Sri Lanka petroleum retailer to look again at hedging after May

April 21, 2007 (LBO) – Sri Lanka’s largest petroleum retailer, the state-owned Ceylon Petroleum Corporation (CPC), is setting its sights on crude oil hedging after ending up on the right side of its maiden gas-oil options position, an official said. During those periods Ceylon Petroleum had run losses around 200 million US dollars.

CPC received a settlement cheque of 300,000 US dollars for a two dollar protection for 150,000 barrels of imported diesel through a gas-oil options collar it bought from Standard Chartered Bank.

“We are happy that the gamble paid off,” Petroleum Minister A H M Fowzie said. “If we had lost money on the first hedge I would have been held responsible.”

CPC Chairman Ashantha de Mel said he was setting his sights on crude oil hedging probably after May.

“At the moment oil prices are very high and we want to wait till it stabilizes,” de Mel told reporters.

Diesel prices surged from 71.98 dollars a barrel at the beginning of the month to 79.80 at its end.

Standard Chartered is also making another payment for 600,000 dollars for gas-oil hedged in April.

“This clearly indicates the benefit to the country of the hedging agreement and mitigate the risk of rising oil prices,” Standard Chartered’s head of Global Markets in Colombo Rukshan Dias said.

CPC was not able to go for futures contracts or a price cap as it would have had to pay a premium which was politically a costly decision to make.

“At the time a cap would have cost us a premium of about four US dollars a barrel,” de Mel said.

“We were not prepared to pay that kind of premium because it was the first time.”

De Mel said the utility had been toying with using a long-seagull position but had decided to go for a zero cost collar instead.

Though the utility got the payment for its first hedging contract, it is running losses because Sri Lanka’s retail petroleum price adjustments need political approval, which is difficult to get due to a belief among politicians that raising oil prices cause inflation.

Though the utility asked for a seven rupee increase in the price of diesel, the government approved only 3 rupees, resulting in CPC continuing to make losses.

CPC’s losses also hurt the Sri Lanka rupee since the utility funds its losses from rupee borrowings.

Earlier in the month, de Mel warned that CPC was heading for an 800 million rupee loss unless it was allowed to raise prices.

Economists point out that an 800 million rupee loss, acts like an eight million dollar open speculative position against the national currency when the borrowed rupees are sold to buy dollars in the inter-bank market.

Losses in CPC had earlier put severe pressure on the national currency, especially in 2004 and 1999/2000 periods, when the country tried to fix oil prices.

During those times Sri Lanka experienced very high inflation and balance of payments problems largely triggered by oil subsidies financed with bank credit, especially from the central bank (printed money).