I Was Kind Of Right
Match 14, 2022
The average price at which businesses lock in hedges in the U.S. and Europe has climbed over the past year
Companies that previously locked in energy prices are being shielded from surging gas, oil and electricity markets, but that protection will fade as hedges expire and the costs of new ones catch up with today’s higher energy prices. Companies typically buy forward contracts, such as swaps and options, to hedge currencies, interest rates and commodities. Many businesses have annual programs that set the size of their hedges and, on a quarterly or half-yearly basis, decide whether to add or reduce them depending on where markets are headed.
Those hedges are proving helpful in today’s environment, with companies including Associated British Foods PLC, speciality-chemicals manufacturer Evonik Industries AG and data-center firm Equinix Inc. saying they take away some of the financial risks associated with climbing energy prices.
But prices are now too high to be adding new hedges, companies and advisers say. “Most companies seem to say, ‘Let’s wait until things settle down a little bit before making any projections or decisions,’” said Amol Dhargalkar, managing partner at Chatham Financial. Global energy prices have surged since Russia invaded Ukraine in late February. Futures for Brent crude oil, the global oil benchmark, traded at $112.12 a barrel on Friday, up 62% from a year earlier. Gasoline prices have also risen as traders are steering clear of oil sourced from Russia, with a gallon of regular gas costing $4.331 on Friday in the U.S., up 53% from a year before, according to automobile association AAA. In Europe, companies are facing even steeper increases, with the European Gas Spot Index, a measure of natural-gas prices, on Friday up more than seven times from a year ago, according to financial-data provider FactSet.
Associated British Foods, the owner of fashion chain Primark, has hedged all of its energy needs, Chief Financial Officer John Bason said. “There are a number of months before we start to feel the effects of these increases in natural-gas prices,” Mr. Bason said. The company, which also operates sugar refineries and food manufacturing plants, has hedge contracts ranging from a few to several months, Mr. Bason said. “We are seeing some benefit, but it is temporary,” he said. The company declined to comment on how much it spends on energy purchases.
Evonik is also cushioned from some of the effects of higher energy prices. “That is why we have so far been less affected by the rapid increases on the spot markets,” said Andreas Steidle, senior vice president of energy management, adding that the company last year decided to increase its hedging ratios. The German company also is considering operating a coal plant, which it was planning to mothball at the end of 2022, for longer. The average price at which companies lock in energy hedges has gone up significantly from a year ago. Companies on Wednesday set hedges on U.S. diesel prices 12 months out at an average price of $2.69 a gallon, up 42% from a year earlier, a review of futures data from the New York Mercantile Exchange by advisory firm Chatham Financial Corp. showed.
The price that companies agreed to for European natural gas hedges 12 months out rose more than fivefold from a year earlier, to €100.06 per megawatt hour, equivalent to $109.21, as of Wednesday, Chatham said. In the U.S., firms locked in natural-gas prices 12 months out at $4.42 per million British thermal unit Wednesday, up 54% from a year earlier, Chatham found. Businesses with high energy needs, such as auto-parts and food-product makers, often hedge one to two years out, whereas energy producers hedge three to five years out, said Ryan Moffett, head of commodity sales at Wells Fargo & Co. This can be a requirement for their debt covenants, with some reserve-based loans for oil-and-gas companies carrying a five-year term with hedging requirements of at least three years. Equinix expects its hedges over the next few years will “really dampen the volatility” stemming from higher energy prices, Chief Executive Charles Meyers said last week. The Redwood City, Calif.-based company operates data centers in Europe and the Middle East, though none in Russia or Ukraine. Equinix is almost entirely hedged for its 2022 power needs for data centers in the EMEA region and is partially hedged into next year and 2024, a spokesman said.
Companies rarely lock in all of their exposure to avoid being overhedged, which could indicate to investors a lack of discipline in financial forecasting, Mr. Dhargalkar said. That means they will still be hurt to some extent by higher costs, but will also have more certainty around their costs than firms that aren’t hedged at all, he said. Summit Materials Inc., a Denver-based supplier of construction materials, in 2021 expanded its hedging program to include coal and natural gas—which it uses as fuel for some of its operations—due to higher inflation, CFO Brian Harris said. The company is considering further changes in response to the current crisis, he said.
Some firms simply don’t get involved in the energy hedging game. Covestro AG , a German speciality-chemicals manufacturer, last year saw energy costs roughly double to €1.0 billion, equivalent to $1.09 billion, and expects them to jump to €1.5 billion to €1.7 billion this year based on current forecasts, CFO Thomas Toepfer said. “We see this continuing,” Mr. Toepfer said, referring to the increase in costs for electricity and gas. Still, Covestro doesn’t hedge its energy costs, and looks to pass on increases in the form of higher prices. “We don’t want to speculate about where energy prices will go,” Mr. Toepfer said.