When to Trim Your Hedges: Purchasing Raw Materials as a Molder
Editor’s note: As molders experience greater challenges with supply chains, material availability, and onerous contract terms, it is imperative that they take the time now to address risk. In the first article of this four-part series, Alan Rothenbuecher, a lawyer with deep ties to the plastics industry, provided advice on how molders can minimize risk related to warranties. The second article explained how the judicious use of Incoterms in sales contracts mitigate risk in the transport and delivery of goods. In the third installment, Rothenbuecher detailed the importance of limitation of liability clauses for protecting manufacturers from financial risk. In this, the final article in the series, he explains how injection molders can use hedging to maintain profitability when the cost of raw materials fluctuates.
As an injection molder, you rely upon access to raw materials to manufacture your products. And, of course, your goal is to maximize your profits. When considering ways to cut costs, understanding the practice of hedging — and knowing when to trim your hedges — can influence your profitability as a molder and help you protect yourself against financial losses.
Unstable or changing environmental conditions can cause the prices of raw materials to fluctuate. When there is a shortage of raw materials — petroleum, resin, and so forth — needed to make plastic parts, the prices of those materials can spike significantly. This creates uncertainty for both the sellers and buyers of such commodities. To minimize risk in a volatile market, hedging is an option to consider — but not to underthink.
What is hedging?
Hedging is purchasing the right to buy raw materials at a set price in the future. It is a method used by global commodity buyers and sellers to reduce risk in the purchasing of raw materials needed to make their products. Hedging can decrease the risk of financial loss that can result from price fluctuation by setting a fixed price for your pre-planned purchase of those raw materials.
Common methods of hedging are futures contracts and options. A futures contract is an agreement to buy or sell that commodity at a set price at a specified time. Options provide the opportunity to purchase raw materials in the future and are priced based on the risk of downside price fluctuations for that commodity.
A seller can use hedging to buy raw materials that they know they will need for future production at a fixed price and avoid buying those materials later at a much higher price. This can allow for greater certainty and can reduce your risk of unforeseen financial exposure. This approach can also create more stability in cash flow, which supports the overall health of your business and helps you pursue your strategic goals with greater confidence.
Key considerations for hedging as a molder
Molders who are considering hedging need to make decisions that are in their financial best interest and further their business goals. The key to successful hedging is being thoughtful and strategic about when and how much to hedge. Molders should avoid placing 100% of their dollars on these options. Unwinding a hedge already placed is possible but requires well-informed and timely strategic action by the purchaser.
Overall, each individual molder must consider what kind of hedging is best for their business and should diversify where they are putting their dollars. Diversification is critical: Just as a skilled investor would not put all of his or her funds in one place, molders should evaluate what approaches to purchasing raw materials are best to minimize their potential losses. Molders should pay attention to what terms they are signing onto in such agreements and whether a right to purchase is serving their best interest. Understanding the complexities of these agreements and how to employ smart contracting strategies can help you decide exactly how trim to keep your hedges.
Special thanks to Katie Berens, who assisted with this article.
About the author
Often hailed as the “plastics lawyer,” Alan Rothenbuecher has developed particular expertise in the plastics industry, enabling him to assess business trends and needs to proactively develop solutions for molders. His industry expertise has led to Rothenbuecher being selected to act as counsel for and to serve on the boards of trade associations and molders considered leaders in the plastics industry.