Hard markets for softs? The case for holistic risk management in agricultural commodity markets

Throughout 2010, an onslaught of drought, fires and record temperatures have rocked the markets, leaving many people hoping that a weak US dollar will help boost demand for exports among foreign buyers. In recent months, Australia has been hit by heavy rain and a drought caused Russia to halt exports of grain. Beyond weather’s pivotal role in helping to drive dramatic price action, it also disrupts supply chains.

Unfortunately for some, the pressure on income statements and balance sheets has resulted in extreme earnings volatility and, in some cases, closure. Overall, stakeholders want better returns and more transparency, and they are expanding their scrutiny to include risk management practices. Investors know too well that a breakdown in risk will either compel them to inject more capital or instead watch their equity value plummet when failures become public knowledge.

Organisations not blessed with deep pockets and large cash reserves may be driven out of the business during the unexpected volatility and price swings. The long-term players will need extremely deep pockets to withstand the storm, and those without that luxury will need an effective strategy to manage this potentially devastating price risk.

In the wake of these experiences, the case for agricultural commodity market participants to adopt more of an enterprise-wide approach to risk management is compelling. In our view, informed decision-making around agricultural commodity price hedging and value chain management is only possible with a truly holistic approach to risk management.

Enterprise-wide risk management can also facilitate closer interaction between the traditionally disparate treasury and risk management functions at larger organisations. Closer collaboration can lead to a clearer picture of liquidity, credit and other non-market risks as well as increase operational efficiency.

More broadly, enterprise-wide risk management can also help drive a more risk-sensitive approach to strategic decision-making. This can be on matters such as the optimal balance-sheet funding mix; selection of suppliers, buyers and counterparties; managing the optionality of supply chains; and divestments and acquisitions.