Despite a sharp drop in crude price leading to huge inventory losses for oil refiners in 2014-15, state-owned oil marketing companies (OMCs) continue to stay away from hedging commodity price risk due to fear of losses and scrutiny from government agencies.
In contrast, private refiners such as Reliance Industries Ltd (RIL) and Essar Oil Ltd hedged aggressively all through 2014-15 as the price of crude oil fell 48% from $107.76 a barrel to $55.11 in the financial year.
The Reserve Bank of India had urged the oil ministry to encourage OMCs to hedge as 20% of their total crude oil consumption came from the spot market, where commodities are traded for immediate delivery, according to a report in The Economic Times dated 4 November, 2014.
But state-run oil firms remained risk-averse. “We have hardly any exposure to hedging as it is risky, includes heavy cost and is difficult to predict a volatile commodity,” said P. Balasubramanian, director-finance of India’s second biggest state-owned refiner Bharat Petroleum Corporation Ltd (BPCL) with a processing capacity of more than 32 million tonnes per annum (mtpa).
It’s the same for the other two state-owned refiners Indian Oil Corporation Ltd with a capacity to process 64mtpa and Hindustan Petroleum Corporation Ltd with a capacity of 24 mtpa. Together, the three state-owned OMCs account for close to 50% of India’s total annual crude oil consumption, according to Petroleum Planning and Analysis Cell (PPAC), a statistical body under the oil ministry.
“While an efficient hedging policy is always welcome, in case of crude oil it is very difficult to do so as one has to take a call on the futures market very much in advance,” said a senior executive from one of the three OMCs who did not want to be named.
The executive said that crude oil refiners have to take into account three main data points to hedge—the expected gross refining margin, the expected price of different products such as diesel, petrol, kerosene, aviation turbine fuel (ATF) and the expected price of the crude itself. Predicting all three accurately is tough and can lead to heavy losses if the prediction goes wrong, the executive said.
“If we make profit on hedging or shield ourselves from a sharp fall or rise in prices, it is good. But in case the bets go wrong, as they usually do, we will not be compensated for our losses and we are answerable to several government bodies,” said another senior executive from among the three OMCs.
This executive said that among the three state-owned OMCs, only IOCL has hedged commodity risk in a limited way.
The three OMCs faced a total inventory loss of `7,400 crore in 2014-15, according to the annual results of the companies.
As these companies had not hedged their product and crude price risks, their losses added up, said an analyst with a domestic brokerage firm. He did not wish to be named due to his company policy.
“While hedging is a very good business decision, the question is who will be responsible for losses in case the hedging goes wrong? And who will stand government scrutiny?” he said, explaining why state-run firms stay away from hedging.
“In the long run, the price of crude and product even out and therefore hedging is not a good business decision for a public sector company which has to be answerable to several government bodies as well as shareholders,” said the head of energy vertical in an international brokerage house. His company does not allow him to speak to the media.
This analyst said that private companies such as RIL and Essar Oil have efficient treasury operations and the expertise to hedge both crude prices and product prices. Since these companies are not answerable to government bodies such as the government auditor Comptroller and Auditor General (CAG), it gives them a free hand.
In 2014-15, RIL hedged a total of 308.71 million barrels annually or 0.85 million barrels per day (bpd) of its feedstock. This is against a total crude oil consumption of 1.32 million bpd that the company needs to run its refinery. This is more than double compared to the 150.95 million barrels a year or 0.42 million bpd hedged in the previous financial year, according to the stand-alone numbers given in the company’s annual report.
“The PSUs (public sector units) are mostly subsidized by the government and their prices are pass through since they sell in a controlled domestic market, so the instruments of commodity hedging never found way in these companies,” said A.V. Rajwade, chairman of A.V. Rajwade and Co. Pvt. Ltd, a risk management company which works with several oil companies in India. He said another reason for minimal interest in product hedging is that not all products have a robust derivative market, which makes it difficult to hedge. The cost of hedging also remains high, said Rajwade.
Source: Mint; 09 June 2015