Hedging Strategies to Manage Price Volatility with Metals, Materials, and Construction

With market volatility increasing for a full range of commodities, a sudden shift in prices can upset a company’s best planning. For companies with a large fleet of vehicles, fuel can be the largest unpredictable expense impacting the bottom line. For many firms, financial hedging provides a solution by offering more price predictability and reducing risk so that they can focus on their core operations rather than speculate on factors outside their expertise. It also provides more certainty with budgeting and forecasting.

"It feels like every week, every month, every year, that some sort of disruption takes place that causes big spikes in commodity price volatility," says Fifth Third Bank’s Justin Brauer, Group Head of Metals, Materials & Construction. "And even if it’s one where we haven’t seen a big spike in volatility, businesses that have exposure to any commodity know that there’s susceptibility around a potential spike."

There are a wide range of metals, materials, and minerals whose future price can be hedged. They include oil, unleaded gasoline, jet fuel, copper, aluminum, zinc, and tin as well as scrap metal. In addition, companies that import commodities often hedge the exchange rates of the U.S. dollar against foreign currencies as well as hedging future interest rates.

Using Futures

The simplest and cheapest hedges are in the futures market—contracts to buffer financial and supply-price volatility in a specific time period. Futures contracts require the buyer or seller to purchase or sell the commodity at an agreed price at an agreed time. A downside of these derivatives is that they trade on public exchanges and require the posting of collateral, which is known as margin, to ensure the deal goes through, which can tie up a company’s capital and can be especially costly with high current interest rates.

Instead, the firm can choose to have a financial partner arrange a "forward" or "swap" derivative for a particular risk. These derivatives cushion against supply price shocks, spikes of interest rates, or currency values. Because the forward is arranged on a bank’s balance sheet, there is typically no need for a company to post collateral with an exchange. In order to pay for the bank’s balance sheet utilization, a small credit spread is built into the swap price.

Forwards are being used by many companies to obtain reliable price stability in this era of increased volatility caused by disruptions such as hurricanes, technology advancements, and wars. Recent examples include:

• Energy. After labor costs, the biggest expense for most companies is energy. With the ongoing conflicts in the Middle East and Ukraine, energy prices are among the most volatile in the commodity landscape. A 10%–15% swing in prices could cost businesses with large fleets of vehicles several million dollars a year.
• Scrap metal. The metals industry is trying to be cleaner for the environment, and recycling scrap metal has become a big business. When the pandemic forced a shutdown of many producers in the U.S., Europe, and China, scrap became scarce, driving up prices. Because of the increased price volatility, scrap customers have turned to hedging their scrap exposure, mainly via exchange-traded futures.

Hedging Makes Forecasting Easier

"Hedging is a way to manage the risk and create more certainty, which allows businesses to budget and forecast more accurately," says Fifth Third’s Rob Yokel, Director of Commodity Derivative Sales, adding that it’s important to understand that hedging tools aren’t designed to save money or win any commodity bets. "The intent is to protect the underlying profitability of the business," he says.

In some cases, a company’s sales team may obtain price escalators from its clients to consider future increases in input costs. But when fixed-price contracts don’t make such arrangements possible, or a company’s fulfillment durations can’t be synchronized with supply deals, a hedge can protect profit margins.

For example, a chemical producer needed a million pounds of copper in 2024, but saw spot prices rising from sub-$4 to around $5 a pound—a break-even point on the cost of goods it sold. It chose to obtain a $4.70 contract, with Fifth Third managing the risk.

Companies tend to hedge in two principal ways: To offer their customers a fixed-price contract, they can use a swap that enables them to pass through the hedge on any increase or decrease on the underlying metal price. The other way a swap is frequently used is when a company knows its exposure and input needs and it wants to protect a certain percentage of margin against volatility.

Locking In a Fixed Price Is the Goal

"It’s not about trying to time the market and generate a profit on the hedge," says Yokel. "It’s really a way for companies to net out at the price where they’re locking in—a certainty creator." The certainty of the result—and the avoidance of multimillion-dollar downside surprises—is key not just to a public company’s quarterly results, but to the ability of a middle-market firm to finance capital investments to sustain and expand a business.

Protecting margins is considered by many to be a company-wide management responsibility. Supply-chain, logistics, and sales teams should be part of the hedge discussions, not just the purchasing department and the finance team. These calls require coordination, whether you’re a regional supplier or one of the world’s largest automakers.

A Minimum Benchmark for Hedges

For effective corporate use of hedge contracts, a yearly spend of $1 million on a commodity is a good benchmark, says Brauer. "When it comes to trade execution, we don’t have a minimum, and it’s actually one of the key advantages of OTC derivatives versus futures." Diesel fuel, for example, would come in monthly lots of 42,000 gallons, but a hedge for that entire month might not always be needed. In contrast, a forward contract could be 54,000 gallons of diesel for one month, 37,000 gallons the next month, or much closer to any particular company’s physical exposures.

Derivatives may seem complicated at first, but they are quite straightforward transactions. "Once you understand how derivatives work, it’s actually very simple," says Brauer. "There’s no interruption to your physical practices, how you’re currently purchasing your metals or your energy products, and there’s portability, allowing you to work with multiple suppliers and not be tied to one physical supplier." Small companies often have a multistep internal approval process for purchases, which delays the settlement process, so the removal of operational challenges allows business to streamline their processes.

Because vendors could represent a potential credit risk if they suffer business distress, a derivative hedge backed by the bank’s credit rating can protect the buyer of the commodity from suffering substantial losses.

Adjusting Hedges Over Time

Firms can adjust the hedge for more extended periods, when it will have more leeway to adjust to changed circumstances. Some go for a layered approach—for example, 75% hedged on critical inputs for the immediate 12 months, 40% hedged for year two, and 25% hedged for year three. Every month or every quarter, as visibility on future business improves, the targets can be revisited.

To construct tailored hedging coverage using derivatives, companies should leverage the expertise of specialists in the specific commodities a company is using for its processes. Fifth Third has a team dedicated to helping companies implement financial risk management solutions, including a robust platform of energy, metal, and mineral hedges, and is one of the few banks that offers hedging on iron ore and cobalt. Fifth Third provides businesses with a mechanism for predictability in a world that is always unpredictable. Learn more.