Sales price indexing vs cost price indexing – Hedging Analysis for a gas trading entity
Prices of refined product sold in the petrochemical industries are frequently indexed against a basket of indicators in order to hedge the seller against differential price behaviour between feedstock costs and sales prices. As there is no traded gas market in South Africa, gas prices are also linked to defined baskets of indicators often including inflation and exchange rate. Our client wished to understand the financial risks to their own business associated with offering a variety of price escalation mechanisms to their customers.
We constructed a comprehensive paramaterised multi-period financial model of the client’s profitability metrics under arbitrary assumptions around volume and macro-economic scenarios. We generated multiple stochastic macro-economic scenarios incorporating the client’s forecasts. We developed a visual spreadsheet tool to illustrate the likely range of consequences under the pricing options envisaged by the client. This process allowed the client to refine their offering and confirm that their business strategy gave them desirable levels of risk/reward from the unhedged exposures.