Firms, Banks In Parleys Over Hedging Tools For Global Commodities
A commodity option gives the buyer the right and not an obligation to buy or sell goods at a pre-determined price
Leading corporates in the tea, coffee, petrochemicals, edible oil, steel, and tyre businesses have commenced negotiations with foreign banks to buy hedging instruments in the international commodity markets, even as the RBI-constituted R V Gupta committee will look into the issue.
Foreign banks are in negotiations with corporates to sell commodity derivatives but are unwilling to reveal the names of the companies. Officials point out that both importers of raw materials and exporters of goods are interested in purchasing options from international exchanges to hedge against price fluctuations.
Reserve Bank officials state that one of the important recommendations the committee is expected to make is that options can be purchased only if there is an underlying transaction or the business projection warrants the purchase of a hedge. Banks are working on this presumption to hammer out the best deal .
The apex bank on Friday had announced the setting up of a nine-member committee to examine various issues relating to hedging against price risk through international commodity exchanges. The committee will identify important import export groups where price volatility affects Indian corporates and where such risks can be hedged through i commodity exchanges.
Standard Chartered Bank was one of the first banks to request the Reserve Bank to allow it to sell commodity derivatives.
A commodity option gives the buyer the right and not an obligation to buy or sell goods at a pre-determined price. This gives the corporate to lock into a price and take volatility out its books.
There are other products too where the corporate locks into a price but incurs a loss if the price moves down or up as the case may be. A foreign bank which is negotiating with a tea major and steel company points out that its client is an exporter. The tea major wants to buy an option to sell tea at fixed price six months down the line. The company has worked out its production levels on the basis of the business projections and by purchasing an option to sell at a fixed price, it is assured of its revenues for the next six months.
In the case of the steel major, it has been suffering due to the low steel prices internationally. Now with international steel prices rising, it wants to lock into a remunerative price. Coffee manufacturers on the other hand are suffering from rising prices of coffee beans and require a hedge against a further rise. The option product that foreign banks have structured is essentially a financial instrument linked to the commodity markets overseas where only cash is exchanged and no goods change hands. A variation in price from the price at which the corporate is locked into will be made good by the bank.
For instance, the company might have locked into a price of say palm oil at $1000 a tonne. In case the price drops to $900 the company can let the option lapse and buy the commodity from the market.
However, if the price rises to $1200 per tonne, the company buys the produce in the market and the bank makes good the $200.
Another product where the company has a downside risk but is much more cheaply priced than an option is where if the price falls the company has to make good the money to the bank.
The price of an option product is worked out on the basis of the volatility in the market.
Market sources are apprehensive that RBI might put restrictions on the option products based on the volatility in the market. Bankers feel that the committee should recommend that the pricing be free and be left to banks.