For the first time in history, Pakistan is considering oil price hedging after the market saw the prices that low, which no one had ever expected owing to a collapse in demand around the world due to COVID-19.
Pakistan has prepared a call option-based oil hedging plan for one year or two years through selected banks, in order to take advantage of the fall in oil prices in the international market.
According to several media reports, the Petroleum Division will be submitting a hedging plan to the Economic Coordination Committee (ECC) of the cabinet anytime soon.
The Ministry of Energy (Petroleum Division) has been working with the Ministry of Finance for the last one month to evaluate the possibilities of hedging some portion of the exposure to Pakistan for import of petroleum products that are directly or indirectly linked to crude prices.
This includes crude oil, motor gasoline, high-speed diesel as well as LNG.
A number of discussions were held with Standard Chartered Bank, Citibank and a consortium of Habib Bank Ltd with JP Morgan to understand the options available and the pricing mechanism.
The advice from all three institutions was that since Pakistan is considering oil price hedging for the first time, it should start with covering 15% or 20% exposure to start with. Once the process starts, it can consider increasing the coverage and making it an ongoing program.
While price indications were also given, it was clearly advised by all that since the prices change hour to hour, the cost of hedging program goes up in a volatile market. The collective view was:
- Not to try to time the bottom of the market.
- Wait for some level price stability.
Petroleum Division is considering a call option where a price cap is bought for a defined volume and a defined period of time. This call option has a price that depends on the length and the level at which the call is set up.
This structure was selected because it acts as an insurance policy with a price ceiling, while Pakistan keeps getting the benefit of market prices as long as they are lower than the ceiling.
Pakistan’s total imports of crude is 68 million barrel per annum, that of HSD is 19 million barrels per annum, PMG 45 million barrels per annum and term of contracts of LNG is 6 million tons. This totals crude, HSD, MS to approximately 175 million barrels per annum.
Petroleum Division has recommended the following options:
- Call option for 15 million barrels of oil for one year, divided into 12 equal monthly amounts, for a strike price of $ 8 above current Brent as long as the fee is within an acceptable range.
- Call option for 15 million barrels of oil for two years, divided into equal 12 monthly amounts, for a strike price of $ 15 above current Brent as long as the fee is within an acceptable range.
- PSO to be approved as the counterparty and Ministry of Finance to give a guarantee of performance by PSO.
- A committee is notified, led by Secretary Finance and comprising of Secretary Petroleum, Secretary Law and Secretary Planning, plus Managing Director PSO to finalize the call options with the selected banks. Final approve will require ECC approval on a short notice
- OGRA be given a policy direction to include the monthly price of the option in the cost of LNG (or any other oil product chosen ) in announcing the monthly prices.
Currently, Brent is in the range of $20-25/ bbl. Since the prices of call options are changing every day with the prices of Brent, it is essential that the approval granted by ECC is for a range of call options price, in order for the Finance Ministry to lock it the day an acceptable offer is put on the table by the relevant banks. A fixed price approval will become irrelevant the next day as the market moves.
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