Key question
How do we hedge commodity-exposed revenues while accounting for the correlated currency risk?
Commodity revenues and local-currency costs create a natural hedge
Many commodity producers price output in USD but operate with costs in a local EM currency. When commodity prices fall, the local currency often weakens simultaneously — reducing the USD equivalent of costs and partially cushioning the revenue decline. This built-in offset is the starting point for any hedging analysis. Example: an oil company with RUB-denominated operating costs benefits from this dynamic when oil prices drop.
Illustrative — inverse co-movement reduces combined earnings risk
Quantify each risk separately, then account for correlation
A four-step approach: (1) assess each risk source, (2) measure the correlation between them, (3) compute combined EaR — which is less than the sum of parts due to diversification, (4) structure a hedge that makes the correlation more negative, further reducing total risk. The key insight: hedging only one risk without the other can eliminate the diversification benefit.
Combined EaR < sum of parts — diversification from negative correlation
Revenue streams
Costs
Individual earnings at risk
Each risk is assessed separately via Monte Carlo simulation (10,000 paths). EaR = maximum EBITDA loss at 95% confidence over 1 year.
EaR · Oil price
$1,360mn
5% chance Brent falls to $42.9/bbl in 1 year
EaR · USDRUB
$900mn
5% chance RUB strengthens to 47.7 in 1 year
Correlation between risks
Oil price and USDRUB move in opposite directions (correlation −48%). When oil falls, RUB typically weakens — adverse scenarios rarely coincide. This is the key input for quantifying the combined risk.
Oil–RUB correlation
−48%
1-year rolling · June 2018
Correlation at maturity
−50%
1-year horizon · Monte Carlo
Combined earnings at risk
Combining both risk factors with their correlation gives total EaR. The diversification benefit ($870mn) reduces combined risk well below the simple sum.
Simple sum
$2,260mn
oil + FX — ignoring correlation
Diversification
−$870mn
from oil–RUB negative correlation
Total EaR
$1,390mn
95% confidence · 1-year
Optimal hedging solution
A hybrid FX instrument artificially strengthens the correlation from −50% to −70%: it pays a better exchange rate when both oil and the local currency move adversely, and a worse rate in favourable conditions — reducing EaR by 20% without hedging oil directly.
EaR before
$1,390mn
EaR after
$1,110mn
Reduction
−20%
corr.: −50% → −70%
Demo is based on historical data. In the full version — current data, your commodity, your company's portfolio.