Navigating market volatility: Commodity hedging in a manufacturer’s supply chain

Words by Lorenzo Dei Tos

Managing commodity prices effectively is crucial for manufacturing companies to maintain financial stability in a volatile market. Our client, a global leader in the manufacturing industry, was managing commodities through short-term, tactical supplier negotiations. However, this approach left them exposed to unpredictable price swings.

The company partnered with Efficio to strengthen its approach to commodity risk management, with a specific focus on steel and copper procurement in China. 

Given the substantial company expenditure and price volatility in these commodities, the initiative identified opportunities for significant cost savings through financial hedging. Historical data indicates how a well-executed commodity hedging approach could have yielded 7% savings on copper costs for our client, as well as stability amidst market fluctuations

Challenges and approaches

Implementing a successful financial hedging strategy presented challenges that required tailored solutions.

Optimising total cost of ownership (TCO)

Assessing the potential increase in TCO due to hedging costs was crucial. The client-Efficio team conducted comprehensive cost-benefit analyses to identify optimal hedging strategies that would balance cost-effectiveness with risk mitigation.

By leveraging market insights and financial modelling, the team built strategies that optimised procurement budgets while protecting against price volatility in key commodities such as steel, stainless steel, and copper.

Building operating models for long-term success

Implementing a structured financial hedging approach requires a smooth transition. For our client, this involved refining operational processes and establishing robust governance frameworks. This ensured the seamless integration of the new commodity hedging strategy into procurement operations and long-term effectiveness in managing commodity price risks.

Overcoming operational limitations

Our client was heavily exposed in China, where the Futures Exchanges market is less developed. Operational limitations of China Futures Exchanges, particularly the lack of long-term hedging options exceeding one year, posed challenges. Efficio leveraged its expertise to identify specialised financial institutions that would provide customised hedging solutions that maximised effectiveness within these constraints. This approach included leveraging alternative financial instruments and hedging strategies tailored to the client’s specific needs and market conditions in China.

The wider approach included strategic partnerships with global and China-focussed financial institutions to navigate regulatory complexities and enhance risk management capabilities. We proposed a phased approach, starting with a proof of concept for copper on the London Metal Exchange. This was followed by an expansion to additional commodities and regions, ensuring a robust hedging strategy with a clearly defined product portfolio, appropriate hedging horizons and ratios, and risk monitoring.

By implementing a strategic commodity hedging programme, this global manufacturer is now better positioned to achieve cost savings and stability in a fluctuating market.