Function documentationHedging the Commodity Price Risk using Commodity Swaps

 

A commodity swap is similar to an interest rate swap, but the parties exchange a fixed price for a commodity with a floating, or variable price for another, or the same, commodity.

Commodity swap offers the hedger the opportunity to convert floating price contract to fixed price and vice-versa, hence helping to hedge the commodity price risk.

Prerequisites

Before you can enter your commodity swap details as a hedging instrument, there are number of settings you must maintain:

  • Commodity master data. See also Commodity Master Data.

  • Commodity curve data. See also Commodity Curve.

  • Create the commodity swap instrument. See also Commodity Swap.

  • Define the calculation type in Customizing:   Treasury and Risk Management  Transaction Manager  General Settings  Hedge Management  Effectiveness Test  Define Calculation Types  

    • Select Calculation Category as 21 Hypothetical Derivative. See also Hypothetical Derivative.

    • Select the Create Hypo. Derivative Automatically check box.

  • Define an Assessment type in Customizing:   Treasury and Risk Management  Transaction Manager  General Settings  Hedge Management  Effectiveness Test  Define Assessment Types  

  • Define the hedging strategy:   Treasury and Risk Management  Transaction Manager  General Settings  Hedge Management  Effectiveness Test  Define Hedge Strategies  

    • The Calculation Type and Assessment Type you have defined, should be included in the Hedge Strategy

Activities

Before completing this activity, see also Hedge Plan (Hedging Relationship Management).

  1. In the SAP Area menu of the Treasury and Risk Management open   Financial Risk Management for Commodities  Hedge Accounting for Exposures  Hedging Relationships  Hedge Plan (THMEX)  

  2. Create a new hedge plan with a Risk Category of Commodity Category Price Risk and save it.

  3. Click the Hedge Plan button.

  4. Enter an unhedged exposure in the hedge plan:

    • Quantity

    • Unit of Measure

    • Commodity ID

  5. Open the Hedge Item tab, create the hedge item and select the hedge category:

    • Cash Flow Hedge

    • Fair Value Hedge

  6. Open the Hedging Relationship tab page and create the hedging relationship using the commodity swap created earlier as the hedging instrument.

  7. Select the Hedge Strategy you defined earlier. This includes the hypothetical derivative method.

Example

Hedging with Commodity Swaps – Hypothetical Derivative method

Commodity Swaps can be used as a hedging instrument in both a cash flow hedge and a fair value hedge. The following types of swap can be used as a hedging instrument in the hedging relationship.

  • Single cash flow at settlement

  • Multiple cash flows at periodic intervals

For example, commodity exposure of 60,000 tons of a “Commodity A”, priced at LME, for delivery after 6 months.

  • Hedge with commodity swap (pay floating, receive fixed) with single settlement after 6 months.

  • Hedge with commodity swap (pay floating, receive fixed) with settlement of 10,000 tons of “Commodity A” every month.

The effectiveness test is run on:

  • Change in fair value of Hypothetical derivative

  • Change in fair value of commodity swap

The delta of the NPV of the hypothetical derivative is compared with the delta of the swap to determine the effectiveness ratio.

Accounting
  • Cash Flow Hedge: The effective part is posted to OCI and the ineffective part to the P&L. See also Cash Flow Hedge.

  • Fair Value Hedge: The change in fair value of the swap is posted to P&L. See also Fair Value Hedge.

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