Commodity Price Risk Management

A manual of hedging commodity price risk for corporates

Overview of commodity price risks and its hedging methodologies for corporates.

The origins of risk management pre-dates the 1700s with the use of probability theory to solve puzzles and its use was largely limited for theoretical purposes –however, during World War II risk management began to be studied and implemented for various purposes. Traditionally, risk management in the market place was always associated with the use of insurance to protect institutions and individuals from bearing losses associated with accidents.

However, from the 1950s, there were other forms of risk management that emerged as alternatives to insurance –especially when insurance coverage became costly and did not cover the risk exposure expected by the institutions. Modern risk management practices began to emerge around 1955 and in the 1970s, the use of derivatives as
instruments to manage or ‘hedge’ against insurable or uninsurable risks began to be used – and went on to be widely used from the 1980s. The wide-spread use of derivatives naturally lead to the formation of various international regulations of using derivatives with financial institutions developing internal risk management models and capital calculation measures to protect themselves from unanticipated risks and reduce regulatory capital.

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