BioFuels Journal

United Bio Energy Risk Management Advisor: Ethanol Producers Need Clear Understanding of Hedging Risks and Must Be Ready to Take Up Multiple Hedging Positions

Wichita, KS—Recent weeks have shown an increasing amount of panic over the state of the U.S. economy and some prominent examples of how even large ethanol producers can run into serious trouble when the markets turn.

Panic, though, is not the right reaction to major market shifts, according to Tom Wapp, United Bio Energy's ethanol market analyst and risk management advisor to ethanol producers.

Wapp says even closures of several ethanol plants pose as much of an opportunity as they do a threat.

"If margins stay right at or around break-even levels for much longer, we'll see plants slow down production or shut down altogether," Wapp said.

"If enough ethanol production were to go offline, we'd likely see a sizable increase in the value of the remaining production quantity."

Recently, a number of ethanol producers ran into trouble with hedging strategies that turned against them when the market shifted directions, often leaving them with contracts to buy high-priced corn as ethanol values began to drop.

This shines a light on the importance of solid purchasing, hedging and risk strategies.

United Bio Energy's Wapp offers this advice for smart, stable risk management strategies:

• Even sound risk management positions must be financed.

Underestimating or not understanding the amount of capital needed to fund a plant's position can lead to a capital shortfall.

• Understand your risk exposure on a hedge position is before you enter it, and know that you have the means to maintain the position even if the market reacts against it.

• When you enter a risk management position or hedge, don't forget there may be additional positions necessary at a later time that will also need to be funded.

Don't use up all of your available capital on one position that would limit being able to take advantage of other positions later.

• Don't panic when the market makes large moves.

Keep the fundamental supply and demand picture in perspective.

It might not seem to matter when outside influences are affecting the market, but eventually the market has to rectify an imbalance in price and in supply and demand.

"We're seeing volatility, and some producers are running into razor-thin margins," Wapp said.

"Plant managers need to run a tight ship -- know their balance sheets inside and out, and know in advance if they can take advantage of potentially profitable positions."

For more information, call 651-695-0174.