United Nations Conference on Trade and Development Risk management strategies that can mitigate...

United Nations Conference on Trade and Development

Risk management strategies that can mitigate budget exposure to oil price

volatility

Rachid AmuiEnergy Analyst,

UNCTAD, Commodity Risk Management, Finance and Information

11th Africa oil and gas trade and finance conference, 23-25 May, Nairobi, Kenya

NOT AN OFFICIAL UNCTAD RECORD


Overview

• Oil price volatility and price forecasting• Impacts of oil price volatility• Price risk management strategies • The way forward

Historical crude oil prices - Brent


C r ude Oil-B r e nt D a te d FO B U $ /B B L (~U $ )FROM 3/5 /87 T O 3 /5 /07 MONT HLY

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

0

10

20

30

40

50

60

70

80

Sourc e: D ATASTREAM


Drivers of volatility

• Lack of accurate information on supply, demand, stocks etc

• Non transparency and predictability of markets • Tight market-Widening supply/demand gap• Rapidly rising demand at a time when most

accessible resources are being exhausted• Uncertain geopolitical environment • Freak weather• Mismatch between crude type and existing

refining facilities• Speculators


Predictability of oil prices

The herd instinct among forecasters makes sheep look like independent thinkers.

Edgar R. Fiedler

Impacts of price volatility

• Higher inflation and interest rates• Balance of payment problems• Decline in economic growth• Exchange rate volatility

• Higher transport costs• Economic instability (due to

power cuts etc.)• Social unrest


Macro

Micro

Strategies to mitigate risk

• Stabilisation funds

• Market based risk management instruments (options, forwards, futures, swaps, instruments linked with loans)



Stabilisation fund

Fund Budget

Oil revenues> Target level

Transfer to Budget

Expenditure

Non oil revenues+

Oil Revenues

Balanced

Drawbacks of Stabilisation funds

• Resources are fungible• Act as a capital source for deteriorating budget

balances • Difficulty in establishing price for accumulating

or withdrawing from fund• Behaviour of oil prices – Administrative set

benchmarks require large transfers when oil prices fall



Hedging using financial instruments

• Hedging principle is governed by a simple formula:

• Gains/Losses in physical market + Gains/Losses in financial market = Price objective

Options, Futures

• Options: Agreement gives holder the right to buy or sell an underlying asset – Call/Put

- Similar to insurance• Futures: Standardized contract allowing holder,

buyer or seller, to accept or deliver a given quantity of asset at a specified place, price and time in teh future

- Deposit of good faith required (5-10%)- Margin calls



SWAPS

Exchange of cash flows at regular intervals to Exchange of cash flows at regular intervals to another party over predetermined time periodanother party over predetermined time period

Producing Country Importing Country

Spot Market

Pays <$40

Pays >$40

Spot price Spot price

Country A End UsersFinancial Institution

Receives difference Receives market price

Sells crude at mkt. pricePays difference to A

Drawbacks of financial instruments

• Lack of familiarity causes heavy losses• Lose exposure to beneficial price developments

– Possible large credit exposure if market prices move in favour of user

• Premiums can be expensive• Lost of premiums• Not easy to find counterparties


Risk management and UNCTAD

• Research and analyis on price risk management tools

• Training on use of risk management tools

• Awareness and seminars for senior decision makers

• Advise on the implementation of proper control sytems when using risk management tools


Conclusion

• Stabilisation funds will work in combination with financial instruments and policy measures

• Budget planning can be made better with financial instruments since income becomes more predictable and in addition hedging increases creditworthiness

• Diversify - tap into entirely new sources of energy for transport, and to build flexibility into the production system


Thank You

[email protected]

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