The Hedging Corner: Wary about hedging the cost of your resins? You’re in good company

Resins comprise roughly half the cost of manufacturing plastics products, so it's smart business to control resins costs. Hedging is and should be an integral part of commodity cost control, resins included.

What is a hedge? For resins buyers, it's an alternative transaction to the purchase of a resin that will be made at some time in the future. Hedges are usually, not always, financial and their primary purpose is to guard against price increases in the associated resin until an opportune time determined by the hedger or until the physical resin is purchased and priced.

Anyone can hedge; not everyone hedges wisely. Plastics processors, many of them new to hedging, are concerned about higher costs (and weak profit margins) but wary of hedging as a means to control costs.

Why the wariness? There are a few reasons, including:

1. Working capital
2. Being second-guessed
3. Disclosure requirements
4. Matching hedges with resin requirements
5. Counter-party credit risk

These concerns and others -- and risk management solutions -- are discussed at length in this article on Plastics Today. While the concerns are legitimate, they are typical for businesses new to hedging. The same or similar concerns were addressed and overcome in other industries, such as energy. When energy futures contracts (heating oil, crude oil, etc.) opened on the NYMEX, industry veterans were wary and dismissive of them for years. Now, of course, there are many and various ways to hedge and trade energy commodities. I anticipate a similar, but accelerated, progression in hedging tools for resins - particularly after options are available in resins futures contracts. (Options help solve concerns 1 and 2 above, and will be discussed in future posts.)

Plastics processors can take solace in the fact that they may be new to hedging, but the trail is well marked - better than they think.

About the author: Tom Langan is a risk management and trading consultant who operates WTL Trading. He specializes in commodity cost control, loves to trade options, and enjoys teaching others ways to protect and increase the value of their manufacturing and personal portfolios. He has worked with private and public entities, as well as individuals, in helping control and take advantage of volatile oil and gas, electricity, resins, and metals prices.  More background information here. Each week Tom will add a new chapter to The Hedging Corner for PlasticsToday's readers.