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How do you incorporate commodity prices into financial models?

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Commodity prices are often volatile and unpredictable, affecting the revenues, costs, and cash flows of many businesses. If you are building a financial model for a company that deals with commodities, you need to account for this uncertainty and its impact on the valuation. In this article, you will learn how to incorporate commodity prices into financial models using different methods and tools.

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Alison Salviano - CFP?, CEA

Bancário | Bradesco
Vishvanath Krishnan, Executive MBA, CA, FMVA

Chartered Accountant | FMVA |Financial Consultant | Ex-PwC | Ex-Crescent Group

1 Historical prices

One way to incorporate commodity prices into financial models is to use historical prices as a proxy for future prices. This method assumes that the past trends and patterns will continue in the future, and that the commodity market is efficient and reflects all available information. To use this method, you need to collect and analyze historical data on the commodity prices that affect your company, and use them to project the revenues, costs, and cash flows for your model. You can use various statistical techniques, such as regression, moving averages, or seasonality, to smooth out the fluctuations and capture the long-term trends.

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Alison Salviano - CFP?, CEA

Bancário | Bradesco
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As commodities s?o produtos elaborados em larga escala e que funcionam como matéria-prima, possuem qualidade e características uniformes. Ou seja, n?o se diferenciam de local para local, nem de produtor para produtor. Os pre?os das commodities s?o determinados pelas leis da oferta e da demanda no mercado internacional. Produtos como milho, arroz, soja, café, petróleo, metais, entre outros. Portanto a escolha das commoditeis para investimentos deve ser feito de forma criteriosa, entender sobre mercado futuro, e como esses índices se comportam em determinados momentos. Em momento de crise, o ouro é bastante procurado devido ser um porto seguro para os investidores, devido seu alto valor agregado.

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Fábio Silva

CEO na FSB INVESTMENTS - Análise de dados
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Compreens?o das Dinamicas de Commodities: Explora??o da ampla gama de commodities, desde energia até gr?os, e a compreens?o de suas dinamicas específicas. Sele??o Estratégica de Commodities: Estratégias para a escolha criteriosa das commodities a serem incorporadas com base nos objetivos e no contexto do mercado. Análise Fundamentada: A importancia da análise fundamentada, incluindo fatores como oferta, demanda, estoques e eventos geopolíticos, para uma modelagem eficaz. Modelos de Séries Temporais na Previs?o: Explora??o de modelos de séries temporais, como ARIMA e GARCH, para prever volatilidade e pre?os futuros de commodities. Incorpora??o de Variáveis Macroecon?micas:

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2 Forecast prices

Another way to incorporate commodity prices into financial models is to use forecast prices from external sources, such as analysts, consultants, or market participants. This method relies on the expertise and opinions of others, who may have more information and insights on the commodity market than you. To use this method, you need to find and evaluate reliable and relevant sources of forecast prices, and use them to project the revenues, costs, and cash flows for your model. You can use various methods, such as weighted averages, scenarios, or sensitivity analysis, to adjust and test the forecast prices for different assumptions and outcomes.

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Vishvanath Krishnan, Executive MBA, CA, FMVA

Chartered Accountant | FMVA |Financial Consultant | Ex-PwC | Ex-Crescent Group
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One thing I found useful is to understand the short-term (1-5 years) and long-term (beyond 5 years) trends in commodity prices. If the short-term trend reflects high volatility and unpredictability, it becomes critical to understand the macroeconomic situation. Either use year-wise data from a reliable external source or use an average for the short-term forecast. Highlight the price risk through a sensitivity analysis. If the entity follows a hedging strategy, the forecast shall be based on the strategy. Use scenario planning if commodity price is the key driver for the forecast. For long-term forecasts, it is best to assume a steady growth/decline rate based on the long-term trend observed and use a reliable source for forecast data.

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3 Commodity futures and options

A third way to incorporate commodity prices into financial models is to use commodity futures and options contracts, which are financial instruments that allow you to buy or sell a commodity at a predetermined price and date in the future. This method allows you to hedge against the risk of adverse price movements, and lock in a certain level of profitability for your company. To use this method, you need to understand and access the commodity futures and options markets, and use them to simulate the revenues, costs, and cash flows for your model. You can use various tools, such as Excel , Bloomberg , or Crystal Ball , to model and value the commodity futures and options contracts.

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4 Commodity price drivers

A fourth way to incorporate commodity prices into financial models is to use commodity price drivers, which are factors that influence the supply and demand of a commodity, such as production, consumption, inventories, geopolitics, regulations, or technology. This method allows you to capture the underlying dynamics and drivers of the commodity market, and forecast the future prices based on your own assumptions and scenarios. To use this method, you need to identify and quantify the key commodity price drivers that affect your company, and use them to project the revenues, costs, and cash flows for your model. You can use various frameworks, such as Porter's Five Forces , PESTEL , or SWOT , to analyze and structure the commodity price drivers.

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5 Commodity price models

A fifth way to incorporate commodity prices into financial models is to use commodity price models, which are mathematical and statistical models that describe and explain the behavior and evolution of commodity prices, such as mean-reversion , jump-diffusion , or GARCH . This method allows you to capture the stochastic and nonlinear nature of commodity prices, and generate realistic and probabilistic scenarios for your company. To use this method, you need to select and calibrate the appropriate commodity price model that fits your data and objectives, and use it to project the revenues, costs, and cash flows for your model. You can use various software, such as Matlab , R , or Python , to implement and simulate the commodity price models.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Rudolf Saffran

Especialista em PJ pela XP Empresas
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Na minha opini?o, ao integrar os pre?os das commodities nos modelos financeiros, é essencial estar atento aos fatores macroecon?micos e geopolíticos que podem influenciar os mercados. A capacidade de ajustar constantemente os modelos para refletir as mudan?as no ambiente econ?mico é crucial. Além disso, uma gest?o de riscos sólida, com estratégias de hedging e diversifica??o, é fundamental para enfrentar os desafios da volatilidade do mercado de commodities.

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How do you incorporate commodity prices into financial models?

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1 Historical prices

2 Forecast prices

3 Commodity futures and options

4 Commodity price drivers

5 Commodity price models

6 Here’s what else to consider

Corporate Finance

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