Transcript hedging is allowed for

HEDGING OPTIONS
G.P.AGGARWAL
GENERAL MANAGER (IT),
INDIAN OIL CORPORATION LIMITED
PRESENTATION COVERS…
• POWER SECTOR IN
INDIA
• OIL PRICE RISKS AND
IMPACT ON INDUSTRY
• RISK MITIGATION POSSIBLE OPTIONS
• REGULATORY
FRAMEWORK IN INDIA
POWER INDUSTRY IN INDIA
SOME INDICATORS
• POWER GENERATION CAPACITY:
– 1947
:
1,362 MEGA WATTS
– CURRENT : >100,000 MEGA WATTS
• SHORTFALL VS PEAK DEMAND
– OVER 10,000 MEGA WATTS
• POWER CONSUMPTION:
– ANNUAL PER-CAPITA CONSUMPTION OF 350
KWH - AMONG THE LOWEST IN THE WORLD
POWER INDUSTRY IN INDIA
(PROJECTS FOR POWER GENERATION)
Ministry of Power
107.1
'000 Mega Watts
120
22.9
100
80
46.2
60
40
9.4
8.3
20
28.5
60.9
13.5
10.6
18.9
65.3
36.8
0
BY 2006-07
Central Govt
06-07 TO 11-12
State Govt
Total by 2011-12
Private Sector
HUGE DEMAND FOR OIL/COAL/NATURAL GAS
FORESEEN IN POWER SECTOR
POWER MIX - INDIA
(% share of fuels in new additions
'000 MEGA WATTS
120
100
3
13
9
7
12
5
49
45
61
35
35
26
80
60
40
20
0
BY 200607
HYDRO
2006-07
TO 201112
COAL/LIGNITE
2012 TO
2020
OIL & GAS
FUEL IS A SIGNIFICANT COMPONENT OF
OVERALL OPERATING COSTS
NUCLEAR
Source: CEA, Ministry of Power
OIL PRICE RISK PROFILE
(APM vs DEREGULATED SCENARIO)
• PRIOR TO APRIL 2002,
– CUSTOMERS ENJOYED STABLE FUEL
PRICES OVER LONG PERIODS INSULATED FROM PRICE VOLATILITY
– OIL COMPANIES ENJOYED ASSURED
RETURNS
– POOL MECHANISM ABSORBED THE
IMPACT OF VOLATILITY
• DEREGULATED SCENARIO W.E.F
APR'02
– ALL PLAYERS VIZ. OIL COMPANIES AND
CUSTOMERS EXPOSED TO OIL PRICE
VOLATILITY
– NO ASSURED RETURNS FOR OIL
COMPANIES
– UNCERTAINTY IN BUSINESS DUE TO
UNSTABLE FUEL PRICES
OIL CONSUMERS - RISKS FROM
OIL PRICE VOLATILITY
• MAJOR CONSUMERS LIKE POWER
PLANTS, AIRLINES, INDUSTRIAL UNITS,
ETC. OFFER CUSTOMERS SERVICES TO
THEIR CUSTOMERS AT FIXED PRICE
OVER A LONG PERIOD OF TIME.
• FREQUENT CHANGES IN FEEDSTOCK
(OIL) PRICES THROWS BUSINESS PLANS
OUT OF GEAR
• CASH FLOWS AND PROFITABILITY
ADVERSELY AFFECTED
PRICE VOLATILITY-IMPACT ON
POWER PLANTS
40
figs in $/bbl
35
VOLATILITY IN NAPHTHA
PRICES
30
25
20
Ja
n
M -01
ar
M -01
ay
-0
Ju 1
lSe 01
p
No -01
vJa 01
n
M -02
ar
M -02
ay
-0
Ju 2
lSe 02
p
No -02
vJa 02
n
M -03
ar
M -03
ay
-0
Ju 3
lSe 03
pNo 03
vJa 03
n04
15
From above price scenario, it is evident that price stability is
highly desirable to ensure sustainabilty of power plants.
PRICE VOLATILITY-IMPACT ON
POWER PLANTS
35
VOLATILITY - FO PRICES
figs in $/bbl
30
25
20
15
Ja
n
M -01
ar
M -01
ay
-0
Ju 1
lSe 01
p
No -01
vJa 01
n
M -02
ar
M -02
ay
-0
Ju 2
lSe 02
p
No -02
vJa 02
n
M -03
ar
M -03
ay
-0
Ju 3
lSe 03
pNo 03
vJa 03
n04
10
From above price scenario, it is evident that price stability is
highly desirable to ensure sustainabilty of power plants.
OIL PRICE VOLATILITY
(IMPACT ON OIL COMPANIES)
FIGS IN $/BBL
35
31
27
23
19
O
ct
-0
0
D
ec
-0
0
Fe
b01
Ap
r-0
1
Ju
n01
Au
g01
O
ct
-0
1
D
ec
-0
1
Fe
b02
Ap
r-0
2
Ju
n02
Au
g02
O
ct
-0
2
D
ec
-0
2
Fe
b03
Ap
r-0
3
Ju
n03
Au
g03
O
ct
-0
3
D
ec
-0
3
15
Brent
Volatile oil prices have adverse
impact on Exploration & Production
companies. Low prices result in
reduced exploration efforts causing
harm in the long term.
Dubai
12
Volatile product vs crude oil
movement result in major refining
margin risks to the refining
companies.
10
8
6
4
2
Nov-03
Sep-03
Jul-03
May-03
Mar-03
Jan-03
Nov-02
Sep-02
Jul-02
May-02
Mar-02
Jan-02
0
OIL COMPANIES CANNOT ABSORB THESE PRICE RISKS IN
ADDITION TO SUBSIDIES ON LPG/KEROSENE
HOW TO MITIGATE RISKS??
• CREATING STABILIZATION FUND LIKE A POOL
ACCOUNT (AS IN APM SCENARIO) TO ABSORB PRICE
FLUCTUATIONS
– TO BE ADMINISTERED AND CONTROLLED BY WHOM ??
– DIFFICULT TO OPERATE IN SUSTAINED PERIOD OF RISING
PRICES
USE HEDGING TO REDUCE VOLATILITY OF OIL
PRICES IS ONE VIABLE OPTION
RISK MITIGATION
HEDGING - A PANACEA?
• HEDGING DOES NOT ENSURE LEAST
COST FOR CONSUMER OR BEST PRICE
FOR OIL PRODUCER. IT HELPS TO
ATTAIN CERTAIN OBJECTIVES LIKE:
– PROTECTION FROM PRICE SPIKES
– ENSURING PRICE LEVEL THAT IS KNOWN
BEFOREHAND
– SMOOTHENING CASH FLOWS THEREBY
AVOIDING CASH CRUNCHES
HEDGING OPTIONS - OIL PRICE
• TO MITIGATE PRICE RISK
DUE TO ADVERSE OIL
PRICE MOVEMENTS,
COMPANIES CAN HEDGE
USING:
– SWAPS ON FUEL OIL/
NAPHTHA
– OPTIONS ON FUEL
OIL/NAPHTHA
– SPREADS BETWEEN F.O.
AND NAPHTHA
ELECTRICITY DERIVATIVES TOOLS
US MARKET
FORWARD CONTRACTS - WITH DELIVERY
FUTURES CONTRACT ON EXCHANGES
(NYMEX, CHICAGO BOARD OF TRADE, ETC)
ELECTRICITY PRICE SWAPS - CASH SETTLED
OPTIONS CONTRACTS WHERE THE BUYER
OF OPTIONS HAS THE RIGHT BUT NOT
OBLIGATION TO PURCHASE ADDITIONAL
POWER AT STRIKE PRICE
SPARK SPREADS ( SPREAD BETWEEN F.O.
PRICE AND ELECTRICITY PRICE - SIMILAR TO
CRACK SPREADS IN OIL MARKET)
HEDGING OPTIONS
SWAPS
CAPS
PAPER
MARKET
ILLUSTRATION OF SWAPS
PAYOUT
Price above $23/bbl, consumer
receives the differential from
provider of swap
Swap level of $23/bbl
Price below $23/bbl, consumer has
to pay provider of swap the
differential
20
21
22
23
24
25
MARKET PRICE ($/BBL)
Swaps ensure locking into fixed price. Irrespective of market going up
or down, consumer pays a fixed price.
ILLUSTRATION OF CAPS
PAYOUT
Price above $23/bbl, consumer
receives the differential from
provider
Cap level of 23
Price below $23/bbl, consumer
enjoys the lower price
Premium
20
21
22
23
24
25
MARKET PRICE ($/BBL)
Caps eliminate upside risk while the entire downside price
movements are enjoyed. A premium is required to be paid
for this tool.
ILLUSTRATION OF COLLARS
PAYOUT
Price above $24/bbl,consumer
receives the differential
Collar level between 22 & 24$/bbl
Price below $22/bbl, consumer has
to pay the differential
20
21
22
23
24
25
MARKET PRICE ($/BBL)
Collars ensure protection against upside price movements
by giving up some downside price advantage with
zero/small cost viz. premium can be zero
HEDGING OPTIONS - OIL
ACTIVE MARKETS
INDIA
PETROLEUM
EXCHANGES
1. NYMEX, NEW
YORK
2. IPE,LONDON
3. TOCOM, TOKYO
PHYSICAL PRICES
ARE
BASED ON
ARAB GULF
OVER-THECOUNTER
MARKETS
1. SINGAPORE
2. LONDON
3. NEW YORK
ELECTRICITY DERIVATIVE MARKETS
TRADING IN ELECTRICITY DERIVATIVES
GOING ON FOR PAST DECADE OR SO.
GREW RAPIDLY IN THE FIRST PART OF
2000 BUT FROM END 2000, THE MARKET
FOR EXCHANGE TRADED ELECTRICITY
FUTURES AND OPTION STARTED
COLLAPSING:
EXCHANGES LIKE NYMEX, CBOT AND MGE
DECIDED TO DELIST/ SUSPEND TRADING IN
ELECTRICITY FUTURES BY FEB 2002
ELECTRICITY TRADERS LIKE AQUILA AND
DYNERGY EXITED FROM OTC
ELECTRICITY MARKET
ELECTRICITY DERIVATIVE MARKETS
(REASONS FOR DECLINE??)
EXIT OF MAJOR PLAYERS LIKE ENRON, DYNERGY,
AQUILA. NOT AN ACTIVELY TRADED AND LIQUID
MARKET CURRENTLY
COMPLEXITY OF ELECTRICITY SPOT MARKET
NON STORABILITY, INSTANT DELIVERY, ETC. OF
ELECTRICITY - NOT CONDUCIVE TO BEING A
FINANCIAL CONTRACT??
ELECTRICITY MARKETS IN MOST COUNTRIES ARE
JUST UNDERGOING DE-REGULATION
IS THE TIME RIPE FOR STARTING ELECTRICITY
DERIVATIVES IN OUR COUNTRY - A MATTER OF
CONJECTURE!!
REGULATORY STATUS IN INDIA
DERIVATIVE CONTRACTS
• HEDGING IS ALLOWED FOR:
– FOREIGN EXCHANGE
– COMMODITIES
• AS PER OUR UNDERSTANDING REGULATORY
FRAME WORK IS NOT
CLEAR ON DERIVATIVES
FOR ELECTRICITY,
SERVICES, ETC.
REGULATORY STATUS IN INDIA
PERTAINING TO POWER INDUSTRY
• HEDGING IS ALLOWED FOR:
– PRODUCTS IMPORTS
– RODUCTS EXPORTS
• HEDGING NOT ALLOWED
FOR:
– DOMESTIC SALES OF PETRO
PRODUCTS
– UNCLEAR W.R.T.
ELECTRICITY FUTURES,
FORWARDS, OPTIONS, ETC.??
POWER PLANTS PERSPECTIVE
• HEDGING OF DOMESTIC PRODUCT,
ELECTRICITY FUTURES, ETC. IF/WHEN
ALLOWED:
– MAY NOT ENSURE LEAST COST FOR
CUSTOMER/POWER PLANT
BUT WILL
– ENSURE STABLE PRICES FOR PLANTS
– HAVE FAVOURABLE IMPACT ACROSS
ECONOMY/INDUSTRY DUE TO PRICE
STABILITY
– AVOID CASH CRUNCHES
THANK YOU