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Capital Mind Gets it Right: RBI asks Government To Hedge Crude Exposure

A few days back, I appeared on ET Now in a show hosted by Ayesha Faridi and Niraj Shah, where I spoke about Oil Hedges:

And then I spoke of how India should hedge some of its Crude Oil exposure. At $80 or below, Brent Crude may be low enough for us to set up longer term hedges, if available. This should be the realm of oil refiners, but most of them do not hedge, and they are government owned etc.  In a purely competitive market, they should have been hedging and reducing the cost of fuels if the hedge worked and so on, but this is not a proper market. In fact, they end up buying dollars directly from the RBI whenever RBI feels that their buying will distort the actual market.

This needs a broader approach because India imports a lot of crude. Just oil imports are more than 30% of India’s overall imports (last year: $160 billion out of the total imports of $480 bn). That means it should be of interest to reduce the overall impact of oil imports. However, the market may not really allow for long term hedges (what if the 2 year or 3 year futures are only available for a much higher price?), which means the question is moot.

It turns out someone at the RBI and the government are thinking exactly the same thing!

The government is actively considering a Reserve Bank of India’s (RBI) proposal to hedge crude oil import risks at a time when international crude prices have slumped close to the lowest in nearly four years, which could significantly reduce country’s over $155 billion petroleum import bill.

Indeed, as oil falls – and some of it is due to supply increases and shale oil in the US – India’s import bill is already down. It would be wise for us to consider setting up long term hedges, for sure. Longer term hedges still cost a lot – the December 2017 Brent Contract on futures runs at 89.35, and the 90 call options are still too expensive. (We could write put options too. Won’t get into details, but a combination of puts and calls as strategies can be used) 

While we’re surprised to see the RBI saying this, and it’s quite likely they’ve been saying it for a while, but it seems like quite an interesting coincidence. I would normally prefer to be modest, but as I’ve recently discovered, it’s he who shouts the loudest that gets all the attention.

Therefore, in whatever way one can scream from the rooftops of the Internet:

We Nailed It.

We’d love it if the government (and RBI) implement some of Capital Mind’s other proposals – to free the rupee, to allow foreign investors to buy a lot more debt (short and long term) and to please allow Indian private companies to invest without needing to set up an NBFC. Having said that, it’s incredibly awesome to chalk up another thumbs up for Capital Mind.

We’re not holding our breath, but if by the small chance that someone from RBI or the appropriate arm of the government is reading this, Thank You.


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  • Srinivas says:

    Hedging is good for locking up some value. To that extent the instrument is good and functional.
    But is high prices only the cause of current problems?
    There are various issues and the same need to be looked at comprehensively. First one is control and cross subsidy. only some steps are initiated recently to address this issue. What every part that is made good by govt/upstream companies, the same will be given at the year end, resulting in OMC incurring huge interest costs on borrowings.
    There are other structural issues. Already India is surplus in HC. We are getting two more refineries in a year’s time and some more like HPCL projects subsequently. are they good from an investment perspective?
    Also the we are aping west by going EURO III,IV…..10 etc. The differential cost is not properly passed on to consumers. It costs much more to reduce sulfure from 500 ppm to 50 ppm to 10 ppm to zero ppm.
    But Modi’s utterings ” Govt has no business to be in business” is a fresh ray of hope. Hope it will fructify.

  • Akash says:

    “He who shouts the loudest”…. Are you referring to Mr. Arnab B here ? 😛
    The approach suggested is good– prepare for price rise when the price is low…. might save the government and the “aam admi” a lot of heartburn later. Feels good to know that the government is becoming proactive about hedging. Long overdue.

  • The current price fall is structural in nature. There are several reasons to it, such as rising shale output in the US, closure of commodity trading desks in leading investment banks, demand slowdown in developed markets, loss of pricing power of OPEC due to internal squabbles and increase in non-OPEC output and so on. These factors will not change in a hurry. It may be a bit too early to spend money on hedges, as the gains from locking in at current prices may be lost in paying for the cost of the hedges itself. Remember the prices fell to USD 30 in 2009 in the aftermath of the financial crisis. I think we should look at hedging if the prices fall to similar levels

    • Yes, of course if the hedges are too expensive then it’s not worth it. But at 80 I think it’s time to start looking for hedgeable contracts, and perhaps start locking in some of the contracts. One idea is to do about 10% at 80, and increase size if we go further downwards.

    • DJ says:

      Good to see this view. I agree. This downturn could be secular and last a long time. Commodities don’t usually rally back up promptly after a large decline. In fact, declines in commodities usually last longer than one expects. Let a few commodity hedge funds go bust, let us hear of some liquidation, etc and then too, it could take months, years to come back up.
      What we should do though is have strategic reserves for defense purposes. The US maintains 6 months of inventory I think (and they have much more at present – about 9 months worth) and China also started a strategic reserve program in 2008/09. I don’t know if we have such a program.

  • Nagarajan says:

    The drop might be coordinated to kill the Shale boom and reduce the funding for US shale companies. Bloomberg article give a interesting view.

  • esotericBlue says:

    I too like the idea of strategic reserve. it won’t hurt to stock up on couple years worth of crude as the price keeps going down. plus, near term hedges, say for the next 12 months might keep end up being LESS costly as the storage capacities are built, albeit on a war footing.

  • Sameer says:

    Government trying to time the market with an underlying assumption, that the crude is at a low levels and will trade at higher levels in future. At this stage looks to be a smart move but also ensures (at my personal level) that petrol prices will not fall further.:)