Hedging Increases in the Food Industry

A couple of days ago, the Financial Times reported that Hershey is the latest in of a long string of food processors that will divert an increasing amount of their financial resources in commodity market hedging against future price increases.

According to the article, Hershey will spend $12 million of its 2009 budget on hedging because it expects prices to double again next year. I must admit that I was surprised. I always thought that Hershey, as a major chocolate maker, would hedge against cocoa price fluctuations. Some companies, like Mars, have been active in the futures market for a long time. Apparently, Hershey, like other food processors, has not bothered, since price fluctuations were not considered a problem so far. The dramatic increase in commodity prices since late last year has caught many companies by surprise and they’re now rethinking their position.

Small changes in commodity prices could always be passed on to consumers, but the magnitude of the recent increases combined with the recession that has curtailed consumer demand has exposed the limitations of that strategy.

Entering into futures market hedging offers one alternative to manage price fluctuations as I have explained here in an earlier post. It is different from supply  management. Rather than focusing on finding the best or most secure supply lines for critical commodities, futures market hedging adds an additional feature, that is, the strategy to counter price increases that might occur even in well established supply relationships. So food companies are now hiring former traders as personnel to manage their newly created risk management departments.

One of the risks that might not be manageable is the risk posed by traders themselves. I remind readers of the case of Baring Bank. In 1995 this bank which had been around to finance the British war efforts against Napoleon, had to declare bankruptcy because one of its traders had lost $1.4 billion in futures market speculation. More recently, the case of France’s Societé Generale showed again how rogue traders can rack up huge losses in the futures market (in this case a loss of $7.1 billion).

So who will hedge against the hedgers?

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