Commodity Hedging Strategies: An Introduction


A key point to understand in relation to hedging is that if you have an exposure to risk (commodity price, interest rate, foreign exchange , inflation or otherwise), doing nothing about the risk is in effect doing something – it is deciding to take the risk and allow your performance to be impacted by its variability.

In this article we look specifically at commodity risk and a basic vanilla hedging strategy.

What is Commodity risk?

Commodity risk is the financial uncertainty caused by fluctuations in the price of commodities. These fluctuations are beyond control and affect future market values and future cashflows.Commodity prices can be quite volatile partially because of their supply-demand dynamics. In addition, geo-political risk is another important inflence factor.

An important starting point in the process is to identify the commodity risks that a particular company is exposed to. Once identified, make sure you understand how these risks impact future cash flows.There can also be a significant impact due to foreign exchange rate movements. This depends on the currency that your company functions with.

For example, if you company operates in Euros and you do not hedge your fuel costs, the company will be exposed to EUR/USD movements over the period. These can be underlying benchmark price movement (likely Dollar denominated). Some large shipping companies saw their fuel costs increase by 13% in 2017 becasue of fuel costs/bunker price increases.

The table below illustrates the impact on commodity price movements to revenue and profitability:

Commodity price movements

Why Hedge the Risk?

Implementing an appropriate commodity hedging strategy can help provide more budget certainty, help manage liquidity and result in a smoother cost profile and limit operational risks. An appropriate commodity hedging strategy implementation can help you limit financial risks. Having a strategy in place helps to:

  • provide more budget certainty
  • to manage liquidity and as a result
  • to achieve a smoother cost profile

Again, not hedging when you have an known risk is a decision in itself. You sould not underestimate the potential impact of overlooking the risks.

How can I hedge the risk?

It is essential to have a robust approach to your hedging strategy. This means achieving the right level of oversight and the relevant approval procedure. The below outlines the high-level approach to implementing a suitable hedging strategy:

High-level hedging strategy

Consumers use fixed-rate swaps to hedge their price risk by fixing or locking in their fuel costs. This happens accross many indutries such as air, marine, rail and road transport. Sellers of commodities also use fixed-rate swap strategies for inventories as well as price risk management.

To illustrate how a hedging strategy can work from a consumer perspective, let’s take the example of a shipping company. This shipping company wishes to hedge 75% of its bunker consumption over the coming year. Say the company consumes 120,000 Metric Tonnes (MT) of fuel oil and they would like to hedge their price risk on 90,000 MTs over a 12-month period (from Jan 18 to Dec 18) – allocated evenly.

The shipping company can do this by entering into a fixed-rate swap on the benchmark (e.g. 3.5% Fuel Oil Rotterdam) for 7,500 MT per month at e.g. €305 per MT.

Let’s have a look at how that would play out for the shipping company over a 12-month period:

Fixed Rate Hedging Strategy (Example)

Example of fuel price & costs under the different scenarios in 2018

As you can see from the table and graph, if the shipping company had passively accepted the price risk over the 12-month period, they would have had significantly higher (€2.7m) and less predictable costs.

Therefore, using a simple fixed-rate swap strategy, the shipping company in this example has reduced total fuel costs, proactively managed their price risk and stabilised their ability to forecast costs. However, it is important to note that if the price had moved the opposite direction over the period, there would have been a missed opportunity for cost saving on the hedged part of fuel costs. This is the cost of implementing an effective hedging strategy which mitigates price risk and stabilises the cost line.

Moreover, from an accounting perspective, it will be important to be in a position to put hedge accounting in place on the trades to reduce any Mark-to-Market volatility on the P&L.

In the following articles we will explore a variety of hedging strategies depending on risk appetite and business requirements.

If you would like to discuss your hedging needs across any asset class (Interest Rate, Commodity, Foreign Exchange, Inflation etc.) do not hesitate to get in touch with us.

Centrus provide independent advice on hedging strategies and support through every stage of the process. From assessing risk and developing an appropriate hedging strategy through to execution and accounting impact post implementation.

To find out more, please contact

Bridging Loans: the funding underpinning new banking relationships


Given the consolidation in the housing association sector in recent years, we often point out that the largest HAs are bigger than their FTSE 100 property equivalents on most measures. The next tier of HAs below that are also now very large corporate entities. One consequence of this is that we are seeing a steady move towards a re-setting of the relationship between these borrowers and their banking groups in the context of a clear strategy.

As legacy bank liabilities steadily amortise, are restructured through mergers, or are replaced with more sustainable market level funding, banking portfolios are looking more like those of other property-owning businesses. HAs have more willingness to restructure their banking relationships and address legacy lenders’ concerns when the result is tailored to support the needs of the HA as borrower. As legacy issues reduce and new lenders come into play, banks are better placed to provide responsive and flexible support through balance sheet, underwriting and ancillary services and take their rightful role as “enablers”.

One good example of this progress and shift in relationships is the increasing provision of “bridge to bond” facilities from HA relationship banks.

Bridging Loans in an HA Context

For HAs, bridging facilities typically provide committed liquidity until they can issue into the public bond markets. As well as providing greater flexibility, bridging facilities also provide an opportunity for HAs to expand the relationship with their key lenders.

In this context, bridging loans are often very short term (2-3 years) with the potential for some or all of that period being unsecured. Mandatory repayment clauses force prepayment and cancellation upon DCM issuance and fee structures incentivise refinancing – the facilities are really meant to be bridges after all rather than “emergency liquidity”. In other sectors the term can be shorter still but given the vagaries of property investment timetables we see it as worthwhile HAs pushing for the longer end of this range.

Key benefits of Bridging Loans

  • Efficient Liquidity Provision – a period of being unsecured means that committed liquidity can be provided at short notice and low cost, with underwriting often sitting separately from core relationship lending teams.
  • Mitigate Execution Risk – the provision of committed liquidity affords some flexibility to the issuer and allows them to enter the market on their own terms rather than being a forced issuer.
  • Leveraging Existing Bank Relationships – by involving a borrower’s core relationship banks, concessions can be gained in legacy facilities as part of the overall relationship package.

Centrus’ Recent Experience

We have recently seen a number of bridges taken by HAs for a variety of reasons and with some interesting nuances in the structures.

One client focussed on the bridge mainly as a vehicle for mitigating execution risk: the purpose of the bond was to refinance existing facilities and the security to be released was required as collateral for the new bond. By arranging the bridge it allowed the issuer to prepay an existing lender, release the security and subsequently allocate as collateral to the bond in a timely manner without risking execution.

A simultaneous bond issuance, prepayment and security release is of course possible, but removing complexity from the primary issuance (alongside the flexibility to issue to the issuer’s own timeline) was seen as a prudent approach that reduced risk in the context of an already complex set of transactions.

Interestingly, this bridge was also dual-tranched with the second tranche coming online once the first bond had been issued: this provided further flexibility for the issuer whilst retaining an efficient fee structure. The RFP process also involved a request for concessions on existing facilities, reinforcing the idea that mature banking relationships should be mutually beneficial – the stick and the carrot both have their places!

Another recent example which undoubtedly highlighted banks’ ability to be responsive and supportive occurred towards the end of 2018: a three week process – from RFP to execution – focussed minds and led to an excellent result for the borrower.

With three banks on board to split the substantial bridge requirement the decision had to be made between a syndicated facility or bilateral agreements. Syndicated bank facilities are more of a norm with large corporates and utilities and, in our view, a move to more mature banking relationships in the HA sector might in part involve a renewed appetite for large syndicated liquidity facilities. Some of the banks had a preference for a syndicated approach where they felt they would have more visibility of the overall transaction, given the low pricing of the bridge funding.

A syndicated facility simplifies documentation, but the entire process could be held hostage by the slowest moving bank. A series of bilateral facilities, on the other hand, would require three separate agreements to be negotiated and documented within the three-week timeframe but would allow execution of just part of the requirement if, for example, only two of the three agreements were finalised.

In this case the decision was made to pursue three bilateral agreements and it paid off: two agreements were swiftly executed with the third also finalised within a very narrow timeframe. Good relationships and open communication helped considerably.

Bridging the divide

Our view is that building better managed relationships with top tier banks via additional ancillary business (DCM, acquisition finance, liquidity facilities, hedging etc.) is a win-win: the banks like the deeper relationships and the erosion of legacy portfolio value naturally makes them more enthusiastic. The quid pro quo is that for HAs with ambitious development programmes, legacy debt has sometimes been a block to progress.

This article has focussed on bridging loans, which give flexibility for HAs looking to enter the public bond market (or indeed other capital markets). On one level they are simply another example of how banks’ direct balance sheet support is now focussed on the short term, but if used effectively they enable borrowers to align funding with the needs of the business. Bridges need to be tailored rather than “taken off the shelf”, but they can help to manage risks around funding investment programmes and thus be a good example of using banking relationships to support the wider business.

For more information, please contact Lawrence Gill, Director – Centrus