Why hedging oil purchases is a win-win situation for Kenya


Chroniclers

Why hedging oil purchases is a win-win situation for Kenya


An employee of a gas station in Nairobi. PHOTO FILE | NMG

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Summary

  • The government’s policy of stabilizing consumer prices against unpredictable fluctuations in world oil prices is proving to be a costly affair and it is time to rethink.
  • For a bankrupt country, seeing oil prices exceed $ 7,500 per barrel, it is no surprise that the government chose to suspend the fuel subsidy program.

Riddle: what is shorter than a soap opera but much longer and convoluted than a typical drama? Answer: a Mexican telenovela.

Famous for their continued melodramatic stories and lifelong distribution, it’s interesting that the same qualities are also shared by another Mexican program – its Oil Hedging Program, which operates on endless volatility but manages to keep the price stable. .

Being a major exporter of oil and the raw material contributing more than a third of the federal budget, Mexico’s finances are effectively linked to the vagaries of the oil market.

However, the country’s finance ministry has for decades used derivatives (mainly oil options) to hedge its oil exports, thus shielding public finances from sharp drops in the price of oil.

The country spends nearly 100 billion shillings each year on its oil hedging program, which is considered the largest annual transaction of its kind on Wall Street.

The government’s policy of stabilizing consumer prices against unpredictable fluctuations in world oil prices is proving to be a costly affair and it is time to rethink.

For a bankrupt country, which watches oil prices exceed $ 7,500 per barrel, it is no surprise that the government has chosen to suspend the fuel subsidy program.

The question is; do we have a cheaper “stabilization” alternative? The answer is yes and the solution is to hedge with derivatives.

Why do we have to cover ourselves? A; Kenya is a net importer of oil. Oil imports account for about 17 percent of the total import bill, or about 316 billion shillings per year.

Of them; a well-made blanket can in fact be net positive. If oil prices are above the hedged level for most of this year, they are almost certainly expected to yield a big gain.

A good example is Mexico, its hedging deals paid off on several occasions, including in 2009 – after the global financial crisis pushed oil prices down sharply – and again in 2015, when a record high of over 600 billion shillings was reached, as well as in 2016.

He also expects a big gain this year, following the drop in oil prices due to the coronavirus pandemic and the price war between Russia and Saudi Arabia earlier this year.

For Kenya, which pays sixty cents for every shilling collected as tax, isn’t this a welcome alternative?

How can we cover? By buying call options – contracts that give him the right to buy at a predetermined price – because they are cheaper than futures.

To implement the hedging, rather than buying the options all at once over just a few months, the government of Kenya (or through the oil collective) can spread its purchases over time and each time buy just one. small quantity to avoid ripple in the market.

An extended approach has a chance to benefit the country with better prices. Equally important, if prices fall Kenya can skip the deal as well, especially when prices are very low, as was the case last year.

In addition, since Kenya imports Murban Adnoc crude, it has the option of entering into an OTC agreement with international banks or may implement the same strategy on standardized derivatives exchanges.

In summary, an oil coverage program is necessary. Not only does it provide stability amid fiscal and budgetary challenges, for a country at risk of having its credit rating downgraded, this could potentially prevent it from lowering the credit rating rank and may also guarantee the country’s credit rating. solvency.

Mr. Mwanyasi is Managing Director of Canaan Capital

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