Chapter 11Hedging Commodity Risk

This chapter focuses on the accounting challenges faced by entities when hedging commodity risk. For many industries, commodity contracts are an integral part of day-to-day business. For example, for companies in the oil, gas, utilities, mining and airline sectors, prices of certain commodities have a significant impact on their profitability and competitive position. Whilst each of these industries has its own accounting peculiarities, in this chapter I try to cover the most common accounting issues arising from their hedging of commodity risks.

11.1 MAIN COMMODITY UNDERLYINGS

The world of commodities includes a large number of different products. Underlyings of the most common commodity derivatives contracts can be grouped into the following categories:

  • oil products – crude oil, diesel, fuel oil, gas oil, gasoline, jet fuel and naphtha;
  • natural gas;
  • coal;
  • power;
  • carbon emissions;
  • base metals – aluminium, copper, lead, nickel, steel, tin and zinc;
  • precious metals – gold, silver, palladium and platinum;
  • agricultural (or soft commodities) – corn, soy complex, sugar and wheat.

11.2 LEASE, DERIVATIVE AND OWN-USE CONTRACTS

A contract to purchase or sell a commodity brings together a breadth of accounting standards – leases, derivatives, revenue recognition, and consolidation – which are individually among the most complicated areas of accounting. For example, a gas company may manage its gas on an integral basis, buying, storing and selling ...

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