Manufacturers and the Merit of Using Derivatives to Manage Risk

By February 16, 2011Economy, Regulations

Excellent statement Wednesday from Craig Reiners, director of risk management for MillerCoors LLC before the House Financial Services Committee’s hearing, “Assessing the Regulatory, Economic and Market Implications of the Dodd-Frank Derivatives Title.”

Reiners was testifying on behalf of the Coalition for Derivative End-Users — to which the National Association of Manufacturers belongs — about the use of derivatives by manufacturers to manage risk . Excerpt (with our paragraph breaks):

MillerCoors uses derivatives for the sole purpose of reducing commercial risk associated with our business. At MillerCoors, we brew beer, and our commitment to our customers is to produce the best beer in the United States and to deliver it at a competitive price. In order to achieve these goals, we must find a way to mitigate and prudently manage our inherent commodity risks. I believe the prudent use of derivatives offers end-users of physical commodities the critical risk management tools to provide a necessary degree of predictability to our earnings. The derivatives our organization has approved for use provide the tools to manage volatility intrinsic to commodities, which allows us to manage cash flow expectations within reasonable parameters. Our single largest commodity exposure is to aluminum. Our agricultural risks include malting barley, corn and hops. Our energy risk portfolio includes coal, natural gas, deregulated electricity and diesel fuel. This annual commodity spend of over $2.8 billion must be prudently managed.

In order to properly manage this significant risk, we created a strict Board-approved commodity risk policy that clearly forbids speculation. This policy allows us to use OTC swaps to precisely match the timing and prices of our complex manufacturing and distribution process. For example, we exactly match our OTC swaps for aluminum with our actual use of cans over the same time frame. This risk management technique allows us to prudently manage our costs and reduce price volatility.

We have used this risk management process both prior to and since the inception of MillerCoors with no adverse consequences. In fact, we would create significantly more price volatility in our business by not hedging our business risks. We believe that end-users generally share the concern that if the cost of hedging our risks rises significantly, entering into swaps may no longer be economical. The result could be a reduction in risk mitigation through hedging, which, ironically, could increase risk and exposure to market volatility.

Sen. Mike Johanns (R-NE) and 12 other U.S. Senators recently wrote a letter to the Securities and Exchange Commission urging the SEC to make sure that new regulations not limit the legitimate use of derivatives as a risk-management tool. The Coalition had encouraged Senators to join the letter, noting the potentially painful economic effects of overregulation:

A Business Roundtable survey from last year demonstrated that the imposition of a 3% initial margin requirement on S&P 500 companies alone would drain $269 million in liquidity per company and could reduce capital spending by $5 to $6 billion per year, causing a loss of 100,0000 to 120,000 jobs. Expanding this data to include non-S&P 500 companies and to account for variation margin requirements would substantially increase job losses.

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