In recent years, geo-political events, financial crises and government regulations have led to increased energy and fuel price volatility and heightened business risks for companies that are exposed to the global energy markets. With as much as 70% of shipping companies costs being fuel-related, volatility in bunker markets can erode margins and frustrate customers who seek price stability, negatively affecting a company’s competitive edge.
There are a number of reasons to hedge and a variety of different strategies. These vary depending on the business risks a company faces within its particular industry sub-sector, as well as on a management team’s attitude to risks and their business objectives.
Ultimately, risk management is about allowing executives to focus on their core competences. They are not experts in oil markets, able to forecast prices, predict events and envisage technological developments. They are experts in the business of transportation and logistics. Hedging exposure to fuel prices allows them to focus their time on what they do best, running their company and securing its competitive edge.
Over the coming weeks I will highlight the principal reasons for hedging and provide a broad outline of the available solutions.
#1: Increase cash-flow certainty
#2: Eliminate risk of financial distress
We will address these two reasons together, as there are inextricably linked. Uncertainty surrounding a company’s cash-flow causes numerous problems for its management team. It makes budgeting, planning and (for publically traded companies) producing earnings guidance, tremendously difficult. Consider a company in need of making a large capital expenditure to upgrade or purchase new equipment. Wild swings in global oil markets and thus fuel prices can cause significant volatility in a company’s cash-flow and profitability. It is difficult for executives to know when and if, they can afford to purchase the new equipment. It also challenging to accurately calculate the likely return on investment, related to this capital expenditure. This in turn can lead to further difficulties when planning future hiring or training programs.
The elimination of financial distress is the logical extension of cash-flow certainty. By hedging exposure to extremely high fuel prices (that may remain elevated for an extended period of time), executives are able to eradicate a scenario that could significantly damage a company’s ability to effectively operate and to generate profits, putting at risk its long term viability.