Concerning producers, hedging guards against any potential drops in the price of the commodity they produce and bolsters creditworthiness when securing financing. An oil company, for example, may lock in a hedge to sell the oil it drills at $60 per barrel for the coming year, knowing it is greater than the profit break-even point and upholding confidence it can sell its production at that price. Hedging at that price means the producer forgoes any extra profit if the price of a barrel increases above $60 per barrel, but it has the benefit to protect against losses if it drops below that price per barrel while ensuring it will have a strong revenue stream.
Hedging for Consumers
Commodity consumers, conversely, use hedges to protect against price increases. In the energy sector, typical consumers can include transportation companies, utilities, manufacturers and logistics firms. These businesses often have natural hedging strategies in place — if fuel prices increase, costs are passed through to the end user. However, amid inflationary periods and when commodity prices remain higher for longer, customers may have less appetite for increased product or service prices. Given the prevailing environment, then, it can benefit an energy consumer to establish a hedge while the commodity is at a lower price to decrease their own costs and reduce pass-through impacts to end users. If the commodity prices go up, the hedge itself will instead pay back the extra cost incurred by the consumer.
Regardless of whether a business is buying or selling a commodity, hedging is a valuable tool for reducing risk and promoting a stable balance sheet. Hedges are not cookie-cutter, however, and businesses should work with an experienced institution to customize an effective plan.
Amid uncertainty over recent market volatility, inflation and tariffs, hedging is likely to become an increasingly valuable strategy. FNB’s Capital Markets team has an emerging specialization developing hedging strategies for companies in the oil and gas industry. Visit fnb-online.com/capitalmarkets to set up an appointment.
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Managing fluctuations in interest rates, including through rates hedges, is also key to mitigating risk. Check out the FNB Knowledge Center article “Growing Through Changing Rate Environments” to learn more today.
