A Common Misconception: Hedging Creates More Problems Than It Solves

This is a common—and costly—misconception.

One of the biggest fears companies have about hedging is getting caught in a 𝗯𝗮𝗰𝗸𝘄𝗮𝗿𝗱𝗮𝘁𝗶𝗼𝗻, which can impact profitability. But avoiding hedging due to this fear can expose businesses to even greater risks.

𝗧𝗵𝗲 𝗕𝗮𝗰𝗸𝘄𝗮𝗿𝗱𝗮𝘁𝗶𝗼𝗻 𝗗𝗶𝗹𝗲𝗺𝗺𝗮

Producers and traders are often 𝗹𝗼𝗻𝗴 𝗽𝗵𝘆𝘀𝗶𝗰𝗮𝗹 before they are short—they hold stock before selling it. This means they are inherently 𝘀𝗵𝗼𝗿𝘁 𝗳𝘂𝘁𝘂𝗿𝗲𝘀 because when they hedge a physical purchase, they sell futures.

So why does being short futures create exposure to backwardation?

Even the best-laid trading plans can face unexpected disruptions—vessel delays, production issues, changing market conditions. Half of being a physical trader is managing uncontrollable factors!

If your hedge prompt dates no longer match your physical flow, you will need to roll the position. When short futures, this involves:
🔹Buying futures on the nearby prompt date
🔹Selling futures on the further-out prompt date

In a backwardation, the nearby price is higher than the further-out price. If you have to borrow it means you buy high and sell lower—leading to a loss. 𝗧𝗵𝗮𝘁’𝘀 𝘄𝗵𝗲𝗿𝗲 𝘁𝗵𝗲 𝗳𝗲𝗮𝗿 𝗰𝗼𝗺𝗲𝘀 𝗳𝗿𝗼𝗺.

𝗕𝘂𝘁 𝗪𝗵𝗮𝘁 𝗛𝗮𝗽𝗽𝗲𝗻𝘀 𝗜𝗳 𝗬𝗼𝘂 𝗗𝗼𝗻’𝘁 𝗛𝗲𝗱𝗴𝗲?
A company that doesn’t hedge avoids these spread costs, but it remains fully exposed to outright price moves.

Let’s break it down:
A company buys refined copper at $9,000/mt. Their sale is delayed by a month, and the market is in $100/mt backwardation.

Without a hedge, they don’t pay the $100/mt to roll their short futures position. But when they finally sell, the market has dropped to $8,500/mt.
While they avoided the $100/mt backwardation cost, they lost $500/mt due to the decrease in outright price.

𝗧𝗵𝗲 𝗞𝗲𝘆 𝗧𝗮𝗸𝗲𝗮𝘄𝗮𝘆
Hedging is about protecting against catastrophic losses.

Yes, avoiding backwardations requires proper position management, but with the right training, they don’t have to be feared—they can even create opportunities for profit.