD’s are actively involved in the decision making, either through a committee that establishes the ‘rules’ for the programme (such as acceptable trading parameters) or around the execution of trades.  Procurement often and increasingly plays a pivotal role including running the programme and helping predict future trends in the market.

Fuel and Energy procurement and the associated Hedge programmes also presents an opportunity for collaboration.  This is not made easy by Hedge Accounting rules; however opportunities do exist to form alliances and work with other organisations to deliver collective benefits.  Should fuel prices continue to climb the focus on this will no doubt increase further.  Making the most of your volumes is particularly important given the low addressable percentage of spend (after all the tax has been stripped out) for fuel and energy.

But of course it must be remembered that the journey from hero to zero can be rapid.  A Hedge programme can deliver stunning results in one year – tens of millions of “savings” (or at least benefits) to the organisation - but poor the next; all entirely dependent on how the markets and the individual programme have performed.  Despite this, the increasing involvement of procurement in fuel and energy hedging strategies is just one example of some of the advanced approaches that many procurement functions are now heavily involved in.  The hard part is getting it right.

Voices (6)

  1. Mike Corley:

    As others have noted, having a sound fuel hedging policy and strategy(s) are the keys to hedging success. With regarding to being on the wrong side of the market when prices decline, by purchasing call options (think of it as an insurance policy against rising fuel prices), rather than futures or swaps, it’s possible to create a win-win situation. That is, if prices increase, you receive a return on the option which will offset your higher fuel costs. If prices decrease, you are simply out the upfront premium payment for the “insurance”.

  2. Peter Smith:

    I think it is the difference between ‘hedging’ and ‘speculating’!
    I’ve got a couple of good stories that Andrew’s piece has inspired me to dig out of the memory banks and write about over the next week or two…

  3. bitter and twisted:

    Hedging is for predictability.

    If you think you can actually beat the market then you are a dunce
    either
    a) you are wrong – youve just been lucky so far
    b) you are right – so why arent you doing it full time?

  4. Andrew F Smith:

    Mike,
    Thanks for your comment. The context for the blog is actually both ways; hence the warning about the ability to move from “hero to zero”. Only a few years ago a number of the markets were falling when the organisation I worked for at the time had a strong hedge in place – the entire organisation quickly became “skilled practitioners in 20/20 hindsight” (great expression!) and didn’t let us forget it. Whilst it is also easy to bring in (expensive) third party advice to help with predicting the market it never fails to amaze me the wide range of predictions from the so-called “experts” at any one time. Having said this, if we could be confident that we could get it right every time we probably wouldn’t be working in Procurement!
    Andrew

  5. Mike Pringle:

    Andrew
    Although I totally agree with everything you have written, the context for your blog is when the market is on the up.
    I worked for a large UK food business in the 1990’s when most commodity markets were in over-supply and deflationary. We operated a similar system to that which you describe with close involvement from the finance community. Cover was kept reasonably short so we were able to post savings versus budget (budget was delivered as were cost savings targets). But this wasn’t good enough; they were skilled practitioners in 20/20 hindsight and became unhappy that we weren’t “beating the market”, particularly when one had to factor in the cost of hedging (no small matter!). There is no such thing as “beating the market”. Procurement cannot take on the mantle of being the organisation’s price predictor as we all know commodity markets are inherently impossible to predict. Hedging is fine in inflationary markets but beware continuing this practice in deflationary markets. With age comes wisdom………………

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