India imports around 45 per cent of its natural gas requirements and about 82 per cent of the crude oil it processes because its economic growth is quite energy-intensive. The cascading effect of oil and gas prices on different industries is seen in the rising domestic inflation. Earlier, commodity price movements were cyclical, letting businesses withstand fluctuations with long-term supply contracts or by passing the price impact to customers. But with markets turning transparent and dynamic with technology, information asymmetries have reduced, and what worked in the past has become largely ineffective today.

In line with these economic and financial developments, corporates, especially the energy-intensive ones, need to evolve and manage energy price risk along with efficient hedging through exchange-traded crude oil and natural gas derivatives. This can help value chain stakeholders maintain profit margins.

Input price risk poses a threat not only to profitability but to long-terms investments because of unpredictable operational costs. The RBI, in 2022, termed volatile commodity prices as ‘high risk’ for the Indian economy.

The energy-intensive industries such as those of forging and glass, transportation and airline, cement and fertiliser, natural gas production and import, oil refineries, automobile, food processing, paint and hospitality are the most vulnerable.

The competitive environment means companies cannot always pass on input price rise to their consumers, thus leading to margin erosion. Apart from shielding the bottom-line from adverse price movements, hedging maximises shareholder value and lowers distress costs.

Commodity hedging works best if included in a comprehensive risk management programme to mitigate EBITDA-margin volatility by accounting for other margin deciders, apart from the price of feedstock. The best hedging strategies are a mix of long-term fixed-price arrangements with both suppliers and buyers, expanded presence in the value chain to avoid exposure to intermediate markets and hedging through the usage of commodity derivatives, in line with the risk appetite.

The sales and operations planning (S&OP) can help manage risk by coordinating sales and purchasing efforts, but only if S&OP is integrated into the price-risk and hedging process. Organisations must also actively manage inventory price risks and avoid keeping their exposure open to prices in the commodities market.

Indian statutory bodies and regulators have also initiated steps to encourage commodity price risk management. One such step has been SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, which require the listed companies to disclose information related to commodity price risk in their annual reports. India’s commitment towards adoption of Ind AS is providing a new direction to the corporates to provide comprehensive quantitative and qualitative risk disclosures and make hedging an economically sustainable activity.

Ruchi is Head-Energy, and Rahul is Manager-Energy, MCX. Views are personal

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