By Javier Blas in London
Published: September 7 2009 18:20
When Agustín Carstens, Mexican finance minister, hedged all his country’s oil sales for 2009 at $70 a barrel, in effect gambling that prices would stay low this year, he surely had in mind the dreadful political experience of a Latin American neighbour.
Ecuador entered into a hedge programme in 1993. But instead of receiving an $8bn windfall like Mexico did this year, Quito’s central bank lost almost $20m to J. Aron & Co, Goldman Sachs’ commodities unit. A political storm followed and a committee investigated “allegations of corruption” against the head of the central bank.
The event illustrates the main obstacle for sovereign hedging of oil prices: politics. Indeed, Mexico’s hedge is noteworthy not only for its success but also for its rarity.
“Very few government officials of commodity-exporting countries are secure enough in their jobs to place a bet on the future level of commodity prices,” wrote the oil economist Philip K. Verleger in his study “
Adjusting to Volatile Energy Prices”.
Such political fears were plainly exposed when the state of Alaska discussed whether to hedge its oil income in 2002. Alaska’s revenues department warned that policymakers would “be reluctant to take the political risks” of a hedging programme.
“If a programme succeeded, it is unlikely the policymakers who took the initiative to create the programme would be rewarded with public congratulations,” the report said. “On the other hand, if the state lost significant sums ... the conventional wisdom is that public criticism would be harsh,” it concluded.
The upfront costs are also high – Mexico, for example, spent $1.5bn for the insurance this year. If prices had moved higher, some could argue that Mr Carstens used scarce budget resources to pay an option premium rather than, say, build a hospital.
The political risk also explains why the few countries or states that have launched sovereign oil hedging including Mexico and, in the past, Ecuador, Colombia, Algeria, Texas and Louisiana, have made use of put options – an insurance policy that sets a price floor without giving away any potential upside – rather than futures that fix a price.
Some, such as Texas, which ran a small hedge programme from 1992 to 2000, have used costless collars – a combination of put and call options that set a floor but also a ceiling. Giving away some upside reduces the cost of the insurance.
Rather than hedging, policymakers in places such as Alaska have resolved the problem of volatile oil prices via stabilisation funds that piggy bank income in the good times to spend it on lean times.
Many economists believe, nonetheless, that the use of stabilisation funds is flawed. For example, an extended oil price shock, such as in 1999 when oil traded on average at $11.40 a barrel, could overwhelm the fund, draining the reserves long before the low-prices crisis was over.
The World Bank noted in a study on “
Managing Oil Booms and Busts in Developing Countries” that, even under optimal circumstances, measures to promote expenditure smoothing such as stabilisation funds can do little in the way of eliminating oil price risk itself. “Financial instruments can help a developing country government manage this risk more efficiently and credibly,” it said.
The aim of the hedge is, in any case, to cap price volatility rather than to earn a big windfall, economists say. The one-off gains are scarce. Mexico’s previous most remarkable coup was in 1991 when economists estimate the country made $800m through a hedge programme. The country hedged with put options at $17 a barrel, while Mexico’s oil export price averaged $15 a barrel because of the end of the Gulf war and the onset of the economic recession in the US, its main client.
There is a final obstacle that may deter hedging: its market impact. If traders learn that a large producer is forward selling its output – or buying insurance for low prices – the market could react immediately, bringing prices down just on concerns the producer is bearish. The International Monetary Fund, in a study in 2001 on hedging government oil price risk, warned about this perception problem, noting that “if the producer is a member of a cartel, for example Opec, the effect may be even larger”.
Mexico’s success in buying insurance for all its oil exports without disturbing the market significantly indicates, however, that the energy derivatives market is now big enough that large producers can successfully execute substantial hedging transactions. Overcoming the political difficulties will be, nevertheless, much more difficult.
Copyright The Financial Times Limited 2009.
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