Price risk hedging for oil and oil products.

Instability of the economic development in the world, as well as geopolitical risks lead to considerable growth of the price fluctuation amplitude in the energy supply market. For the protection against the strong price fluctuations in the market of oil products, more and more popular becomes the practice of physical commodity hedging with the help of energy derivatives, including the usage of OTC Energy Swaps (financial tool, used for hedging or speculations, where the physical delivery of the goods is excluded).

With the help of these tools, based on the current price of the commodities, the company insures its goods against the price change for the specific period of time in the future. In other words, you may insure the commodity price either against its decreasing or increasing in the future. Now, let us examine an example where the business company purchases some certain raw materials (oil, oil products or others) in Russia or the countries of the CIS with its following resale in the countries of the Baltic States, the European countries or any other distant foreign ones. While all this, during the transportation and search of the client, the price in the market can change towards the unbeneficial direction. In the mentioned example, the potential profit after the sale may greatly decrease or even turn into loss. In order to avoid such way of development of events, hedging is necessary. In this case the sale of futures or OTC Energy Swaps contracts may be used, so the change of the market-price during the commodity transportation will be compensated by the futures or OTC Energy Swaps contracts. In case if the goods price decreases in the market, the marginal account of a hedger is credited with the money, compensating a price drop of the physical commodities. But if the price is increasing, the hedger is obliged to pay the negative variation margin but which is compensated by the price rise of the physical goods.

At this certain moment, the companies may use various hedging strategies:

• Absolute hedging;
• Selective hedge;
• Active hedging;

Absolute hedging: opening of the position in the exchange or off-exchange (OTC) market of the equal volume and specification but with a different direction towards the real goods. Completely hedges the risk of the unbeneficial price change.

Selective hedge: the hedging of the physical commodity by another commodity alike (but not similar to it) at the exchange (for example, hedging the diesel fuel with the low content of sulfur ULSD 10 ppm. with the futures contracts IPE/ICE Gasoil) or using the hedging with the identical commodity but not in a full volume (leaving a part of the physical commodity unhedged). The selective hedge demands a constant market analysis and research of the market tendencies from the company and, consequently, is more risky than the absolute hedging

Active hedging: the usage or not usage of hedging for one’s physical commodity, directing one’s attention towards the current situation on the market, forecasts and self opinion. It is a very risky strategy for the hedging.

It is appreciably to mention that the hedging is frequently used by automobile carriers (large bus parks), ship owners or the ship operators, airlines, which all bear the risk of the transportation price rise in the time of the price rise on the oil products. In this case, they, as a rule, make a purchase of the fixed price for the specific period of time (1, 3, 6 months, for 1 year and so on), with this eliminating the risk of the fuel value influence on the value of the ticket price. According to statistics, airlines in the developed countries hedge from 30 to 60% consumed fuel.

Undoubtedly, hedging has its own side effects. One cannot secure him/herself from the loss due to decreasing of the price, leaving potential of the profit unchanged in case of its rise. The meaning of hedging lies exactly in financial streams’ stabilizing, making them less dependable on price fluctuation on the goods market. In addition to that, an opportunity of getting profit in case of prices rise, as well as their fall, has a rather clearly marked pecuniary valuation. The main inconvenience of hedging is distraction of some part of circulating assets. The mortgage for OTC Energy Swaps is 5-10% (more information can be found here) from its volume in the money terms, and is the minimum amount of means which should be found in the account for assurance of obligation fulfillment.

The risk insurance, connected with price changes of the raw material goods, rate of exchange and rate of interest has become a norm among the west companies, as well as becomes more popular in the Baltic States and in the CIS countries. As a matter of fact, there is an economic meaning of the world market and OTC Energy Swaps existence due to an assignment of the given opportunity. The market risk hedging brings in the element of stability to the work of the company, decreases the vagueness of future financial streams and secures a more effective financial management. As a result, the profit fluctuation gets reduced and the production controllability improves. AS IBC Renesource Capital being one of the leading broker service centres in the Baltic states, dedicatedly develops the spectrum of accessible tools which are intended for solving tasks of all the kinds of risk hedging – commodity, price, rates of exchange and interest ones; as well as offers consultations for its clients in the field of working with the derivatives.