when commodity-dependent companies don't hedge

Discussion in 'Economics' started by tortoise, Aug 7, 2008.

  1. a very close friend of mine went to visit her parents this weekend. her dad is c.f.o. for a public transportation sector company. like most (all?) such companies, her dad's company has been taking it on the chin with oil prices. but when she asked him why his company doesn't hedge against rising oil prices with oil futures, he said "we're not in the business of speculation."

    Huh? Am I missing something here? Does anyone know of a plausible reason why a company vulnerable to rising commodity prices would NOT hedge that risk with futures contracts?
     
  2. well i can only speculate of course on the reasons, one might be
    they've previously been burned trying to hedge via a futures
    broker salesman proposing what you're suggesting
    they might think hedging requires a trading department or at
    least having to employ one possibly expensive person to manage
    the hedging
    it's the cfo that should be the one to examining hedging not the
    president but in very small companies/businesses i think 'they'
    have no knowledge whatever of hedging tho accutely aware of
    what's affecting their bottom line, hedging may be taught in mbm
    programs but it's likely the average business person has a similar
    reaction as your example thinking of hedging in terms of speculate

    when the C$ was at its low some companies moved to the States
    tho the commodity producers were of course laughing all the way
    to the bank
    it's an interesting topic from the pov of trading since if one thinks
    of the consequences of higher/lower prices many more trading
    opportunities appear
    an awareness needed by individuals when trading international
    markets - currency hedging as well many of the smallest business
    such as a 'tourist shop' when the US tourists stop visiting Canada
    and vv - many US retailers on the border closed when the C$ fell
     
  3. ]

    If he doesn't hedge, then he IS in the business of speculation. What a moron.
     
  4. m22au

    m22au

    While I agree that hedging is sensible, there are some reasons why companies don't hedge 100%, or even 1%:

    (1) Amount of commodity expense (eg. oil) is unknown, so they don't want to have the risk of 'over hedging'

    (2a) Futures:
    Given that futures are MTM, and the expense may be paid in the future, the company may not have the cash and/or may not want to pay the cash upfront if and when the commodity price falls

    (2b) Options:
    May be reluctant to pay time premium if buying call options

    (3) When oil was above $140, some companies with oil-related expenses would be reluctant to hedge at that price, given it was lower in the preceding weeks and months. In other words, they may think about hedging but want to wait/hope for lower prices. Using the airlines as an example, hedging at $147 might bankrupt some carriers. Their main hope of staying in business is to hope that oil goes (and stays) well below $147.

    (4) The company may not fully understand the truth in Cutten's argument
    "If he doesn't hedge, then he IS in the business of speculation."


     
  5. Daal

    Daal

    The should be worried about underheding since they are lifetime buyers of the commodity
     
  6. Casey30

    Casey30

    I believe SEM Group went bankrupt due to overhedging. SGLP is a sister company of sorts. I am not completely sure, but I believe that was the company line on why they went belly up. So there is always the risk that a company over hedges.


    Lastly, although not a great excuse, if very few players or no players are hedging against costs, then everyone is pretty much at a level playing field costs wise. Also, if you hedge and costs decline, you are at a competitive disadvantage to your peers.
     
  7. When there are excess speculation in the market, sometimes behavior of hedgers becomes speculative, often hedging against prior hedges. That is what SemGroup was doing before it had to cover it's position and declare bankruptcy. This is how excess speculation and speculators often induces speculation in otherwise normally behaved players in the market.