PTI govt plans hedging to benefit from low oil prices

Proposal for call option for two years sent to ECC for approval

Zafar Bhutta May 11, 2020

ISLAMABAD: The federal government has decided to pursue a plan of hedging 15 million barrels of oil to benefit from the low prices in the global market in the wake of coronavirus lockdowns after finding offshore oil storages as unfeasible because of the higher costs.

Oil had witnessed a drastic decline in the last few months, starting from a price war led by Saudi Arabia and Russia, who perhaps had a common goal of forcing out the American shale oil producers to the collapse, and because of plummeting demand due to Covid-related lockdowns around the globe.

Pakistan’s crude oil import is 68 million barrels per annum. The import of high-speed diesel (HSD) is 19 million barrels and of petrol is 45 million barrels. The liquified natural gas (LNG) stands at 6 million tonnes. This makes the total volume of imports at around 175 million barrels per annum.

The petroleum division has been working with the ministry of finance for the last one month to evaluate the possibilities of hedging some portion of the exposure to Pakistan for import of petroleum products that are directly or indirectly linked to crude prices.

Extensive consultations

This includes crude oil, motor gasoline, HSD and LNG, sources told The Express Tribune. They added that the petroleum division had moved a summary to the Economic Coordination Committee (ECC) of the cabinet for its formal approval.

In order to materialse the hedging plan, several discussions had been held with the Standard and Chartered Bank, Citibank and a consortium of Habib Bank and the JPMorgan to understand the available options and the pricing mechanisms.

The advice from all the three institutions was that since Pakistan was considering oil price hedging the first time, it should start with covering 15-30% exposure. Once this programme is operational, it can consider increasing the coverage and making it an ongoing programme, the sources added.

The sources added that these institutions had also advised that the oil market had been volatile, therefore, Pakistan should wait for a second phase of stability in the prices because the cost of a hedging programme went up in a volatile market.

Considering all the possible hedging instruments, the petroleum division has firmed up two options, which seemed to it as practical to evaluate. First, is a ‘straight swap’, where a variable price is converted to a fixed price or a defined volume and a defined period.

The fixed price will, of course, be higher than the current price as longer the swap, higher the price. The second option is ‘call option’, where prices cap is bought for a defined volume and a defined period of time. This call option has a price, which depends on the length at which the call is set up.

However, after initial discussion, the first structure was rejected because though it gave certainty of fixed price, it took away any benefit of low prices if they declined further.

And the second structure was selected because it acted as an insurance policy with a price ceiling—giving the benefit of market prices as long as they were lower than the ceiling. So, if Pakistan targets around 9% per year for two years, around 30 million barrels for two years would be hedged.

However, since only government entities were involved in the LNG sector and the private companies were involved in refineries and oil marketing companies (OMCs), it would be better to allocate it to the LNG. It will help keep prices of LNG at manageable levels.

Against this backdrop, the petroleum division has proposed to hedge price for 15 million barrels of oil for one year, divided in 12 equal monthly amounts, for a strike price of $8 above the current Brent as long as the fee is within an acceptable range.

In second call option, it proposed to hedge price for 15 million barrels of oil for two years, divided in 12 monthly amounts, for a strike price of $15 above the current Brent price, as long as the fee is within an acceptable range.

Currently the Brent price is in the range of $20-25 per barrel. Since the prices of the call options are varying every day along with the prices of Brent, it is essential that the approval granted by the ECC is for a range of call option prices in order for the finance ministry to lock it the day an acceptable offer is put on the table by the relevant banks. A fixed price approval will become irrelevant the next day as the market moves.

The petroleum division has also proposed to give guarantee to the Pakistan State Oil (PSO) if it was involved in oil price hedging. It further proposed that a committee be formed under the finance secretary, and including the secretaries of petroleum, law and planning divisions and the PSO managing director to timeline the call options with the selected banks.

It also proposed that Oil and Gas Regulatory Authority (Ogra) be given a policy direction to include the monthly price of the option in the cost of LNG [or any other oil product chosen] in announcing the monthly prices.

PSO maintains supply

Meanwhile, a shortage of diesel with several oil marketing companies have forced customers to flock to PSO pumps. Several OMCs failed to maintain, adequate stocks of the fuel, therefore, the PSO took their burden as well.

A PSO regional head said that petrol pumps of Lahore, Sheikhupura and Gujranwala are supplied diesel from its depot in Machikay. “Approximately 1 million liters of diesel is supplied from Machikay installation as the demand rises in the wheat harvesting season. None of PSO outlet faced any shortage of diesel,” he said.

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Fahim | 1 year ago | Reply We will need electricity irrespective of corona lockdown or not so LNG and power plant supply must be hedged for 3-4 years. Cars/Buses fuel we don't know when lockdown will be over
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