The government’s policy to stabilise consumer prices against unpredictable swings in global oil market prices, is proving to be a costly affair and it’s time for a rethink.
For a broke nation, watching oil prices hover above Sh7,500 per barrel, it’s no surprise the government chose to suspend the fuel subsidy programme.
Riddle: What is shorter than a soap opera but far lengthier and convoluted than a typical drama? Answer: a Mexican telenovela.
Famous for their continuing melodramatic story lines and a permanent cast, it is interesting that same qualities are also shared by another Mexican programme - its oil hedging programme, which works through unending volatility but manages to keep a steady price.
Being a major oil exporter and with the commodity contributing more than a third of the federal budget, Mexico’s finances are effectively tied to the vagaries of the oil market.
However, the country’s Finance ministry has for decades used derivatives (mostly oil options) to hedge its oil exports, protecting public finances from sharp drops in the price of oil.
The country spends almost Sh100 billion every year on its oil hedging programme, which is considered the largest annual deal of its kind on Wall Street.
The government’s policy to stabilise consumer prices against unpredictable swings in global oil market prices, is proving to be a costly affair and it’s time for a rethink.
For a broke nation, watching oil prices hover above Sh7,500 per barrel, it’s no surprise the government chose to suspend the fuel subsidy programme.
The question is; do we have a less costly “stabilisation” alternative? Answer is yes and the solution is hedge using derivatives.
Why do we need to hedge? One; Kenya is a net oil importer. Petroleum imports account for about 17 percent of the total import bill or an estimated Sh316 billion annually.
Two; hedging done properly can actually be net positive. If oil prices are above the hedged level for most of this year, it is almost certainly set to give a sizeable payout.
A good example is Mexico, its hedging deals have paid several times, including in 2009 - after the global financial crisis sent oil prices sharply lower - and again in 2015, when a record of more than Sh600 billion was reaped, as well as in 2016.
It’s expecting a big payout this year too, after oil prices crashed due to the coronavirus pandemic and the price war between Russia and Saudi Arabia earlier this year.
For Kenya, which is paying sixty cents for every shilling collected as tax, isn’t this a welcome alternative?
How can we hedge? Through purchasing call options - contracts that give it the right to buy at a predetermined price - because they are cheaper compared to futures.
To implement the hedge, rather than purchase the options in a big swoop over only a few months, Kenya’s government (or through the oil collective) can spread their purchases over time and buy each time just a little to avoid ripples in the market.
A prolonged approach stands a chance of benefiting the country with better prices. Equally important, should prices fall, Kenya can also skip the deal especially when prices are super low such as witnessed last year.
Furthermore, since Kenya imports Murban Adnoc crude, it has the option of arranging an over the counter deal with international banks or can implement the same strategy at the standardised derivatives exchanges.
In summary, an oil hedging programme is necessary. Not only does it offer stability amid public finance and budget challenges, for a country at risk of a credit rating downgrade, it potentially could prevent it from sliding down the credit rating rank and also can guarantee solvency.
Mr Mwanyasi is managing director at Canaan Capital
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