Risk management in commodities: how does it work?

Understand what commodity risk management is, how it works, and how important it is in this volatile market.

January 8, 2023

hEDGEpoint Global Markets

The commodities market is characterized by price volatility. In this sense, risk management makes all the difference for players in this sector.

Factors such as the weather, economic changes, and wars can alter the dynamics of the production and marketing of these commodities at a local and global level. For example, many commodities are traded in dollars and depend on exchange rate fluctuations.

Relying on hedging tools allows businesses to be better protected in this context. But how does risk management work in practice and what is its real importance?

We’ll explain all the details below!

What is risk management in the commodities market?

The concept of risk management is linked to the planning, organization, and control of resources. The aim is to minimize the risks that can arise in scenarios of uncertainty.

As commodities are traded on the stock exchange and vary according to supply and demand, the producing nations are subject to incidents in their production processes. As a result, internal and external factors influence prices.

Just think of a country known for its huge wheat production, like Argentina. After experiencing one of the worst droughts in history last year, production was considerably affected. At the same time, the war in Ukraine broke out around the world. One of the consequences of this situation? Wheat prices have risen due to reduced supply and inelastic demand.

In this way, commodity risk management helps producers to have better control over their margins. In other words, it allows them to analyze the market as a whole more accurately and position themselves in the best possible way.

How to manage risks in commodities?

Risk management aims to identify and assess the various sources of risk associated with commodity operations, such as:

  • Exchange rate and interest rate changes;
  • Geopolitical instabilities;
  • Climatic phenomena;
  • Trade agreements.

Players can adopt alternatives to mitigate risks and minimize potential adverse impacts by understanding these aspects. These include futures, forward, and options contracts.

These financial instruments allow market participants to protect their interests against unfavorable movements in commodity prices. To do this, they set purchase or sale values at a future date. Consequently, they reduce exposure to market variations.

Read also:

  • Hedge: a guide to understanding this tool and managing risk.

  • Hedging commodities: why is it an excellent option in this market?

In addition, commodity risk management also involves implementing continuous monitoring practices. Therefore, relying on market intelligence becomes crucial to check daily updates, follow trends, predict possible movements, and identify opportunities.

After all, it is these analyses that contribute substantially to more assertive decision-making, as they provide important data for market players.

Why is risk management important in this sector?

Volatility impacts producers, cooperatives, industries, and consumers of commodities. Risk management is fundamental to avoiding or reducing price variations. For this reason, it also affects the income of these agents since it seeks a balance between risk and financial return.

Commodities, which include products such as oil and grains, are susceptible to a wide range of factors that can significantly affect prices. The importance of risk management lies in the ability to protect participants against systemic risks.

Market participants can adopt tools that help mitigate the risks associated with commodities operations by proactively identifying and assessing them. Furthermore, effective risk management is crucial to the sustainability and continuity of operations in the commodities market.

Companies that depend on these products for their supply chains or that operate directly in this market face significant financial risks. With risk management, they can anticipate and protect themselves from variations in values. This is the case for airlines that need oil, for example.

In short, risk management not only preserves the value of investments but also contributes to the long-term stability of commercial activities. It avoids abrupt price rises for suppliers, producers, and consumers alike.

hEDGEpoint: hedging to manage volatility risks

hEDGEpoint offers hedging products to manage commodity risks. We also carry out market intelligence analysis, providing valuable insights and data for participants in this sector.

Read also:

  • hEDGEpoint: learn about the company’s sectors of activity

From producers and cooperatives to traders and large industries, we exist to manage volatility and turn risks into opportunities. Our commercial approach is customized to respond strategically to market movements.

In this way, we combine the knowledge of our professionals with cutting-edge technologies, adapting risk management tools according to each stage of the chain.

Talk to a hEDGEpoint professional to find out more!


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