The GCC’s industrial sector makes up a substantial portion of domestic production, well above half to be more precise. Chief amongst the industrial sector are manufacturing businesses, which come in various sizes. A manufacturing business’s model revolves around the output of products from an input of materials. In many circumstances, such materials used in manufacturing input are commodities, such as aluminum, copper, petrochemicals, and sugar, to name a few. The price movements of these materials, consequently, have a large impact on the cost of goods produced.
Commodities generally have a global market, spurred by the ease of shipping and distribution of resources. This has led the cyclicality of world markets to have a significant impact on commodity prices. This impact has been further heightened during the past few years with the increased volatility of world economic outlook.
For a manufacturer using a commodity as a main input in generating its product, volatility results in corresponding fluctuations in production costs. Most manufacturers, however, cannot simply pass on cost fluctuations to their customers, either due to selling prior to production (and cost determination), or to the elasticity of demand that leads customers to buy an alternative product to the one not competitively priced. This pricing risk is further exacerbated in small businesses, which do not have the cash capabilities to ride various pricing cycles. We see them therefore resorting to production delays, sale contract violations or default, or substitutions with cheaper commodities.
To remedy the situation and to introduce a level of cost (or revenue) stability, financial markets have developed a number of instruments that allow commodities users (buyers and sellers) better manage the prices of commodities, largely through buying future needs well in advance without taking delivery, or selling future supplies. Futures, forwards, and options are tools used by producers and traders every day in a market that exceeds 25 trillion dollars hedging a wide range of commodities from oil to grain, coffee, sugar, aluminium, and gold.
The world of commodity price management to is at the hands of entrepreneurs around the world; the key to unlocking it is knowing how it works. The first step a producer must take to manage his costs is understanding his commodity exposures. After that, comes structuring a portfolio that neutralizes such commodity exposures over certain business cycles. The results in stabilizing business margins are astonishing. By stabilizing input costs, producers are able to offer their products with more certainty and competitiveness.