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James Debono
After years of partisan wrangling over hedging – demonised by government and hailed as a magic wand by the opposition – forward buying has finally found a place in Enemalta’s fuel procurement policy.
The fuel procurement advisory committee has advised Enemalta to purchase 75 per cent of its requirements through forward buying arrangements on a six to nine-month basis.
The recommendations have been endorsed by Enemalta’s board of directors, a spokesperson for the Ministry for Investments and Information Technology told MaltaToday.
MLP deputy leader Charles Mangion said the committee’s recommendations were recognition that hedging is a useful technical tool for containing the negative effect of price volatility in the procurement of fuel.
The volatility in the price of oil has been reflected in a surcharge of 55 per cent established back in November 2005, which is being revised every two months. In January the surcharge fell to 47 per cent, only to rise again in March to 67.5 per cent.
An imminent change is expected in the next month amid apprehension on spiralling prices in the international oil market.
Setting the tone for the tough times ahead, on Monday the Nationalist Party daily In-Nazzjon gave prominence in its front page to the news that the price of oil had hit the USD70 per barrel mark.
A spokesperson for the MIIT confirmed that Enemalta has already entered in to forward agreements to cover forward its oil purchases, as suggested by the committee.
Enemalta is also seeking a catastrophe cover as suggested in the same report. Despite accepting the idea of purchasing oil by forward agreements, the government will still continue to change the surcharge every two months. Enemalta has also appointed a risk management committee which has an executive function.
Just like the gambling term “to hedge your bets”, hedging is an investment that serves to reduce or cancel risk by purchasing fuel in advance at a fixed price for future delivery, to protect against the shock of anticipated rises in price.
“It’s all about stability”
Economist Lino Spiteri contends that hedging can bring greater stability but would not being about a reduction in fuel tariffs for the consumer.
Economist Lino Spiteri told MaltaToday that if Enemalta secures forward buying arrangements, tariffs can be established on a more long-term basis, avoiding the need of constant revisions as has been happening in the past months.
But Spiteri also warns hedging will not in any way result in a decrease in tariffs. According to the former finance minister, tariffs would at any given time be above those that derived from purchasing in the spot market.
“In a nutshell what one can talk about is managing risk to secure relative price stability and avoid as much as possible price shocks.”
Spiteri said complete price stability will only result if all fuel requirements are bought at a fixed price for a given period. “If one were to cover forward 100 per cent of oil purchases for six months, tariffs will be stable at the input price for that period.”
This would be an absolute guarantee that no changes in the price of fuel will take place in that period. But Spiteri questions the wisdom of buying the full amount of oil at set prices, viewing it as too risky.
In a scenario where Enemalta buys only part of its fuel requirements through hedging and continues to buy the rest at the spot market price as suggested by the advisory committee, tariffs will have to fluctuate depending on the movement of the spot price for the amount bought in the market and not bought at a fixed rate.
Another measure not contemplated by the fuel procurement committee, suggested by Lino Spiteri, is to cover forward the US dollars required to finance the covered purchase.
MLP’s reaction
Although the fuel procurement advisory committee was against recommending long-term hedging as practiced by the 1996-1998 Labour-led government, deputy leader Charles Mangion has criticised the Nationalist government for dismantling and publicly condemning the hedging structures set up by the previous Labour government.
Noting that since 2000 the price of fuel has practically always shot up, he accuses the government of irresponsibility for giving up hedging until January 2005. “This underlines the irresponsibility of this government when it comes to addressing issues having national economic and social implications.”
But Mangion acknowledges that deciding whether to hedge or not is not an emotional political decision to be taken at whim. “It requires sound technical and expert advise based on broad analysis and in depth study of the situation as it evolves from day to day.”
He also concurs with Lino Spiteri that since the procurement of fuel is paid in dollars, the dollar requirement in hedging transactions should also be covered. “In this respect one has to assess whether the fuel procurement advisory committee needs strengthening technically.”
Mangion would not commit himself that hedging would result in a decrease of prices as alluded by MLP spokespersons in the past.
But he said taking the right decision at the right time would definitely pay: “Proper hedging would mitigate the economic and social instability that the current fuel pricing situation is causing in Malta.”
“Give hedging a chance”
Exasperated by continuous changes in the price of oil, business leaders have agreed with Lino Spiteri that hedging can restore a degree of price stability.
Fluctuating fuel prices are turning business risks into a gamble, Malta Employers Association director-general Joe Farrugia said: “Take the case of firms seeking to enter into contracts with their clients: the more significant energy prices are in the cost structure, the more vulnerable the company will be when it commits itself to a price.”
Vince Farrugia, GRTU director-general, argues that price changes have a negative impact on businesses exporting on a forward basis as well as hoteliers who sign contracts with tour operators months before oil prices are revised.
“While operators can foresee an increase in labour costs as these are regulated by collective agreements, electricity and water costs cannot remain so volatile.”
Echoing the sentiments of business leaders, the fuel procurement advisory committee called on the government to “attempt to secure, to the extent possible, predictability in electricity prices.”
According to the committee’s report the manufacturing, commercial and tourist sectors can plan forward and price their respective products if a degree of predictability is restored.
The committee also maps the way forward out of the impasse. Unlike the Malta Labour Party, the committee excludes long-term hedging, which is deemed as an “unacceptable economic, commercial and political risk.”
The report says the government cannot risk being criticised if it were to commit itself to hedging at a price which turns out to be higher than spot market prices, if the international price of oil falls again.
But in order to mitigate volatility and restore price stability, it recommends that with for a rolling six to nine-month time horizon, Enemalta should purchase or otherwise cover forward up to 75 per cent of its requirements through a number of forward agreements.
It also recommends Enemalta to secure a catastrophe cover of a period of up to three years to cover against unforeseen events.
Vince Farrugia is wary of long-term hedging but disagrees with the short-term approach adopted by the government so far, arguing that it makes more sense to hedge for six month on a rolling basis.
“Hedging should not be done sporadically. It should be done in a programmed way. As far as I know the government is not engaged in speculation on petroleum prices. Its aim should be that of smoothening the impact of increases and create stability.”
The MEA’s Joe Farrugia acknowledges that hedging may incur a cost, since ultimately, hedgers operate to profit from market fluctuations. However, he said the benefits of price stability through hedging may – within parameters – outweigh the premium that may be paid as a result. “It will certainly be easier for businesses to plan and enter into contractual agreements with their clients. This factor alone makes a strong case in favour of giving hedging its due weighting, particularly in a volatile international political environment.”
The fuel procurement committee was a confirmation that the government’s present policy of buying oil at spot market prices is resulting in unpredictable price changes, which undermine the competitiveness of Maltese businesses.
Hedging might not be the magic wand that defies the geo-political realities pushing up oil prices – but it’s definitely not a dirty word, not even for investments minister Austin Gatt who has accepted the committee’s recommendations.
jdebono@mediatoday.com.mt
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