India enters perilous world of metal hedging

India enters perilous world of metal hedging
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First Published: Fri, Aug 10 2007. 02 18 PM IST
Updated: Fri, Aug 10 2007. 02 18 PM IST
By Reuters
New Delhi: Indian metal producers and consumers are flocking to commodity exchanges to hedge their exposure to volatile prices after government restrictions were relaxed.
But firms face new perils if they dabble in this potentially expensive and high-stakes game. The Reserve Bank of India in April amended rules that limited hedging to importers and exporters of metals, allowing firms to hedge even if their price risk was solely in the domestic market.
“Within a couple of years, a majority of companies in India dealing in the commodities market would be at least prepared for hedging,” said Vikram Dhawan, head of commodities in the Reliance Mutual Fund, one of India’s top funds in asset value.
Hedging allows firms to lock in prices at set levels by offsetting a physical position with an equal and opposite position in a futures market. But hedging brings its own risks. In the case of nickel, prices have fallen nearly 50% from record highs touched in May, but if a consumer had put on a hedge at those higher numbers, the company would not benefit from the recent price move.
The main drawback of hedging is the cost. Clearing houses insist that position holders pay margins -- lines of credit or deposits that cover the largest likely one or two day move in prices of an asset -- on open positions to guard against the risk of default.
In the case of London Metal Exchange copper, LCH.Clearnet, which clears the contract, insists on a margin of $550 a tonne. “If you hedge excessively, then you can create cash flow problems,” Dhawan said, adding that paying the margin money alone could pose problems.
On the other hand, hedging too little may not insulate from volatility.
Increasing Interest
“After the regulation change, we see an increasing interest from Indian metal producers to hedge on the London Metal Exchange,” a London-based trader told Reuters.
“Every day more and more companies are contacting us to trade metals, usually a brokerage firm based in India contacts us rather than the company itself,” she added.
Though it was tough to identify how many firms were planning to start hedging, traders estimated at least 20 to 30 this year -- from auto makers and equipment manufacturers to cable suppliers.
A senior official with a leading private Indian bank said that hedging activity would really pick up in the coming months as soon as some routine procedural clearances for individual firms and banks were given by the central bank.
Several Indian metal companies said they were testing the waters by hedging small quantities. A senior official with steelmaker Ispat Industries Ltd. said they were hedging about a million dollars worth of aluminium and an equal amount for zinc.
“We are planning to step up our hedging in futures on the London Metal Exchange,” he said. Leading stainless steel producer Jindal Stainless has also started hedging small quantities of nickel, while India’s third-largest copper producer, Hindustan Copper, was first looking at the domestic futures bourse, before considering options overseas, industry officials said.
With more and more companies involved in building new roads and expanding the telecom network and power generation capacity in India’s rapidly-growing economy, most of them will look to cut their exposure to volatile prices through hedging, industry officials say.
“It is essential to manage their projects so that there are no large cost overruns,” said Gnakasekhar Thiagarajan, director of Commtrendz Risk Management. “Hedging will become a tool of necessity.”
Analysts said metal companies charting out expansion plans were also likely to find it easier to borrow from banks if they have hedging systems in place.
“In a good number of cases, banks insist on putting the hedging systems in place before they release the funds,” Dhawan said.
Thiagarajan said that the large- and medium-sized firms were likely to look to the London Metal Exchange, the world’s largest nonferrous metals market, because it provided greater trading volume and offered more options for futures.
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First Published: Fri, Aug 10 2007. 02 18 PM IST
More Topics: Hedging | metal | Money Matters | Commodities |