Petroleum ministry seeks oil purchase at higher rates

Published May 11, 2020
Move is aimed at hedging of about 20pc of total imports. — AFP/File
Move is aimed at hedging of about 20pc of total imports. — AFP/File

ISLAMABAD: In a risky move, the petroleum ministry is seeking purchase of oil at $8-15 per barrel higher than the current low price for hedging of about 20 per cent of its total oil imports and pass on the cost of this higher rate to consumers.

In a summary moved to the Economic Coordination Commit-tee (ECC) of the cabinet, the petroleum ministry has advocated that the proposal would be hedging some portion of exposure to Pakistan for import of petroleum products directly or indirectly linked to crude prices.

This includes crude oil, motor gasoline, high speed diesel as well as LNG. The proposal has been finalised in consultation with the Standard Chartered Bank, Citibank, Habib Bank and JP Morgan.

A former managing director of the Pakistan State Oil (PSO) said the proposal would entail that Pakistan and its consumers would not take the full benefit of the prevailing market crash in case of petroleum products and LNG while some smart hedge managers would move away with a quick buck.

He said a better idea would be to allow oil companies, particularly the PSO, to move a part of their purchases to spot market to take full benefit of low prices in a balanced basket. The proposed hedge tag of $8 and $15 per barrel is too high.

Move is aimed at hedging of about 20pc of total imports

The petroleum ministry, on the other hand, said all the above banks had advised Pakistan to start with covering 15-20pc exposure to begin with and then consider increasing it. The bankers also gave price indications but said that since the prices changed hour to hour, the cost of a hedging programme went up in a volatile market. They advised not to try to time the bottom of the market and wait for some level of price stability.

The petroleum ministry has sought approval for a call option for 15 million barrels of oil for one year, divided in 12 equal monthly amounts, for a strike price of $8 above current Brent as long as fee is within acceptable range. It has sought to have another call option for 15m barrels of oil for two years, divided in 12 equal monthly amounts, for a strike price of $15 above current Brent as long as fee is within acceptable range.

The ECC has been requested to approve the PSO as the counterparty and the Ministry of Finance to give a guarantee of performance by the PSO. At the same time, a committee should be notified, led by the finance secretary and comprising the secretaries of petroleum, law and planning, plus managing director of the PSO, to nalise the call options with the selected banks. Final approval will require ECC approval to be obtained on short notice.

The ECC has also been asked to give policy direction to Ogra to include the monthly price of the option in the cost of LNG or any other oil product chosen in announcing the monthly prices.

Pakistan’s total imports are about 175m barrels per annum of oil equivalent. This includes total crude imports of 68m barrels per year, 45m barrels of petrol, 19m barrels of high speed diesel and 6m tonnes of term contracts of LNG.

The petroleum ministry has advised to target hedging about 9pc per year for two years that translates to about 30m barrels of call options. The call option is a financial instrument exercise under which when the price goes above the call level, the amount received can be allocated to any particular product to keep its pricing fixed at the ceiling for the hedged period. However, since in the LNG sector, only government entities are involved, while private companies are involved in refineries and OMCs, it would be better to allocate it to LNG. This will also help in synthetically fixing the LNG price at the manageable level, it argues.

The ministry has said that it calculated call option when Brent was around $35 per barrel; they were in the range of $3m per month for first option with a strike price of $45 and $5m per month for second option for a strike price of $50, if paid upfront fully. If they are staggered into monthly payments, there will be a small financing cost in the installments.

The ministry has recommended this option, saying that in addition to not having to pay upfront this would allow Ogra to pass this option cost in the monthly fuel procurement whether LNG or oil products. However, in this instance, the agreement between the banks will either be directly with the Ministry of Finance or with the PSO but guaranteed by the Ministry of Finance. In either case the actual cost can be paid by the PSO since it will able to recover in the product pricing.

At present, Brent is in the range of $20-25/bbl. Since the prices of the call options are varying every day with the prices of Brent, the petroleum ministry has sought approval of the ECC for a range of call option prices, in order for the finance ministry to lock it the day an acceptable offer is put on the table by the relevant banks. A xed price approval will become irrelevant the next day as the market moves.

Published in Dawn, May 11th, 2020

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