Dollar daze: hedge your bets against the high US dollar

PHOTO: THINKSTOCK

It’s as if Southwest Airlines had gazed into a crystal ball. The US discount airliner needed a way to cut costs at the height of the 2008-09 global financial crisis as energy prices spiked, and to keep fares reasonable it took a gamble and locked in its fuel prices before they skyrocketed.

In 2008, about 70% of its fuel costs were locked in based on oil prices at $51 per barrel; 55% in 2009 at the same price. The practice protected it against oil price shifts and played a significant role in the company’s ability to turn a profit that year within a delicate economic environment. This year Southwest said it expects to save $1 billion in costs.

It’s called hedging and it’s something manufacturers can use to manage their procurement costs in the face of a bloated (and volatile) US dollar.

Indeed, the US dollar has climbed to its highest point in 11 years and manufacturers are already under pressure from intensifying global competition. US goods are more expensive to source, specifically for manufacturers that sell domestically, and this is damaging bottom lines and profit margins.

Canada is America’s largest trading partner, accounting for 17% of its trade-weighted average. To understand the dollar’s purchasing power, this metric determines which countries the US trades with the most.

What’s trending the US dollar upwards? Paul Noel, senior vice-president of procurement solutions at Ivalua, a global vendor of cloud-based spending management software based in Redwood City, Calif. (with a recently opened Montreal office), believes it has to do with the relative strength of an otherwise slow recovery from the financial crisis, and lower oil prices.

“Manufacturers need to look beyond their US suppliers if high-dollar volatility continues to play a role in procurement processes,” he says. “You’re going to get squeezed selling in this environment.”

In its simplest form, a hedge is used to reduce the risk of any substantial losses or gains, and can be constructed from a number of financial instruments, such as stocks, exchange traded funds, insurance or forward contracts that allow you to lock in an exchange rate today for a currency transaction at a later date.

An alternative tool is an option, which sets the exchange rate the company chooses to apply. If the current rate is more favorable, the company won’t exercise the option.

Noel says agreeing on forward exchange contracts with suppliers provides some relief from the back and forth of the exchange rate.

Western Union Business Solutions notes currency hedging can be a complicated proposition, but first steps include identifying exposures, formulating a currency risk management policy, determining budget rates and goals, formulating a strategy, executing it and then evaluating the results and making adjustments.

A 2009 survey by Export Development Canada (EDC) found manufacturers were hedging currency risk in a number of ways, such as: increasing expenses incurred in a foreign currency to match earnings in that currency (59%); changing product prices to reflect changes in the value of the dollar (50%); invoicing foreign buyers in Canadian dollars (41%); matching the due date or receivables in a foreign currency to payables in that currency (17%); and entering into foreign exchange swaps.

Procurement strategy
Noel believes because there’s so much trade between the US and Canada, some companies forget the role currencies play in their relationships with foreign suppliers.

“[Procurement people] don’t always consider where they’re buying from because they’re usually focused on the costs,” he says. “It brings some folks into a sense of false security.”

Hedging is also a great idea, Noel adds, if a manufacturer has invested a lot of capital into what it’s making and doesn’t want to risk everything on something it can’t control.

Farmers do this when they gauge the prices of their crops. They consider how much their produce could sell for based on how well their competitors’ harvests went – the price could be high or low. Either way, there’s uncertainty about a crop’s potential take. Some buy into forward contracts and lock in their prices so they know almost exactly how much money they’re going to make at the end of the harvest.

When you don’t have control over the currency exchange rate, you can at least mitigate its impact by making hedging part of your procurement strategy.

This article appears in the April 2015 issue of PLANT.