Case Study: Hedging US$5 Billion of Annual Commodity Exposure
A commodity exporter carrying US$5 billion of annual price exposure, entirely unhedged. Not through oversight: protection had been priced and judged unaffordable.
The exposure was well understood.
Conventional cover had been quoted at a premium the budget could not absorb, and in the absence of an affordable structure the position was simply unhedged. Full exposure to global market gyrations had become the default.
Challenge
Full protection was available and unaffordable. Quoted on at-the-money vanilla options, comprehensive cover would have consumed 15 to 20% of exposure in premium each year, a cost no budget of this size could sustain and the reason the exposure remained unhedged.
- Conventional at-the-money vanilla cover quoted at 15 to 20% premium per annum
- Double digit price movements recurring through the year, in both directions
- The full exposure carried open, with no floor beneath the annual budget levels
- No established counterparty lines or execution framework in place
Solution
Dynamic Hedge Programme
- A blended instrument structure holding premium cost to 4 to 6% per annum
- Instrument allocation adjusted as macro, geopolitical and supply and demand conditions moved
- Hedge ratio, strike selection and front or back loading reviewed weekly against the agreed protection and participation target
Results
The exposure did not change. What changed was whether protecting it was affordable at all.