Oil price hedging the key to stable fuel prices....

Volatility in the price of crude globally has adversely impacted fuel importers globally. As such pump prices of fuel have been adjusted upwards resulting in a ballooning in production costs. This is as a consequence of higher pump prices of fuel ( gasoline, diesel and JET Air fuel). Recently the Energy Regulation Board – ERB announced a steep hike that has seen petrol 16.85% higher to K16.06, diesel 21.98% to K14.65 and Kerosene 28.14% to K11.34 per liter.

A swap, on the other hand, locks in the purchase of oil at a future price at a specified date. If fuel prices decline instead, the airline company has the potential to lose much more than it would with a call option strategy.

The above strategies have been successfully implemented by corporations across the world. Surely countries cannot be an exception.

A CASE STUDY OF MOROCCO (Source: Financial Times)

Morocco has become the first oil-importing country to turn to Wall Street banks to protect itself against high oil prices. The move highlights the challenges faced by governments in Africa and the Middle East grappling with social discontent because of rising fuel costs.

Morocco has entered into derivatives contracts to hedge any unexpected rise in the cost of imported fuel, the FT said, citing two people familiar with the deal. The rare hedge transactions, made last month, come as Morocco starts to wind down a costly subsidies program under pressure from the International Monetary Fund.

Morocco is the only oil importing nation known to be hedging its consumption through derivatives arranged by the government, the FT said. Ghana, an oil exporter, has previously taken out hedges on oil imports and exports at the same time.

The Moroccan government initially hedged its imports with local bank Banque Marocaine du Commerce Exterieur (BMCE), and BMCE then paid premiums to Barclays, Citi and Morgan Stanley to take on the risk. The transactions covered a large chunk of Morocco's expected fuel consumption for the rest of the year, and cost the government roughly $50-60 million, the FT said, citing a person familiar with the deal.

The government bought so-called call options for European diesel, which give Morocco the right to buy fuel at a predetermined price for the rest of the year. Morocco's move comes as countries across the world balance the cost of fuel subsidy regimes with the threat of social unrest if they unwind them.

CONCLUSION

I therefore recommend the Energy Regulation Board - ERB and the Zambian Government consider the viability of implement effective hedging strategies to mitigate risk in price movements of crude oil. The country can then lock in hedging contracts that will ensure a stable and predictable fuel price regime in Zambia.

Note from ZBT - There should however be public sensitization that once hedged, the country cannot benefit from any price drops, which are mostly rare in Zambia. The hedge however should be taken when fuel prices average out.

About the Author - Philip is a keen reader of the Zambian Business Times and wrote this article to contribute to the debate on available options for Zambia to stabilize its fuel pump prices and find a lasting solution.

This article has been republished and was first carried on our website www.zambiabusinesstimes.com in 2017.