How Skanska can handle risks due to price fluctuations in commodity markets : Is it Economic Effective to Use a Commodity Hedge?

Abstract: This thesis is written in commission for Skanska Financial Services (SFS), which is a support unit that services the multinational construction company Skanska AB and Skanska’s Business Units, and coordinates the Group’s relations with financial markets and institutions. Construction companies that undertake construction projects face a number of unique problems. Of particular concern, is the fact that in many instances the final costs may be uncertain subject to substantial change, particularly changes in raw material costs. Increasing crude oil prices could turn projects expected to be profit generating into being unprofitable. The purpose of this thesis is to investigate how to protect a company, which knows it will have to buy a specific energy commodity in the future, against risks due to price fluctuations in the energy commodity market. Bitumen and diesel commodity hedges will be initiated by using the financial derivative instruments futures contracts and swaps. The effectiveness of the hedges will thereafter be evaluated from an economic perspective. The conclusions from the investigation are that futures contracts are not a good alternative for trying to create an effective bitumen hedge. To avoid the risk of entering a hedge that is neither effective from the perspective of locking in a price nor assumed to result in a financial gain, it is also not recommended to create a diesel hedge by using futures contracts. When it comes to swap hedges, there is no clear evidence that any of the specific type of swap constructions consistently will result in a total gain or loss. The timing has a major impact on the economic gain of a swap hedge, especially when hedging bitumen exposures. Moreover, it can be said that swap hedging offers great flexibility and possibility to fully lock in diesel and bitumen exposures. For Skanska it is preferable to hedge the diesel (QUSDL50-C-NWE) exposure with a bulk swap hedge for which the currency rate is fixed throughout the lifetime of the hedge. The bitumen (QHFO-ARA) exposure should be hedged with a 1 year swaps or a combined 1 year and 2 year swap hedge construction for which exchange rates are fixed according to the length of the swaps.