Hid­den in the Hedges

Al­berta and Canada should seek safety from oil busts of the fu­ture

Alberta Oil - - SMART MONEY -

RE­CENTLY, OIL REV­ENUES HAVE SHARPLY

de­clined, af­fect­ing jobs, lives, and the fu­ture. Yet, this should not come as a sur­prise—volatile mar­kets like crude oil have al­ways been cycli­cal in na­ture. How­ever, Al­berta does not have to keep get­ting caught with its pants down. In­stead of pray­ing for prices to re­bound, we could ac­tu­ally come up with a so­lu­tion—some­thing that would ma­te­ri­ally pro­tect us as a prov­ince and as a na­tion from the down­side risk of crude oil.

The so­lu­tion is hedg­ing. Given that non-re­new­able re­source rev­enues ac­count for roughly a third of Al­berta’s econ­omy— and af­fect fed­eral trans­fer pay­ments—you would think hedg­ing would be ob­vi­ous. Yet, we con­tinue to be am­biva­lent.

As a re­sult, Al­berta’s non-re­new­able re­source rev­enues are fore­casted to drop from $9 bil­lion in 2014-15 to $1.4 bil­lion in 2016-17, a level not seen in 40 years. Since 2014, Al­berta has lost about $13 bil­lion in rev­enues. Had Al­berta cov­ered even one-third of its oil rev­enues us­ing a con­ser­va­tive hedg­ing strat­egy, the govern­ment could have eas­ily gen­er­ated bil­lions over the past two years.

So why don’t we hedge? Just like when tak­ing out an in­sur­ance pol­icy on a home or your car, there is a risk/re­ward trade-off im­plicit within hedg­ing. While it re­duces or re­pays the po­ten­tial risk of a bad con­se­quence, it may have an as­so­ci­ated cost and can chip away at po­ten­tial gains. This has caused a gen­eral ner­vous­ness in the past as some have feared the prov­ince would miss out on higher rev­enues in the event of strong oil prices, lead­ing to po­lit­i­cal risk.

While hedg­ing isn’t free, it’s pru­dent. Most Al­ber­tans and Cana­di­ans would agree to give some up­side in ex­change for bet­ter job se­cu­rity and eco­nomic sta­bil­ity over the long term—es­pe­cially when the prob­a­bil­ity of a down­turn in the fu­ture is not only likely, but im­mi­nent.

Since the Gulf War, Mex­ico, Brazil, and Chile have used hedg­ing to pro­tect them­selves from the risk of lost oil rev­enues. In fact, Mex­ico re­cently won Bloomberg’s “Oil Deal of the Year” for its stel­lar hedg­ing pro­gram, which is ex­pected to gen­er­ate a cu­mu­la­tive hedge gain of $6.8 bil­lion for 2015-2016.

For en­ergy-de­pen­dent coun­tries—or even prov­inces—so­cial pro­grams are para­mount, and steep de­clines in oil rev­enues can crip­ple these ini­tia­tives. More­over, these gov­ern­ments re­al­ize that an eco­nomic down­turn is a great time to build in­fra­struc­ture while la­bor is cheaper and in­puts like en­ergy are less ex­pen­sive.

By im­ple­ment­ing pru­dent hedg­ing poli­cies, our na­tion could be a force of sta­bil­ity and op­por­tu­nity, even in com- mod­ity down-cy­cles. An ef­fec­tive hedg­ing pro­gram can re­duce the mar­gin of er­ror in bud­get pro­jec­tions, gen­er­ate rev­enues when the econ­omy needs the most sup­port, take ad­van­tage of low price en­vi­ron­ments and off­set cash flows to cre­ate jobs dur­ing dif­fi­cult times.

Canada is well-po­si­tioned to be able to cap­i­tal­ize on the global oil mar­ket­place. We lead the top 10 oil re­serve na­tions in terms of hu­man rights, democ­racy, so­cial progress, free­dom of speech, free­dom of the press, equal­ity, cli­mate change reg­u­la­tions, en­vi­ron­men­tal in­no­va­tion and en­vi­ron­men­tal lead­er­ship. More­over, we have the re­sources and the abil­ity to fill a grow­ing global need. If Al­berta makes a ded­i­cated ef­fort to pro­tect against down­side risk, and max­i­mize the fi­nan­cial up­side of our do­mes­tic oil in­dus­try, the pos­i­tive ef­fects will be felt na­tion­wide.

Newspapers in English

Newspapers from Canada

© PressReader. All rights reserved.