Better Ways to Buy

Treasury is teaming up with purchasing to tame commodity risk.

On the Chicago Mercantile Exchange early this summer, the price of block cheddar cheese was up 79 percent from a year earlier. In central Illinois, No. 2 yellow corn was up 68 percent from a year ago. And down in Texas, natural gas at the Henry Hub was up 15 percent from a year earlier and a dramatic 63 percent from its 52-week low.

Those are volatile pricing trends for corporate purchasing agents to manage. Increasingly, however, they don’t have to — at least not alone. Instead, companies are asking their treasury departments to export to their commodity-buying operations the same risk-management expertise they have long exercised in foreign-exchange and interest-rate markets.

“Treasury [managers] have gained a lot of knowledge in providing risk-management execution in those other areas,” says Robert J. Baldoni, leader of the global treasury advisory service for Big Four accounting firm Ernst & Young. “They’re the keepers of the tools and strategies. It is a natural progression for them to be moving down the risk spectrum to what is, at many companies, the next major risk.”

Darrell Thomas, assistant treasurer for capital markets at $35.1 billion beverage and foods company PepsiCo Inc., says he and his staff began working with his company’s global procurement and accounting teams about three years ago to better manage the company’s exposure to commodity risk. A big buyer of corn sweeteners, flour, potatoes, sugar, wheat, and other food staples, PepsiCo also consumes vast quantities of natural gas and fuel to produce and deliver its products. In addition to relying on productivity initiatives and global purchasing programs to manage the price risk, it also uses derivatives contracts.

By getting involved in protecting the company against commodity-price risk, Thomas says, treasury also provides senior executives with better visibility into PepsiCo’s hedging program.

Thorny Hedges

Better visibility into any sort of financing activity has itself become a prized commodity since the Sarbanes-Oxley Act of 2002 began requiring public-company CEOs and CFOs to formally sign off on the accuracy of financial statements. It is especially important for hedging transactions, because hedge accounting can be treacherous. In 2001, the Financial Accounting Standards Board began requiring companies to mark their derivatives contracts to market, with gains or losses flowing through the income statement, except under very tightly prescribed circumstances in which the contracts qualify as hedges rather than speculative transactions.

Plenty of companies have had problems hewing to the new derivatives accounting standard, commonly known as FAS 133 (see “Lost in the Maze,” May 2006). The consequences can be harsh. If a company’s hedge accounting fails to pass muster, the company must restate its financial results in both current and, where applicable, prior earnings periods to reflect mark-to-market accounting. And hedge accounting can be surprisingly easy to mess up, especially with commodities hedges.

Say you’re importing wheat from Mexico and paying your Mexican supplier in dollars under a contract that requires you to pay a kicker if the peso rises by 5 percent or more against the dollar. “That’s a common practice among purchasing people, who don’t like sourcing in local currency and don’t know how to manage currency risk very well,” says a Fortune 50 treasury executive who asked not to be identified. Unfortunately, he adds, that price kicker could be considered an embedded currency option under FAS 133, which would require mark-to-market treatment. Examples like that, he says, show why companies would be foolish not to get treasury involved in managing their commodity risks.

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