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Hedging of fuel imports will save Kenya pricing see-saws

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An attendant at a Total Petrol Station in Nairobi. FILE PHOTO | NMG

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Summary

  • The recent outrage in the country following high petroleum prices clearly demonstrated the desperate case of oil importing countries.
  • Skyrocketing prices for net oil-buying nations tend to lead to higher import costs with an adverse effect on gross domestic product (GDP), exchange rate, inflation and balance of payment.
  • In such a scenario, the government usually has three options; pass price increases to consumers, introduce subsidies in order to protect households and businesses from rising oil prices or pursue hedging.

The recent outrage in the country following high petroleum prices clearly demonstrated the desperate case of oil importing countries.

Skyrocketing prices for net oil-buying nations tend to lead to higher import costs with an adverse effect on gross domestic product (GDP), exchange rate, inflation and balance of payment.

In such a scenario, the government usually has three options; pass price increases to consumers, introduce subsidies in order to protect households and businesses from rising oil prices or pursue hedging.

The first two are possible but tough to implement in our current economic situation. Passing price increases works when there are minor adjustments but is inefficient in the case of large fluctuations.

Targeted subsidies for refined oil products are problematic. For instance, liquid fuels can be easily smuggled across borders, a scenario which can have a negative effect on government expenditure and worsening of balance of payment that consequently results in further debt crises. Hedging, in my view, is the only viable option.

Crude prices have soared to pre-Covid-19 levels in recent weeks driven by production cuts by the Organisation of the Petroleum Exporting Countries (Opec) nations and mass rollout of Covid-19 vaccines in many high-income countries.

The price of Opec crude oil basket rose from Sh4,261 per barrel in November 2020 to Sh6,448 per barrel today. Consequently, our total oil import bill will shoot higher.

According to the Kenya National Bureau of Standards (KNBS), leading economic indicators for January 2021, fuel and lubricants accounted for 15.32 percent of the total value of imports. We paid Sh24.6 billion for these fuel imports.

That said, launch of Murban crude futures contract last month by the new ICE Futures Abu Dhabi (IFAD) oil exchange comes at an opportune time.

The Murban deal, which prices the flagship Abu Dhabi grade that accounts for more than half of Abu Dhabi’s National Oil Company’s (ADNOC) production, will enable traders to hedge.

It would also allow them to compare the values of competing supplies from Russia, Europe and the United States with similar quality using a range of cash-settled derivatives against Brent and West Texas Intermediate.

It is a physically delivered contract with delivery at Fujairah in the United Arab Emirates (UAE) on a free-on-board (FOB) basis. The UAE, the third biggest oil producer in the Opec behind Saudi Arabia and Iraq, pumps between 2.5 million and three million billion barrels per day, mostly produced by ADNOC.

What needs to happen? Hedging policies aimed at reducing the cost of import need to be implemented in order to help mitigate the adverse effect of oil price rises.

Specifically, oil marketing companies can hedge their petroleum purchases using Murban Crude futures contracts when it is presumed that prices can increase in the future.

Plus, this can help the government maintain a steady price for the consumer. With Opec, which has revised down demand growth, however, still expecting output cuts to keep the market in deficit throughout 2021, it’s possible that oil prices will remain high. And the higher they go, the more reason the country needs to embrace hedging.

Mr Mwanyasi is the managing director at Canaan Capital