Commodity Risk

Commodity Risk

Commodity risk is the risk that a business’s financial performance or position will be adversely affected by fluctuations in the prices of commodities. Producers of commodities, for example energy sectors, are primarily exposed to price falls, which mean they will receive less revenue for the commodities they produce. Our company will confront with such issue.

Recently, the oil market is suffering from enormous plunge, nearly 20% this month. Continuous high volume output from the Middle East area and lately breakthrough in Iran issue have been trigger of the oil slump. The American energy revolution, meanwhile, has created a massive supply glut and the tepid global economy is depressing demand growth for oil. Chevron, as a producer of energy, will decrease sales revenue with falling price, thereby potentially decreasing the value of the company, leading to change in business strategy.

However, we can use financial market instruments to manage commodity risk.

• Futures contracts

   We can employ a short hedge to lock in a future selling price for an ongoing production of crude oil that is only ready for sale sometime in the future. Nowadays, Saudi Arabia Chevron has just entered into a contract to sell 200,000 barrels of crude oil, to be delivered in 3 months' time. The sale price is agreed by both parties to be based on the market price of crude oil on the day of delivery. By the end of 07/28/2015, the Crude Oil Brent is 53.01/barrel. The price of crude oil futures for delivery in 3 months' time is USD 53.86/barrel. We want to lock the selling price of 53.86/barrel so that our company get a short position in Brent Crude Oil Futures

Pros & Cons

Pros: The futures contracts are standard and can hedge risk without needing physical settlement. There is no counterparty risk as futures are settled through clearing house.

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