Companies who are first to define their risk management metrics to include extreme prices and anticipate how they can best benefit from them will have a significant competitive advantage. The starting point is to understand the company’s holistic commodity risk profile using analytics and modeling tools. A holistic commodity risk profile helps the organization assess its individual and net exposure to commodity prices across business and customer segments. This provides a common understanding for senior management and a "fact-based" foundation for evaluating the effectiveness of current risk-mitigation actions and alternative risk management strategies.
Determining the commodity risk profile can be quite challenging. In-Practice Guide: Six Steps to Assess Commodity Risk Exposure sets out a six-part analysis to determine commodity risk exposure and includes a illustrative Microsoft Excel-based workbook to help companies:
- Calculate expected commodity exposure
- Centralize risk management options undertaken across organization
- Calculate exposure after incorporating current risk management portfolio
- Determine impact of commodity price projections and exposure on financial metrics (e.g. EBITDA, cash flow, debt covenants)
- Define options for managing commodity price risk
This Guide and the associated paper, "Volatility, Not Vulnerability" is the second in a series of papers being developed by Oliver Wyman and the Association for Financial Professionals. The series addresses critical issues for finance professionals with the objective of stimulating discussion and feedback to Oliver Wyman and AFP through interactive roundtables, presentations at professional events, surveys, webinars, and personal interviews. The first article in this series, "The New Weakest Link in your Supply Chain," examined how companies can protect themselves against the deteriorating financial strength of suppliers.