Financial Times

Doosra by the Banks?


Was Ceylon Petroleum Corporation (CPC) Chairman Asantha De Mel, a former Sri Lankan test fast bowler, and his hedging-expert and colleague Lalith Karunaratne bowled a doosra or googly by the banks?

Slowly but surely evidence and facts pieced together by The Sunday Times – which includes De Mel’s own admission on the wrong instrument – point out to the wrong hedge option being used in protecting the CPC against the vagaries of volatile oil prices.

It must be said however that De Mel cannot be blamed entirely for looking at a way out of a crisis when oil prices were seen rising sharply at the time in early 2007. But he, backed by Karunaratne, went for the wrong hedge and the rest is history.

If oil prices continue at current levels – between $48-$60 per barrel -- for the next couple of six months (to May 2009) when the hedging contracts end, the CPC will end up coughing out a total $300 million (plus $38.5 paid so far), and that along with the money paid out so far is equivalent to 15% of Sri Lanka’s foreign reserves.

If the cabinet was explained in such simple terms the risks – losing a possible $300 million plus as against a far-lower gain – it’s certain that the ministers would have rejected the deal. However even for that to happen, the cabinet was not properly briefed and only a cabinet paper was presented by Minister A.H.M. Fowzie.

De Mel has publicly said ministers and politicians didn’t understand hedging and a little bird whispers that – under pressure from the ministers at the cabinet meeting – he says he has been misquoted in The Sunday Times FT interview. All we can say is that the interview was recorded and we have it on tape.

However much De Mel and Karunaratne claim to be experts, they are not. In fact the first proposals for oil hedging came through hedge specialist Upul Arunajith who made the proposal to the Central Bank and subsequently the CPC where he was hired as a consultant. In both cases Arunajith, frustrated by his repeated but failed attempts to provide a barrier against volatile oil prices over the years, says his proposals were copied by the Central Bank and then CPC’s Karunaratne (see Arunajith’s analysis in another part of this section).

De Mel, in defence, says that when the CPC gained (total of $24 million), no one criticized the deal but when the CPC has to pay up, the screws are on. Well the fact remains that the CPC has already paid out $38.5 million and with a possible $300 million payout hanging over their heads, this is a serious dent in foreign exchange reserves and must be condemned in no uncertain terms as a bad judgement call. Add the $400 million that will ultimately go out in terms of Central Bank bonds redeemed by foreigners… and we are heading for a major foreign exchange crisis.

After The Sunday Times series on the oil hedging fiasco hit the streets over the past two weeks, stunning details have emerged about a product that never should have been resorted to. Among the issues:

•Cabinet approval was not given
•Central Bank guidelines were violated
•CPC officials duck COPE hearing and ask for time
•CPC Board directors say they were not consulted
•The Attorney General says he was not consulted on the legality of such contracts.
•The Standard Chartered Bank CEO Clive Haswell says the CPC gave an undertaking in writing that it understood the risks but CPC board directors say no such undertaking was given.
•De Mel talks of 30% of the oil requirement being hedged. But in reality when the prices come down, the way SCB has structured the hedge, the CPC must buy double the quantity -- this means hedging 60%.

Hedging is still a misunderstood mechanism. Former CPC Chairman Daham Wimalasena says hedging is speculative (see article) but Arunajith says this is incorrect (read his article).

Thus if the government is continuing to use this mechanism to protect the CPC against volatility in the markets as Minister Fowzie has announced, proper advice should be sought and risk management procedures set in place.

In the meantime oil prices which peaked at a record $143 per barrel on July 11 this year, have crashed to $48 just four months later, on Thursday, November 20 – almost falling by $100. If this isn’t shocking at the lack of risk management procedures by CPC, then what is, when one counts the losses?
It’s public money (billions of rupees) that is going down the drain -- all because a couple of officials believed they were experts and risked the tax payers hard earned cash. If De Mel and Karunaratne are culpable, then Minister Fowzie is even more accountable.

There is more than meets the eye in these deals – the market is awash with rumours that certain officials got ‘benefits’ and bank positions for their relatives with responsible citizens prepared to come forward with documented information.

All this must be investigated by the authorities and COPE. A group of corruption-busters are also preparing a fundamental rights case on the oil hedging contracts. In the light of this … surely, Mr President, someone has to pay for this economic crime.

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