For companies exposed to commodity prices, hedging has long been the conventional answer to an uncomfortable question: what happens if prices move sharply against us?
Futures, forwards and swaps can all provide certainty. But certainty comes with trade-offs. A hedge may lock in a price when what a business really wants is protection from the worst outcome while retaining the benefit if the market moves in its favour.
That distinction matters. Insurance will not replace hedging in every situation, but there are circumstances where it can be a more natural fit.
1. When you want protection, not a fixed price
Suppose a manufacturer is buying aluminium at £2,000 a tonne. It can absorb normal market fluctuations but would struggle if the price rose above £2,300.
A traditional hedge can provide certainty by fixing the future price. The problem is that the company may no longer benefit fully if aluminium subsequently falls to £1,700.
Insurance takes a different approach. Cover can be structured to respond above an agreed price level. Below that level, the company continues buying at the prevailing market price. Meaning they benefit from price movement in the opposite direction to that, that they are protecting against.
It is the difference between asking “How do I fix my costs?” and “How do I protect myself if costs get significantly worse?”
2. When the commodity is difficult to hedge
Financial markets work well for some commodities. There are deep and liquid derivatives markets for products such as oil, copper and aluminium.
The picture becomes more complicated further down the supply chain or in the secondary (recycled) market.
A food manufacturer may be exposed to a particular vegetable oil. A packaging company might buy recycled PET or kraftliner. The price paid to a supplier may not map neatly onto an exchange-traded contract.
Businesses can sometimes hedge using a related commodity, but that introduces basis risk (the hedge and the actual purchase price may not move together).
Insurance can instead be structured around the raw material price reference that more closely reflects the company's physical exposure, subject to the availability and suitability of that reference.
3. When margin calls are unattractive
A hedge can protect against adverse price movements and still create short-term cash-flow pressure.
Depending on the instrument and structure used, collateral or margin may be required as markets move. That can tie up cash precisely when a business would prefer to preserve liquidity.
Insurance works differently. The cost of transferring the risk is established through the premium ahead of inception, with no margin calls through the policy period.
For a manufacturer focused on protecting working capital, the difference can be important.
4. When volumes are uncertain
Commodity purchasing rarely follows a perfect forecast.
A manufacturer may expect to buy 10,000 tonnes over the next year, only for customer demand to change. Orders can be cancelled, production schedules altered or volumes reduced.
Hedging more volume than the business ultimately requires can create its own financial exposure.
Insurance can offer another way of approaching the problem. Cover can be designed around eligible physical purchases during the policy period, with claims supported by evidence that the underlying transaction actually took place. Seasonality volumes can also be structured in.
That can make the structure particularly relevant where the business has genuine commodity exposure but less certainty over exactly when every purchase will occur.
5. When the business wants a simpler risk-management tool
Derivatives are familiar territory for large treasury teams. They can be less straightforward for businesses that have never hedged before.
There are questions around documentation, accounting treatment, collateral, governance and the management of positions over time. For some companies, that infrastructure is entirely justified. For others, it is a considerable undertaking for a risk they simply want to cap.
Insurance puts the exposure into a framework most businesses already understand: identify a risk, agree the level of protection and pay a premium to transfer part of that risk to an insurer.
That simplicity can be valuable, particularly for mid-sized manufacturers without specialist commodity trading or treasury teams.
Insurance or hedging?
The answer does not have to be one or the other.
Hedging remains an effective tool where a company wants price certainty and has an exposure that can be matched efficiently in financial markets. Insurance is more interesting where the objective is different: protecting the downside without necessarily giving up the upside.
Some businesses may ultimately use both.
The important question is therefore not simply “Should we hedge?” It is what the business is actually trying to achieve.
If the objective is to know exactly what a commodity will cost, hedging may be the natural answer. If the objective is to remain exposed to favourable prices while putting a limit on how damaging an adverse move can become, insurance deserves consideration.
ChAI Protect provides commodity price insurance for businesses exposed to raw material price movements. Cover can be structured around a company's commodity exposure, purchasing requirements and the level of price risk it wants to retain.
