CHICAGO — The floodgates aren't open yet for risk management in the plastics industry, but a recent gathering in Chicago showed the tide definitely is rising.
The Nov. 17-19 Plastics News Executive Seminar featured a half-day session on contracts that can minimize financial risk from fluctuating resin prices.
Risk management contracts, which are common in the oil, natural gas, agricultural and financial markets, are designed to protect buyers and sellers from extreme price movements. The contracts allow buyers and sellers to lock into a price ceiling or floor, with the risk management company paying out the difference if prices exceed or fall short of the target figure.
Risk management firms profit from managing a portfolio of financial contracts based on dealings with producers and buyers.
In the past two years, four firms — Shell Chemical Risk Management Co. (SCRiM) of Houston, Enron Corp. of Houston, Louis Dreyfus Energy Corp. of Wilton, Conn., and Koch Industries of Wichita, Kan. — have entered the plastics risk management market. Industry sources estimate the four currently have between 250 million and 300 million pounds of petrochemicals under contract each month.
SCRiM Vice President Jack Perini said it is important for plastics processors to look at their purchasing and sales contracts to identify ``squeeze points'' where their price risk is the greatest.
``If you can pass the risk through, you're OK. If not, you're the price risk holder,'' Perini said. ``That's who we're trying to find.''
Risk management specifically can help plastics processors by providing them with a more stable financial framework that could allow them to invest in capital improvements to their business, according to David Scharfstein, a professor of management at the Massachusetts Institute of Technology in Cambridge, Mass.
``When PVC resin is high, you traditionally don't want to make a lot of investments in equipment because your cash flow is low,'' Scharfstein told meeting attendees. ``With risk management, you can insulate your cash flow so you have the money for that investment.''
Curiosity abounded among the seminar's attendees, many of whom seemed intrigued by the possibility of a resin budget that resembled the plains of Kansas instead of the Rocky Mountains.
The soft resin market of 1998 has put many processors in the position of paying less than they expected for materials, but industry veterans such as Richard Gill, president and chairman of Polyfab Corp. in Sheboygan, Wis., realize the pricing cycle is bound to go up again.
``This year we came out ahead, but it puts you in a trap because next year your customers want you to do it again,'' said Gill, whose firm posted 1997 injection molding sales of $8.5 million. ``I'm not sure if we're going to hedge or not, but I wanted to find out more about it.''
Several attendees, such as Michael Indeck, purchasing director for Miniature Precision Components Inc. in Walworth, Wis., wondered if risk management could be applied to lower-volume, less-cyclical engineering resins as well as to large-volume, commodity materials.
``It might be able to help us out with our polypropylene, but in nylon, we're really locked in to specific materials according to what our customers want,'' Indeck said.
SCRiM's Perini explained that risk management contracts currently are not offered on engineering resins such as nylon and polycarbonate, because the low number of producers leads to less volatility and less need for hedging.
Other attendees wanted to know if risk management could apply to processors that don't buy resin but still feel pressure from resin pricing.
``We're thermoforming sheet material, but we're subject to the same price fluctuations as resin buyers,'' said Stephen Abernathy, chief executive officer of C.O. Tools Inc. in Elkhart, Ind.
``We get [price changes] passed through to us because both our suppliers and customers are larger than we are — we're just exactly the wrong size,'' Abernathy said. ``I think we might be able to use hedging since 40 percent of our cost structure is in material costs. That's been a part we can't get under control.''
The story at C.O. Tools is a classic example of a processor absorbing price risk, Perini said.
``If there's a high degree of correlation between his sheet price and the resin price, risk management would work,'' Perini said.