What does a laptop, a smartphone, and an electric vehicle have in common? They all rely on lithium-ion batteries to function properly. As indicated by the name, lithium is a key ingredient in these batteries, alongside nickel and cobalt.

As the world transitions to a low carbon economy, batteries are in high demand – especially as companies and countries aim to phase out internal combustion engines (ICE) over the coming years. With demand for lithium expected to grow drastically to meet that challenge, companies need to think about how to manage the risk associated with fluctuating lithium prices.

CME Group offers an effective mechanism to hedge the price risk of lithium with the Lithium Hydroxide CIF CJK Fastmarkets futures contract.

Lithium prices have shown persistent volatility in the past. This can present problems for both sellers and buyers of lithium as profit margins can be affected by price changes. One way to offset the risk of disadvantageous price movements is through hedging using derivatives, which allows you to protect yourself from unforeseen market events in the future. Derivatives, such as futures contracts, are financial instruments whose prices move in line with the prices of their underlying market.

The Lithium futures contract is a cost-efficient hedging tool to protect profit margins and minimize risk. The underlying Fastmarkets assessment for battery grade lithium hydroxide delivered into China, Japan, and Korea serves as a reference point for the industry.

Some potential participants in Lithium futures could be producers, trading houses, battery makers, original equipment manufacturers (OEMs), car manufacturers, or investors. Regardless of which side of the equation you are on, buyers and sellers can benefit from using futures contracts.

In early July, a lithium producer agrees to sell 50 tons of battery grade lithium hydroxide to a battery maker for December delivery at the prevalent Fastmarkets Lithium Hydroxide December average price. The producer is now faced with the risk of falling prices when it comes time to sell the lithium to the battery maker.

To hedge its risk on this forward sale, the refiner can sell 50 December futures contracts at the price currently available in the futures market. Should the price in the physical market decrease from July to December, the lower selling price to the battery maker will be offset by a gain in the futures market.

Since the producer sold the futures contracts, its futures position shows a gain when the price of the commodity drops. On the other hand, if the lithium market rallies, any benefit from a higher physical selling price is offset by a loss in the futures markets.  Regardless of the direction of the market, the producer has certainty about the selling price after netting the physical sale on the one hand and financial gains or losses on the futures contracts on the other.

It is important to note that by hedging, a company is trying to mitigate risk, not make additional profit through speculation. Therefore, if properly hedged, adverse and favorable price fluctuations will net the same result.

Lithium futures are available to trade through your bank, broker, or electronically nearly 24 hours a day through the CME Direct front end trading system. The future is unknown. Lithium futures allow those involved in the purchase or sale of lithium to manage their price risk.