Contract Hedging – The Candy Store

If you have a perception that you cannot leverage contracts into hedging programs, you are missing a very large opportunity.

I have negotiated deals directly with the largest companies from GE to ExxonMobil, and down to mom and pop businesses. The size of the company, or that they are bigger than you, does not mean sophistication.

There are many, many contracts I have negotiated, assisted other groups in analyzing, renegotiating, having provided insight from every angle of the energy business from assets to trading, worldwide.

There are some companies that are harder than others to negotiate, and there are others, who to my complete bewilderment, still today allow for embedded options, from volume to price to including incremental asset-builds that ensure not only they make money, but make even more money as the contract clauses are executed, one after another.

That is a candy store – huh?

I have seen very sophisticated contracts that do take a financial engineer, not a typical real engineer, or an accountant, but someone trained in taking language and formulas to back them into the rates of return that are astronomical in relation to the risk.

And, there is one large company in particular that I run into in a variety of angles that continues to give away what the next company would never tolerate.

Another avenue, while quickly on this topic, is that many contracts are not digested and not implemented as stated. They get implemented on a perception. In my day, I have found millions upon millions of dollars not billed per the contract.

After a contract is implemented, for some it may be hard to go back and re-bill the customer for prior years. For some, the rebill will occur or they will cancel or want to renegotiate the contract. If you must rebill a client, make sure this human nature is not taken lightly before just sending bills. Relationships can be at stake here, so please consult the executive level.

I realize these contracts are hundreds of pages long, and that several pairs of eyes may need to review them, but that is where millions of dollars are just sitting ready to be unpacked.

One quick story: I read a 400-page contract in recent years, one of untold over my career, and the contract terms were nothing like how the client had depicted the transaction in their portfolio.

They had the deal modeled as a fixed priced deal. When I say fixed priced, I mean take or pay. But, in that contract are terms that allow you take more than a minimum, which many contracts do. I asked the client, “How do you value this extra volume?”

The response was a blank stare. “It is just additional volume.” My next question was, in which I already knew the answer, “Is the price for the additional volume the same as the minimum volume?” The response was, “No, it is different.” I realize many just consider incremental volumes a tiered pricing system, but that is an option, which has value. Value meaning it has risk that you may not leverage it properly without the proper tools. Risk that you do not “maximize.”

I can write an entire book on contracting, but the point is contracts are like a candy store in my experience, just full of goodies to discover, unpack, and to enjoy. Unpack them and negotiate terms in the contracts that provide options, hedges, optimization and maximize your risk/reward profile.

I realize everyone is terribly busy, and reading lots of contracts is boring. If you are open to reviewing your contracts in place today and how you contract tomorrow, please reach out to us at www.frontmidback.com and we will find that candy stash and share it with you!