Firms urged to hedge on their purchases of base metals

Businesses have been urged to hedge against risks stemming from highly volatile prices for commodities like copper, aluminium, zinc and nickel.

Commodity prices have recently been more volatile than the US-dollar-to-baht exchange rate, Kanyarut Thavarasukha, senior assistant vice president of the Bank of Tokyo-Mitsubishi UFJ (BTMU), said yesterday.

The price of commodities, including oil, rose sharply in 2006, fell last year and rose again this year.

Looking ahead, there are great uncertainties about the outlook for commodities prices, she told a seminar hosted by the BTMU.

Hedging may be a good policy for private firms, she suggested.

Firms that import base metals like copper and aluminium have been facing higher risks stemming from a mismatch of pricing. Regarding revenue, their income comes from fixed product prices sold to clients, while their expenditures are subject to the volatility of prices for raw materials used in production.

Without hedging, these firms have been facing rising production costs and narrower profits, she said.

To manage risks, firms may buy commodity swaps from banks.

The commodity-price-linked swap enables firms to lock in a price for a certain period, usually six months. For example, if a firm agrees to buy copper-price-linked swaps from a bank at Bt8,500 per metric tonne over six months, and the average price in the spot market is Bt9,000, the bank will pay the firm a net cash settlement of Bt500 at settlement date. The firm will thus gain from the swap. However, if the spot price is Bt8,000, the firm will face an opportunity loss - the chance to cut production costs by taking advantage of the lower price in the spot market.

The swap does not involve transactions in the underlying asset - in this case, copper.

To manage risks better, firms may buy swap contracts worth about 70 per cent of actual purchases of a commodity in each transaction, she suggested.

Commodity swaps are an over-the-counter instrument that is more flexible than future contracts, she said. The swap can be customised to meet the needs of a firm. Local firms are also expected to face rising production costs, due to rising interest rates.