One way to protect against South Africa’s fluctuating diesel prices

Diesel prices are three times more volatile than the rand, causing South African corporations to increasingly turn to diesel hedging to manage the growing risks.

Roger Hewson, Corporate Commodity Structurer at RMB, explained this on The Money Show with Stephen Grootes.

“The volatility of diesel prices has now reached levels three times higher than that of the South African Rand (ZAR), shifting focus towards diesel as a significant risk factor for Southern African companies,” he said.

Hewson explained that South Africa’s currency is one of the most volatile in the world, and corporations hedge the currency constantly.

However, at three times more volatile than the rand, “diesel prices are excessively volatile”.

“Many corporations in Southern Africa, such as mining companies, large manufacturing facilities, and airlines, are directly exposed to diesel costs. Even more companies have indirect exposure.”

“Hospitals and property companies are exposed through the need for diesel generators, for example. All companies that have goods transported are effectively exposed to diesel prices through costs charged by logistics providers.”

Oil prices, normally fairly volatile, have experienced seismic shifts in recent years, driven by both economic and geo-political factors, the latter, and most obviously, being the Ukraine war and the escalating tensions in the Middle East.

Donald Trump, who recently won the US elections, and his “drill, baby, drill” campaign promise will also play a role in this volatility over the next four years.

These factors can cause oil prices to double or halve unpredictably, making it essential for companies to manage these fluctuations effectively.

The diesel volatility has been further accentuated by unprecedented swings in refining margins, making diesel hedging a critical risk management consideration for businesses across Southern Africa.

“We have experienced a sharp increase in queries to help businesses manage their exposure through hedging strategies,” Hewson noted.

Hedging diesel prices is a strategic approach that businesses can employ to mitigate the financial risks associated with fluctuating diesel costs.

Global fuel prices are the main factor influencing local fuel costs. Corporations with significant exposure to these volatile price changes can use diesel hedging to protect themselves.

Managing risk with diesel hedging is not about predicting future fuel prices; it’s about creating stability. Corporations need certainty in their costs to set pricing for customers and ensure profitability.

Unlike hedge funds that speculate on price changes, businesses focus on removing risk to provide stable pricing for clients and secure their profit margins.

By locking in a fixed price for fuel in rand terms, they can reduce their risk from unpredictable fluctuations in the global market.

Without any protection businesses very existence may be under threat such is the volatility in diesel prices,” Hewson noted.

South Africa has a diesel hedging formula that links local prices to global diesel prices and the rand. While not perfect, due to differences between the formula and the actual diesel prices used, the formula offers a robust hedging solution.

While oil prices have traditionally been the primary focus, recent market developments have highlighted the importance of considering crack spreads, which have experienced significant volatility following the energy crisis in Europe.

Crack spreads describe the difference between the price of crude oil and the price of refined petroleum products.

“But many companies still do not fully grasp the importance of hedging diesel risk or are even aware that this risk can be effectively managed and antiquated treasury management policies can hinder adoption,” Hewson warned.

The popularity of diesel hedging has extended beyond South Africa’s borders, with neighbouring countries adopting similar approaches.

While there may be minor variations in pricing and regulatory frameworks, the underlying principles of diesel hedging remain largely consistent across the region.

By effectively hedging diesel costs, businesses can protect their margins, improve their financial planning, and enhance their overall resilience to market fluctuations.

“As the Southern African region continues to grow and develop, diesel hedging is poised to become an even more essential component of corporate risk management strategies,” Hewson said.

Managing risk with diesel hedging is not about predicting future fuel prices; it’s about creating stability.