Hedging Horror Stories

There are untold stories I can share about hedging gone awry, or hedging perceived to have gone rogue. In these cases, they have gone rogue, and there are others where entire industries are suffering due to the lack of hedging.

 

$10 million losses – in one day!

There are numerous examples of weather, to being short in volatile times, to just very large short positions I have seen in oil, chemical, metals, and power that have driven many unwanted losses.  All of those are not public and buried in financial statements, and may be immaterial to some companies.

I am sure you have seen your share, and if we visited each trading to asset related company, we will find that each one of them have stories like these to share.

Power Markets

A trading arena where there is more volatility than most is the power markets. There is not a utility that can say they have escaped multi-million dollar losses in a single day due forecasting errors, even if forecasting processes or tools are in place. Getting caught flat-footed, standing still while power prices surge to $800/MWH and up to $2,500/MWH, or even $8,000/MWH, is no longer an acceptable approach.

In many states, even in heavy regulated to non-regulated power companies, such as those in California and Texas, respectively, for example, today who are installing nice hedging programs by layering in hedges, buying options, and forecasting day-ahead to decades-ahead, with both physical and financial procurement, trading, risk, hedging strategies, and with tools that drive results and benefits that pay for themselves in year one.

And, there are plenty of utilities where people are counting down the days until retirement, praying nothing happens before that day.

We are responsible to leave a legacy, a footprint and, no pun intended, not a carbon one, but a footprint that people will follow for decades to come. It’s a choice.

The Walmart Hedge 

Here is another story that highlights why having a hedging strategy is so important it is worthy of its own book.

Walmart is a great company, a great story in keeping the lowest cost products on the shelves, helping the consumer like no other company has ever achieved for our daily needs. As I type this, my wife is dropping our hard-earned money off at one of their stores. Yours, too?

As a consumer, most everyone would agree, and sure we have had negative experiences everywhere, but time and time again I find Walmart cheaper than the rest, whether it be food or a variety of products.

I have a unique perspective on Walmart, an insider view of sorts like no other. Since I have worked in energy, and worked on the chemical products, as well, in my commodity and energy career, I came to know, indirectly, the pressure Walmart puts on product companies, challenging why they charge so much for their products.

Walmart has staff who can cost the products provided by the vendors on their shelves, if that surprises you. And, I knew exactly who those companies were.

Why and how?

Nearly everything we use starts with oil and/or natural gas. We called it drilling rigs to dashboards and from slurry to soap. You name the product, you name the company, and most came to us for hedging all their chemicals that feed into their industries and products.

Big and small, you know these product companies and all of us have them in our home.

Several product companies were aggressive in pursuing hedges, as they knew the risk was just too great that once Walmart secures their agreement on price, they would continue pressuring them to proactively manage their cost even more effectively next year.

If oil which, at the time was about $30/bbl., kept rising, the ultimate cost of your cars to drinking cups, and detergent to deck shoes, would cost more to produce. Therefore, many consumer products companies I met with were also pursuing off-the-shelf hedging strategies tools as fast I was quietly developing them behind the scenes with a small army of PhDs.

Big Consumer Product Companies

I recall vividly a large, well know consumer product company who didn’t come to us, but we went to them. We said, “By the way, your competitors and industries alike who sell to Walmart are at our doorstep hedging their risk. What is your risk program?”

Response: “We don’t have one.”

There are two examples I think are noteworthy that all companies should never fall into for both political and/or ethical reasons.

The first is a major consumer product company we all know as a household name; I can find their products in every home in America. While oil and natural gas prices were rising, so was the cost of their chemicals they needed to produce their products. A billion pounds of chemicals each year is not small.

Visit after visit, teleconference after teleconference, we built a trusting relationship. After 18 months, they basically said we cannot hedge because if the hedges lose money, we think we will lose our jobs.

I would completely understand if they bought more hedges than chemicals needed to produce their products. I get, too, that going from zero hedging to 100% hedging is extreme – a reaction and probably not prudent, save you had a very compelling reason to manage a budget, cash flow, and/or debt covenants.

We were not talking, though, about 100%, 75%, 50%, or even 25% of their chemical hedging needs. We were talking around 5-10%, to start. Then, layering in more as they needed them over the years.

Since I was a CPA as well, I had gone through their financial statements and they did not enjoy large margins, and with rising oil and gas prices it was a perfect fit to create a hedging program.

Finally, after two years, they hedged a few million out of the billion pounds.

How did that immaterial hedging turnout for them?  They were in the money, and they collected cash monthly, but far from the point for those of us who know that even a basic hedging program is a must-have, not a nice-to-have.

In the period around 2002 to 2007 the S&P 500 rose by over 50%, this company’s stock price went down by over 10%. And, with the markets at new highs in 2016, this company still has not recovered to levels it once was in the 1990’s. Not proactively seeking a hedging program, much less one at all, vs. their competitors and this is the result – a negative stakeholder return over 20 years.

And, one of the companies whose products we use every day, who actively pursued hedging strategies and tools, has continued their upward trending stock price for decades. They chased every avenue to manage risk proactively and with a sense of urgency. You, too, have not one, but multiple amounts of their products at your home. For stakeholders, as well, the stock returns have been stable and upward.

Call me, and I will tell you who each of these companies are, in confidence.

Self-Hedging Story – Shhh!

Another story I will reserve for those who contact me directly is one where a company can self-hedge their chemical needs. How did they self-hedge without owning oil, natural gas, or chemical plants?

No, they did not buy WTI or NG futures or any other financial hedging instruments. They just came out and said: This is how we do it. A few who have worked around consumer products will know instantly.  Others may want to give me call.