Study Identifies Companies With the Worlds Most Sophisticated Hedging Strategies

Date: Thursday, May 15, 2008
Author: Ryan Utsumi, Riskcenter.com

Four energy companies and two airlines receive top honors for having the world’s most sophisticated strategies for hedging energy exposure, according to a new survey of companies around the world by Greenwich Associates.

With soaring prices making hedging energy exposures a top strategic priority, Greenwich Associates asked the 420 corporations participating in its 2008 Global Commodities Research Study to name the companies they considered the most sophisticated in terms of hedging commodities risk. The following companies were cited most frequently for their expertise in hedging commodities exposure:

·  BP

·  Constellation Energy

·  Exxon Mobil

·  Lufthansa

·  Shell Group

·  Southwest Airlines

Financial Hedging Strategies

The Greenwich Associates research reveals that companies around the world use financial instruments to hedge an average 45% of their energy commodities exposure. Included in that average is the 53% of commodities exposure typically hedged in this manner by companies that are consumers of energy and the 37% of financially hedged exposure among energy producers.

Airlines and other transportation companies are much more active than other energy commodities consumers when it comes to hedging using financial instruments, with nearly 65% of their total exposure hedged in this way. In comparison, the typical industrial company uses financial instruments to hedge just over 40% of its exposure, and utilities hedge an average 48%.

Among producers, oil and gas companies hedge an average 35% of their energy commodities exposure financially. “On average, companies in Continental Europe hedge 52% of their commodities exposure using financial instruments, compared with only 35% among companies in the United Kingdom, 47% in the United States and slightly more than 40% in the Asia Pacific region,” says Greenwich Associates consultant Peter Kane. “In Canada, where there is a much higher proportion of commodities producers, companies use financial instruments to hedge an average 37% of their commodities exposure.”

In carrying out their financial hedging strategies, slightly more than 70% of the companies participating in the Greenwich Associates research say they use OTC swaps. Just more than half use OTC options and roughly a third use structured derivatives. Fifty-eight percent of the companies also say they actively trade physical products with dealers. “The use of OTC swaps has become common practice in many industries,” says Greenwich Associates consultant Andrew Awad. “Among airlines, utilities and chemical companies, more than three-quarters of companies use these products, and among non-airline transportation companies usage increases to 85%.”

Airlines are taking the lead in incorporating products into their commodities hedging strategies that have yet to gain widespread acceptance. More than 80% of airlines around the world say they use OTC options, compared to less than half of other transportation companies and only 40% of industrials. More than 55% of airlines use structured derivatives, a product used by only a quarter of other transportation companies and just 20% of industrials. Forty percent of companies use OTC derivatives for natural gas and about a third use them for crude and/or refined oil. “Our research shows that, although many companies in many different industries have begun taking a more proactive approach to hedging their commodities exposures, the bulk of the actual trading volume in OTC commodity derivatives is coming from petroleum producers, utilities and airlines,” says Greenwich Associates consultant Frank Feenstra.

Hedging Policies and Practices

Across all industries, hedging strategies vary widely in terms of sophistication and approach. Many of the companies participating in this year’s Greenwich Associates research say they have no actual hedging policies at all or carry out their hedging through a largely subjective process. Others, especially airlines and oil companies, use advanced formulaic strategies to hedge individual commodities exposures and make strategic decisions about hedging policy at the board level.

Over 60% of companies around the world say CFOs or CEOs are involved in setting hedging policy, and more than 20% say their boards of directors are involved in the process. “With the dramatic increase in commodities prices, many companies are now addressing the issue at the highest and most strategic levels,” says Greenwich associates consultant Woody Canaday.