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Hedges temporarily relieve companies from soaring energy prices

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Companies that previously locked in energy prices are protected from surging gas, oil and power markets, but that protection will fade as hedges expire and the costs of new hedges catch up today’s higher energy prices.

Companies typically buy futures contracts, such as swaps and options, to hedge currencies, interest rates, and commodities. Many companies have annual programs that set the size of their coverages and, on a quarterly or semi-annual basis, decide to add or reduce them according to the evolution of the markets.

These hedges are proving useful in today’s environment, with companies such as Associated British Foods PLC, specialty chemicals manufacturer Evonik Industries AG and data center company Equinix. Inc.

saying they remove some of the financial risks associated with rising energy prices.

But prices are now too high to add new coverage, companies and advisers say. “Most companies seem to be saying, ‘Let’s wait until things calm down a bit before we make projections or make any decisions,'” said Amol Dhargalkar, managing partner at Chatham Financial.

Global energy prices have surged since Russia invaded Ukraine in late February. Brent crude oil futures, 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 shun oil from Russia, with a gallon of regular gasoline costing $4,331 in the United States on Friday, up 53% from a year earlier, according to the AAA automobile association.

In Europe, companies are facing even bigger increases, with the European Spot Gas Index, a measure of natural gas prices, on Friday more than seven times higher than a year ago, according to the FactSet financial data provider..

Associated British Foods, owner of fashion chain Primark, has covered all of its energy needs, said chief financial officer John Bason. “There are several months left before we start to feel the effects of these increases in natural gas prices,” Bason said. The company, which also operates sugar refineries and food manufacturing plants, has hedging contracts ranging from a few months to several months, Mr. Bason said. “We are seeing some benefits, but they are 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 rising energy prices. “That’s why we have so far been less affected by rapid increases in spot markets,” said Andreas Steidle, senior vice president of energy management, adding that the company decided the year last to increase its coverage ratios. The German company also plans to operate a coal-fired power plant for longer, which it planned to mothball at the end of 2022.

The average price at which companies lock in energy blankets has risen significantly from a year ago. Firms hedged 12-month U.S. diesel prices on Wednesday at an average price of $2.69 a gallon, up 42% from a year earlier, a review of futures data showed. of the New York Mercantile Exchange by consulting firm Chatham Financial Corp.

The price companies accepted for European 12-month natural gas hedges increased more than fivefold from a year earlier, to €100.06 per megawatt-hour, or $109.21, on Wednesday, Chatham said. Companies in the United States locked in 12-month natural gas prices at $4.42 per million British thermal units on Wednesday, up 54% from a year earlier, Chatham found.

Companies with high energy needs, such as auto parts and food manufacturers, often hedge over one to two years, while energy producers hedge over three to five years, said Ryan Moffett, head of commodity sales at Wells Fargo & Co. may be a requirement for their covenants, with some reserve-based loans for oil and gas companies having a five-year term with coverage requirements of at least three years .

Equinix expects its hedges over the next few years to “really mitigate the volatility” resulting from rising energy prices, chief executive Charles Meyers said last week. The Redwood City, Calif.-based company operates data centers in Europe and the Middle East, but none in Russia or Ukraine. Equinix is ​​almost fully covered for its electricity needs in 2022 for data centers in EMEA and is partially covered through next year and 2024, a spokesperson said.

Companies rarely lock in all of their exposure to avoid being overhedged, which could signal to investors a lack of discipline in financial forecasting, Dhargalkar said. That means they’ll still be hit to some degree with higher costs, but they’ll also have more certainty about their costs than businesses that aren’t covered at all, he said.

Top materials Inc.,

a Denver-based building materials supplier, 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, said Chief Financial Officer Brian Harris. The company is considering further changes in response to the current crisis, he said.

Some companies just don’t get involved in the energy hedge game. Covestro HER

a German specialty chemicals maker, saw its energy costs double to 1.0 billion euros, or $1.09 billion, last year and expects them to drop from 1.5 to 1.7 billion euros this year based on current forecasts, said chief financial officer Thomas Toepfer.

“We see this continuing,” Mr Toepfer said, referring to rising electricity and gas costs. Yet Covestro does not cover its energy costs and seeks to pass on increases in the form of higher prices. “We don’t want to speculate on the evolution of energy prices,” Mr. Toepfer said.

Russia’s attack on Ukraine helped push the price of oil above $100 a barrel for the first time since 2014. Here’s how rising oil prices could further boost inflation in the American economy. Photo illustration: Todd Johnson

Write to Mark Maurer at [email protected], Nina Trentmann at [email protected] and Kristin Broughton at [email protected]

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