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Common mistakes in commodity risk

Commodities RiskRaw materialsMarket Volatility+-

In this guest post, Procurement Leaders invites Søren Vammen of Kairos Commodities to look at where mistakes are being made in the commodity risk management process. This column appears in the Commodity Watch section of Issue 44 of Procurement Leaders Magazine.

 

Current commodity risk management practice has flaws, something we uncovered having published a comprehensive report on commodity risk management in Europe.

 

Limited understanding of risk

 

A startling discovery is that only 50% of all companies are quantifying their risk exposure, leaving every second company in the dark about where, in their commodity spend, the risk lies. Far too many companies rely on ambiguous assumptions about volatility, but fail to properly identify how price developments of various categories relate to each other.

 

Inadequate performance measurement

 

Most companies measure their commodity price performance against their own budget. a mere 30% stated that they compare their performance with the market, leaving 70% unaware of their competitive performance. This poses a problem, since it is much easier to create savings against budget in a down-trending market than in an up-trending.

 

Renegotiations driven by expiry date

 

Around 75% of the companies do not renegotiate their commodity contracts until they are about to expire. In commodity markets all companies are price-takers. accordingly, companies that optimise the date of renegotiation by applying market information will obtain a competitive advantage. The difference in terms of impact is 10-20% of total commodity spend.

 

Static hedging strategies

 

Many companies apply a static hedging strategy. More than one-third responded that the type of contract they use within commodities will remain the same regardless of the market development. a further 34% stated that they have no strategy regarding types of contract, leaving only 30% with a market adjustable strategy. Ideally, a flexible approach is applied where fixed price contracts are used in up-trending markets, while floating price contracts are used in downtrending markets.

 

Søren Vammen is CEO of Kairos Commodities

 

The report is based on an extensive survey of more than 300 companies across a wide range of industries. Download the full report at www.kairoscommodities.com

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