Friday 17 October 2008

High Volatility Making Oil Hedging Tough

Big oil consumers also face problem of fewer counterparties

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High Volatility Making Oil Hedging Tough

Big oil consumers also face problem of fewer counterparties

By RONNIE LIM
17 October 2008

(SINGAPORE) The heightened volatility in oil prices - with the New York benchmark plunging on Wednesday to a 13-month low of US$73 a barrel, or half of July’s peak of over US$147 - is making it harder for big consumers such as refiners, airlines and power companies to manage such fluctuations.

It can be very costly if the wrong bet is taken on say, oil prices heading further south, when the market rebounds instead.

‘It’s getting harder to manage the volatility. Besides, there are also fewer players to hedge with, as there are not only fewer counterparties in the game, but also riskier ones,’ one refining official admitted.

Oil refiners here - including Shell, ExxonMobil and Singapore Refining Company - usually buy their crude feedstock on term contracts, although pricing is fixed at the time when the cargo is loaded onto the VLCC.

‘It takes about two to three weeks before the oil arrives here, and then you’d need to refine the crude into final products like gasoline, jet fuel and diesel, which means roughly five weeks in all,’ the official added. ‘But if oil product prices fall (faster than crude prices) during that time, then the refiner may take a hit.’

Energy consultant Ong Eng Tong said that the problem with the current volatility is that if airlines, for instance, hedged their jet fuel purchases for the rest of this year by buying in the last three months, they would have paid around US$100 a barrel, whereas jet fuel prices have now dipped to around US$80.

He said that it was a case of damned-if-you-do and damned-if-you-don’t, as jet fuel had shot up to as high as US$170 a barrel recently.

Mr Ong agreed that many of the investment banks such as Lehman, Goldman Sachs and Morgan Stanley are no longer in the oil game.

‘It’s hard to find counterparties and those who want to hedge cannot find buyers for their physical and paper products,’ he added.

A power generating company (genco) official here told BT: ‘We don’t take forward positions but manage the oil price volatility through hedging. But we still have to manage risks, like assessing which counterparties to deal with.’

‘Typically, Singapore gencos spread their hedging risks by using as many as 10 counterparties, whether oil traders, investment banks or others,’ he said, adding that this helps to limit exposure, ‘especially if, for instance, you were exposed to someone like Lehman (which collapsed last month).’

While the gencos here mainly use natural gas as feedstock, this is still pegged to high sulphur fuel oil (HSFO) prices, which move in tandem with crude prices.

Those with more than one gas supplier - such as SembCorp and Gas Supply Pte Ltd - can hedge by getting their gas supplies from one supplier based on current-month HSFO prices and from another based on the previous month’s HSFO prices.

Every quarter, gencos also hedge their electricity vesting contracts by calculating the fuel needed to fulfill their contractual electricity supplies, at a specific price, to the Singapore grid. So, for instance, this month, they will hedge for the Jan-Mar 2009, he said. In between, gencos also need to hedge their other contracts, like those with large corporate customers.

The official explained that with deregulation, electricity consumers here are now exposed to the full impact of oil price changes - like this quarter’s 21 per cent hike.

Previously, the PUB uses a ‘fuel equalisation account’ to adjust electricity tariffs when oil prices moved.