15 May 2012 23:21 [Source: ICIS news]
BRUSSELS (ICIS)--Polymer producers and converters are beginning to use financial hedging instruments to mitigate price volatility risk in the physical markets, a director at Barclays Capital said on Tuesday.
Price hedging in the form of fixed-for-floating swaps is relatively new in the polymer industry, although financial hedges are common in other commodity markets.
“Hedging is big in the energy and metals markets,” said Andy Bookas, a director at Barclays Capital.
Bookas made his comments at the ICIS World Polyolefins Conference.
“Now these hedging instruments are slowly also becoming available for various olefins and polymers," he said.
“However, unlike crude oil, they are not exchange traded commodities, so it is still somewhat more difficult to structure a hedge,” he said.
Fluctuating spreads between feedstock and polymer prices present a risk for producers, while converters and consumers with predictable sales revenues are exposed to volatile resin costs affecting their bottom line.
In hedging, producers and converters decide on a pre-determined amount, representing the polyethylene/polypropylene (PE/PP) to naphtha spread in the case of producers and the resin price in the case of the latter.
The PE/PP price and PE/PP-naphtha spread are normally based on physical market pricing benchmark indices of ICIS and Platts, Bookas said.
The financial hedge then compensates for the difference between the agreed spread or price and the monthly average published price, in both directions. In other words, the bank pays or receives the difference in order to bring the net price back to the agreed level.
Producers lock in the spread between PE/PP and naphtha with a bank at levels they are comfortable with.
“If the spread narrows, the bank steps in and pays the difference between the narrower spread and the pre-agreed number,” Bookas said, “thereby guaranteeing an acceptable production margin and mitigating the risk of a loss for producers”.
However, if the spread widens, and is higher than the pre-agreed figure, the producer pays the difference to the bank.
Meanwhile, converters who enter into fixed-for-floating swaps lock in a pre-determined PE/PP price with a bank.
“It is called a fixed-for-floating swap as the company pays a fixed price and receives a floating price,” he said.
“If the monthly average published reference price for PE or PP is above the swap level, the converter receives the difference. If it is below the swap level, the converter pays the difference,” Bookas said.
This reduces converters' risk from fluctuating PE/PP prices and allows them to offer fixed price supply contracts to customers without having to worry about price risk, he explained.
“So basically they are locking in the margin between revenue and raw material cost.”
The bank holds swaps with both producers and converters and is able to offer new hedges to both at their target levels once naphtha prices drop to required levels.
“The success of putting a hedge in place at the desired level essentially depends on how the oil markets move,” Bookas said.
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