Financial Times

Hedging against oil futures


Asantha de Mel, the outspoken chairman of the Ceylon Petroleum Corporation (CPC), came out with his guns blazing on Monday. He was offended by the stories in The Sunday Times on the oil hedging deals, that the CPC stands to lose millions of dollars on the deal – in the next six months – if current rates prevail -, and that it was misled by the banks over the mechanism.

While the CPC chairman insists that they have done no wrong, the fact of the matter is that the state petroleum importer and distributor went for the wrong option. And De Mel admits that: "We told the Cabinet the best way to do this is to purchase an option (not zero collar) but the cabinet and people were not agreeable because you have to pay upfront," he told this newspaper in an interview.

He goes on to say that while the best option is a mix of zero collar and premium option, the cabinet decided otherwise. However what we fail to understand is that it was in fact the CPC Deputy General Manager Finance Lalith Karunaratne who prepared a concept paper where the zero collar option was proposed. That is on record. Thus how can the CPC chairman say zero collar is not the best option, a proposal made by his own expert! In fact in the interview, he says it is the DGM and himself who are experts in the field in Sri Lanka, having travelled the world learning everything one wants to know about hedging.

Another point raised in our stories was whether the CPC was adequately briefed on the risk by Standard Chartered (SCB) and other banks. De Mel says he was adequately briefed while SCB CEO Clive Haswell also says that the CPC was explained the risk and the bank got written confirmation that the board had understood the risks.

However the Central Bank doesn’t think so and has launched its own probe as to whether the due process has been followed in all the transactions. At the end of the day, did the country benefit? The CPC says yes. Did the people benefit? Everyone knows the answer to that question.

Something else is puzzling: De Mel said at Monday’s briefing that the total payments that have been made or are due to be made by the CPC were - $5 million payment to the SCB in September, $6.5 million to Citibank on November 10, and $27 million (due to be paid) to the SCB on Friday (which was paid). This makes a total of $38.5 million paid by CPC in the past two months.

However CPC officials also say the total pay-out is $33 million while the CPC (which Minister Fowzie also confirms) has received $24 million (over a period of time). There seems to be a contradiction in the figures – on the other hand it may be a bona fide mistake somewhere.

One of the biggest problems has been the debt burden carried by the CPC due to non payments by state agencies like the Ceylon Electricity Board (CEB) and Mihin Lanka. The CEB in fact has a huge overdue payment to make and the CPC has gone on record saying that fuel prices locally include subsidising the cost to the CEB. Mihin Lanka also has a sizable debt which its new chairman is reported as saying will be settled no sooner it receives the promised Rs 6 billion from the Treasury. Mihin Lanka is another disaster; debts in the region of Rs 9 billion and when it would recover remains to be seen given the state of the airline industry and the negative environment for budget airlines. But that’s another story altogether.

Back to the oil hedging mechanism, everyone jumped this bandwagon in 2006 only after Upul Arunajith, a Sri Lankan hedge specialist based in Canada first proposed it around 2002 or before. Subsequently the Central Bank and the CPC took up the mechanism and came up with proposals – and that’s where we are today.

Both De Mel and the Minister have gone on record saying that they may move out of hedging because of the criticism – and not for any other reason. But the ‘proof of the pudding is in the eating’ and it’s evident now that this was not the best option that the CPC used (whether recommended by Cabinet or not) – even De Mel says so.

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