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Risk management strategies that can mitigate budget exposure to oil price volatility

NOT AN OFFICIAL UNCTAD RECORD. Risk management strategies that can mitigate budget exposure to oil price volatility. Rachid Amui Energy Analyst, UNCTAD, Commodity Risk Management, Finance and Information 11 th Africa oil and gas trade and finance conference, 23-25 May, Nairobi, Kenya.

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Risk management strategies that can mitigate budget exposure to oil price volatility

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  1. NOT AN OFFICIAL UNCTAD RECORD Risk management strategies that can mitigate budget exposure to oil price volatility Rachid Amui Energy Analyst, UNCTAD, Commodity Risk Management, Finance and Information 11th Africa oil and gas trade and finance conference, 23-25 May, Nairobi, Kenya United Nations Conference on Trade and Development

  2. Overview • Oil price volatility and price forecasting • Impacts of oil price volatility • Price risk management strategies • The way forward United Nations Conference on Trade and Development

  3. Historical crude oil prices - Brent United Nations Conference on Trade and Development

  4. Drivers of volatility • Lack of accurate information on supply, demand, stocks etc • Non transparency and predictability of markets • Tight market-Widening supply/demand gap • Rapidly rising demand at a time when most accessible resources are being exhausted • Uncertain geopolitical environment • Freak weather • Mismatch between crude type and existing refining facilities • Speculators United Nations Conference on Trade and Development

  5. Predictability of oil prices The herd instinct among forecasters makes sheep look like independent thinkers. Edgar R. Fiedler United Nations Conference on Trade and Development

  6. Impacts of price volatility • Higher inflation and interest rates • Balance of payment problems • Decline in economic growth • Exchange rate volatility • Higher transport costs • Economic instability (due to power cuts etc.) • Social unrest Macro Micro United Nations Conference on Trade and Development

  7. Strategies to mitigate risk • Stabilisation funds • Market based risk management instruments (options, forwards, futures, swaps, instruments linked with loans) United Nations Conference on Trade and Development

  8. Stabilisation fund Oil revenues > Target level Non oil revenues + Oil Revenues Transfer to Budget Fund Budget Balanced Expenditure United Nations Conference on Trade and Development

  9. Drawbacks of Stabilisation funds • Resources are fungible • Act as a capital source for deteriorating budget balances • Difficulty in establishing price for accumulating or withdrawing from fund • Behaviour of oil prices – Administrative set benchmarks require large transfers when oil prices fall United Nations Conference on Trade and Development

  10. Hedging using financial instruments • Hedging principle is governed by a simple formula: • Gains/Losses in physical market + Gains/Losses in financial market = Price objective United Nations Conference on Trade and Development

  11. Options, Futures • Options: Agreement gives holder the right to buy or sell an underlying asset – Call/Put - Similar to insurance • Futures: Standardized contract allowing holder, buyer or seller, to accept or deliver a given quantity of asset at a specified place, price and time in teh future • Deposit of good faith required (5-10%) • Margin calls United Nations Conference on Trade and Development

  12. Pays <$40 Producing Country Importing Country Pays >$40 Spot price Spot price Spot Market Pays difference to A Sells crude at mkt. price Country A Financial Institution End Users Receives market price Receives difference SWAPS Exchange of cash flowsatregularintervals to another party over predetermined time period United Nations Conference on Trade and Development

  13. Drawbacks of financial instruments • Lack of familiarity causes heavy losses • Lose exposure to beneficial price developments – Possible large credit exposure if market prices move in favour of user • Premiums can be expensive • Lost of premiums • Not easy to find counterparties United Nations Conference on Trade and Development

  14. Risk management and UNCTAD • Research and analyis on price risk management tools • Training on use of risk management tools • Awareness and seminars for senior decision makers • Advise on the implementation of proper control sytems when using risk management tools

  15. Conclusion • Stabilisation funds will work in combination with financial instruments and policy measures • Budget planning can be made better with financial instruments since income becomes more predictable and in addition hedging increases creditworthiness • Diversify - tap into entirely new sources of energy for transport, and to build flexibility into the production system United Nations Conference on Trade and Development

  16. Thank You rachid.amui@unctad.org United Nations Conference on Trade and Development

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