United Nations Conference on Trade and Development 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, May, Nairobi, Kenya NOT AN OFFICIAL UNCTAD RECORD

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

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

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 Predictability of oil prices The herd instinct among forecasters makes sheep look like independent thinkers. Edgar R. Fiedler

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 United Nations Conference on Trade and Development Macro Micro

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

Stabilisation fund FundBudget Oil revenues > Target level Transfer to Budget Expenditure Non oil revenues + Oil Revenues Balanced

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

Hedging using financial instruments Hedging principle is governed by a simple formula: Gains/Losses in physical market + Gains/Losses in financial market = Price objective

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

SWAPS Exchange of cash flows at regular intervals to another party over predetermined time period Producing CountryImporting Country Spot Market Pays <$40 Pays >$40 Spot price Country A End UsersFinancial Institution Receives difference Receives market price Sells crude at mkt. pricePays difference to A

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

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

United Nations Conference on Trade and Development 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 Thank You