Is it better for countries to plunge and soar with the oscillations of global markets? Or to buckle themselves in as they ride the roller coaster?
Both oil exporters and importers are now taking the second option – and trying to protect their massive energy revenues and expenditures. But is it time for major oil sellers in the Arabian Gulf to consider hedging their exposure?
Oil makes up about 70 per cent of the Qatari government budget, 90 per cent of Saudi Arabia’s, and 95 per cent of Iraq’s.
Conversely, regarding oil importers, Morocco spent 6 per cent of its GDP on energy subsidies, Jordan 8 per cent and Egypt as much as 13 per cent. These countries are all under severe fiscal pressure, with Morocco and Jordan turning to the IMF and Egypt to concessionary GCC loans.
Although oil prices have been stable over the past three years, averaging about US$110 per barrel, when crisis strikes they can be wildly volatile. In just six months during the 2008 economic upheaval, Brent crude fell from $147 to $34 per barrel. Conversely, with the first oil shock, prices quadrupled between October 1973 and January 1974.
Hedging through the futures markets can be a flexible and attractive way to protect the national budget and economy from such wild gyrations. Countries can hedge by buying options, paying an upfront premium to guarantee a minimum price for their oil exports.
Or a “costless collar” involves no premium, but the hedger gives up gains if the oil price rises above a certain level. A third possibility is to use swaps to lock in a set price for some share of exports.
Mexico, a significant non-Opec oil exporter, has been hedging since the early 1990s – inspired not by its national oil company, but by the finance ministry. The country’s finance minister Agustín Carstens hedged the country’s 2009 oil sales, making an $8 billion profit as prices plunged. In 2012, Mexico paid $800 million to $1bn to set a floor of $75 per barrel.
Qatar reportedly hedged a quarter of its 2012 sales. Conversely, among the oil importers, Morocco spent some $50m to $60m to fix a maximum price for last year’s fuel purchases.
Given its attractions, why do major oil exporters not hedge more often? One reason is that it is often not well understood by Middle Eastern and Asian governments, who regard it as dangerous “speculation”.
In 2008, the chairman of Sri Lanka’s state refining company had to resign after his company was exposed to up to $1bn of hedging losses. Indeed, its hedges were poorly designed and inflexible. But the losses arose because oil prices had plunged – good news for the refiner. And the country’s own central bank had approved the transaction.
For the individual decision-maker, there is an asymmetry of risk. If the chief executive of a national oil company, or an Opec finance minister, chooses not to hedge, they can blame unpredictable markets or shadowy “speculators” for losses. But if they do hedge, any losses will be laid on their desk.
So it may be better for a committee to take collective responsibility. And countries considering hedging should hire or develop top-quality expertise to avoid a repeat of the Sri Lanka debacle.
Hedging programmes should not aim to avoid moderate fluctuations in oil prices. A drop of, say, $10 per barrel can be accommodated by trimming the government budget, borrowing money or selling some liquid sovereign wealth fund investments.
Rather, hedges should guard against market collapses, such as in 2008 – or spikes. Such events are rare enough that insurance against them is not expensive, but, when they do occur, they can be catastrophic for national budgets.
Protecting against unanticipated price movements is not speculation. Much more risky is to accept the vicissitudes of the markets.
Robin Mills is the head of consulting at Manaar Energy, and the author of The Myth of the Oil Crisis
