SAP Commodity Management: The Power of an Integrated Solution

The recent periods of commodity price volatility have brought commodity risk management to the spotlight in numerous companies, where commodities constitute a substantial component of the final product, but pricing arrangements prevented a substantial hit of the bottom line in the past calm periods.  

Understanding Commodity Risk Management is ingrained in the individual steps of the whole value chain, encompassing various business functions with different responsibilities. Purchasing is responsible for negotiating with the suppliers: the sales or pricing department negotiates the conditions with the customers; and Treasury is responsible for negotiating with the banks to secure financing and eventually hedge the commodity risk on the derivatives market. Controlling should have clarity about the complete value chain flow and make sure the margin is protected. Commodity risk management should be a top item on the CFO's list nowadays. 

SAP's Solution: A Comprehensive Overview 

Each of these functions need to be supported with adequate information system functionality and integrated well together, bridging the physical supply chain flows with financial risk management.

SAP, as the leading provider of both ERP and Treasury and risk management systems, offers numerous functionalities to cover the individual parts of the process. The current solution is the result of almost two decades of functional evolution. The first functionalities were released in 2008 on the ECC 6.04 version to support commodity price risk in the metal business. The current portfolio supports industry solutions for agriculture, oil, and gas, as well as the metal business. Support for power trading is considered for the future. In the recent releases of S/4HANA, many components have been redeveloped to reflect the experience from the existing client implementations, to better cover the trading and hedging workflow, and to leverage the most recent SAP technological innovations, like HANA database and the ABAP RESTful Application Programming Model (RAP). 

Functionalities of SAP Commodity Management 

Let us take you on a quick journey through the available functionalities.  

The SAP Commodity Management solution covers commodity procurement and commodity sales in an end-to-end process, feeding the data for commodity risk positions to support commodity risk management as a dedicated function. In the logistics process, it offers both contracts and orders with commodity pricing components, which can directly be captured through the integrated Commodity Price Engine (CPE). In some commodity markets, products need to be invoiced before the final price is determined based on market prices. For this scenario, provisional and differential invoicing are available in the solution.  

The CPE allows users to define complex formulas based on various commodity market prices (futures or spot prices from various quotation sources), currency exchange translation rules, quality and delivery condition surcharges, and rounding rules. The CPE conditions control how the formula results are calculated from term results, e.g., sum, the highest value, provisional versus final term. Compound pricing conditions can be replicated using routines: Splitting routines define how the formula quantity will be split into multiple terms, while Combination routines define how multiple terms will be combined together to get the final values.  

Pricing conditions from active contracts and orders for physical delivery of commodities constitute the physical exposure position. Whether in procurement, in a dedicated commodity risk management department, or in the treasury department, real-time recognition and management of the company’s commodity risk positions rely on accurate and reliable data sources and evaluation functionalities. This is provided by the SAP Commodity Risk Management solution. Leveraging the mature functionalities and components of the Treasury and Risk Management module, it allows for managing paper trades to hedge the determined physical commodity risk position. Namely, listed and OTC commodity derivatives are supported. In the OTC area, swaps, forwards, and options, including the Asian variants with average pricing periods, are well covered. These instruments fully integrate into the front office, back office, and accounting functionalities of the existing mature treasury module, allowing for integrated and seamless processing. The positions in the paper deals can be included within the existing Credit Risk Analyser for counterparty risk limit evaluation as well as in the Market Risk Analyser for complex market risk calculations and simulations. 

Managing Commodity Exposures 

Physical commodity exposure and paper deals are bundled together via the harmonized commodity master data Derivative Contract Specification (DCS), representing individual commodities traded on specific exchanges or spot markets. It allows for translating the volume information of the physical commodity to traded paper contracts and price quotation sources. 

In companies with extensive derivative positions, broker statement reconciliation can be automated via the recent product SAP Broker Reconciliation for Commodity Derivatives. This cloud-based solution is natively integrated into the SAP backend to retrieve the derivative positions. It allows for the automatic import of electronic brokers' statements and automates the reconciliation process to investigate and resolve deviations with less human intervention.  

To support centralized hedging with listed derivatives, the Derivative Order and Trade execution component has been introduced. It supports a workflow in which an internal organizational unit raises a Commodity Order request, which in turn is reviewed and then fully or partially fulfilled by the trader in the external market. 

Innovations in SAP Commodity Management 

Significant innovations were released in the S/4HANA 2022 version. 

The Commodity Hedge Cockpit supports the trader view and hedging workflow. 

In the area of OTC derivatives (namely commodity swaps and commodity forwards), the internal trading and hedging workflow can be supported by Commodity Price Risk Hedge Accounting. It allows for separating various hedging programs through Commodity Hedging areas and defining various Commodity Hedge books. Within the Hedge books, Hedge specifications allow for the definition of rules for concluding financial trades to hedge commodity price exposures, e.g., by defining delivery period rules, hedge quotas, and rules for order utilization sequence. Individual trade orders are defined within the Hedge specification. Intercompany (on behalf of) trading is supported by the automatic creation of intercompany mirror deals, if applicable.  

Settings under the hedge book allow for automatically designating cash flow hedge relationships in accordance with IFRS 9 principles, documenting the hedge relationships, running effectiveness checks, using valuation functions, and generating hedge accounting entries. All these functions are integrated into the existing hedge accounting functionalities for FX risk available in SAP Treasury and Risk Management. 

The underlying physical commodity exposure can be uploaded as planned data reflecting the planned demand or supply from supply chain functions. The resulting commodity exposure can be further managed (revised, rejected, released), or additional commodity exposure data can be manually entered. If the physical commodity exposure leads to FX exposure, it can be handed over to the Treasury team via the automated creation of Raw exposures in Exposure Management 2.0. 

Modelled deals allow for capturing hypothetical deals with no impact on financial accounting. They allow for evaluating commodity price risk for use cases like exposure impact from production forecasts, mark-to-intent for an inventory position (time, location, product), and capturing inter-strategy or late/backdated deals.  

Even though a separate team can be responsible for commodity risk management (front office) - and it usually is - bundling together the back office and accounting operations under an integrated middle and back office team can help to substantially streamline the daily operations.  

Last but not least, the physical commodity business is usually financed by trade finance instruments. SAP has integrated Letters-of-Credit, as well as Guarantees into the Treasury module and enhanced the functionality greatly in 2016.  

All-in-all, every commodity-driven business, upstream or downstream, consumer or producer, works under different setups and business arrangements. The wide variety of available functionalities allows us to define the right solution for every constellation. Especially with commodity management functionalities active in the supply chain modules of the ERP system, SAP commodity risk management can offer a lot of efficiencies in an integrated and streamlined solution. We are happy to accompany you on the journey of defining the best solution for your enterprise.